General

We continue to pursue a strategy of increasing market share in existing and surrounding geographic markets through internal growth and selective acquisition of local and regional companies. In addition, we will continue to expand into new geographic markets on a selective basis, either through acquisition or by opening new operating centers, when we believe it will enhance our business. Our focus remains primarily on oxygen and other respiratory therapy services, which represent approximately 92% of our revenues.

Critical Accounting Policies

The consolidated financial statements include the accounts of Lincare Holdings Inc. and its subsidiaries. We have made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these financial statements in conformity with generally accepted accounting principles.

Critical accounting policies are those we believe are both most important to the portrayal of our financial condition and operating results and require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Judgments and uncertainties affecting the application of those policies may result in materially different amounts being reported under different conditions or using different assumptions. We consider the following policies to be most critical in understanding the judgments that are involved in preparing our consolidated financial statements.

Revenue Recognition and Accounts Receivable

Our revenues are recognized on an accrual basis in the period in which services and related products are provided to customers and are recorded at net realizable amounts estimated to be paid by customers and third-party payors. Insurance benefits are assigned to the Company and, accordingly, the Company bills on behalf of its customers. The Company's billing system contains payor-specific price tables that reflect the fee schedule amounts in effect or contractually agreed upon by various government and commercial payors for each item of equipment or supply provided to a customer. The Company has established an allowance to account for sales adjustments that result from differences between the payment amount received and the expected realizable amount. Actual adjustments that result from differences between the payment amount received and the expected realizable amount are recorded against the allowance for sales adjustments and are typically identified and ultimately recorded at the point of cash application or when otherwise determined pursuant to the Company's collection procedures. We report revenues in our financial statements net of such adjustments.

Certain items provided by the Company are reimbursed under rental arrangements that generally provide for fixed monthly payments established by fee schedules for as long as the patient is using the equipment and medical necessity continues (subject to capped rental arrangements which limit the rental payment periods in some instances and which may result in a transfer of title to the patient at the end of the rental payment period). Once initial delivery of rental equipment is made to the patient, a monthly billing cycle is established based on the initial date of delivery. The Company recognizes rental arrangement revenues ratably over the monthly service period and defers revenue for the portion of the monthly bill that is unearned in accordance with SFAS No. 13, "Accounting for Leases." No separate payment is earned from the initial equipment delivery and setup process. During the rental period, we are responsible for servicing the equipment and providing routine maintenance, if necessary.

Our revenue recognition policy is consistent with the criteria set forth in Staff Accounting Bulletin 104- Revenue Recognition ("SAB 104") for determining when revenue is realized or realizable and earned. We recognize revenue in accordance with the requirements of SAB 104 that:

• persuasive evidence of an arrangement exists;

• delivery has occurred;

• collectibility is reasonably assured.

Due to the nature of the industry and the reimbursement environment in which we operate, certain estimates are required to record net revenues and accounts receivable at their net realizable values at the time products and/or services are provided. Inherent in these estimates is the risk that they will have to be revised or updated as additional information becomes available. Specifically, the complexity of many third-party billing arrangements and the uncertainty of reimbursement amounts for certain services from certain payors may result in adjustments to amounts originally recorded. Such adjustments are typically identified and recorded at the point of cash application, claim denial or account review.

Included in accounts receivable are earned but unbilled receivables. Unbilled accounts receivable represent charges for equipment and supplies delivered to customers for which invoices have not yet been generated by the billing system. Prior to the delivery of equipment and supplies to customers, we perform certain certification and approval procedures to ensure collection is reasonably assured and that unbilled accounts receivable are recorded at net amounts expected to be paid by customers and third-party payors. Billing delays, generally ranging from several days to several weeks, can occur due to delays in obtaining certain required payor-specific documentation from internal and external sources, interim transactions occurring between cycle billing dates established for each customer within the billing system and business acquisitions awaiting assignment of new provider enrollment identification numbers. In the event that a third-party payor does not accept the claim for payment, the customer is ultimately responsible.

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

Bad Debt Expense, Sales Adjustments and Related Allowances for Uncollectible Accounts Receivable

Accounts receivable are reported net of allowances for sales adjustments and uncollectible accounts. The majority of our accounts receivable are due from Medicare, Medicaid and private insurance carriers, as well as from customers under co-insurance provisions. Third-party reimbursement is a complicated process that involves submission of claims to multiple payors, each having its own claims requirements. In some cases, the ultimate collection of accounts receivable subsequent to the service dates may not be known for several months. Bad debt is recorded as an operating expense and consists of billed charges that are ultimately deemed uncollectible due to the customer's or third-party payor's inability or refusal to pay. We record bad debt expense based on a percentage of revenue using historical Company-specific data. The percentage and amounts used to record bad debt expense and the allowance for doubtful accounts are supported by various methods, including current and historical cash collections, bad debt write-offs, and aging of accounts receivable. Our proprietary management information systems are utilized to provide this data in order to assess bad debts. In the event that collection results of existing accounts receivable are not consistent with historical experience, there may be a need to increase our allowances for doubtful accounts, which may materially impact our financial position or results of operations. The Company has established an allowance to account for sales adjustments that result from differences between the payment amounts received from customers and third-party payors and the expected realizable amounts. Actual adjustments that result from such differences are recorded against the allowance for sales adjustments and are typically identified and ultimately recorded at the point of cash application or when otherwise determined pursuant to the Company's collection procedures. We report revenues in our financial statements net of such adjustments.

Business Acquisition Accounting

The Financial Accounting Standards Board's Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets," provide

guidance on the application of generally accepted accounting principles for business acquisitions. We apply the purchase method of accounting for business acquisitions, and use available cash from operations, borrowings under our revolving credit agreement and the assumption of certain liabilities as the consideration for business acquisitions. We allocate the purchase price of our business acquisitions based on the fair market value of identifiable tangible and intangible assets. The difference between the total cost of the acquisition and the sum of the fair values of acquired tangible and identifiable intangible assets less liabilities is recorded as goodwill.

Goodwill and Other Intangible Assets

We have recorded intangible assets, including goodwill and customer and contract relationships, in connection with business acquisitions. Estimated useful lives of amortizable intangible assets are determined by management based on an assessment of the period over which the asset is expected to contribute to future cash flows. The allocation of amortizable intangible assets impacts the amounts allocable to goodwill.

In accordance with Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets," we perform a goodwill impairment test using a two-step method on an annual basis or whenever events or circumstances indicate that the carrying value may not be recoverable. The recoverability of goodwill is measured at the reporting unit level.

The first step of the impairment analysis compares the Company's fair value to its net book value to determine if there is an indicator of impairment. If the assessment in the first step indicates impairment then the Company performs step two. The second step compares the implied fair value of goodwill to its carrying amount in a manner similar to a purchase price allocation for a business combination. If the carrying amount of goodwill exceeds its implied fair value, an impairment loss is recognized equal to that excess.

In determining fair value, SFAS No. 142 allows for the use of several valuation methodologies, although it states quoted market prices are the best evidence of fair value. The Company calculates its fair value using two different approaches. The first approach utilizes the closing market price of its common stock at the annual impairment testing date and the number of shares of common stock outstanding on that date.

The second approach utilizes a discounted cash flow projection which is based on assumptions that are consistent with the Company's best estimates of future growth and the strategic plan used to manage the underlying business. Factors requiring significant judgment include the future cash flows, growth rates, discount factors and tax rates, amongst other considerations. Changes in economic and operating conditions impacting these assumptions could result in goodwill impairment in future periods.

We completed the annual impairment test during the third quarter of 2008 and determined that no impairment existed as of the date of the impairment test. No recent events or circumstances have occurred to indicate that impairment may exist.

Long-Lived Assets

In accordance with Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," we review property, plant and equipment and amortizable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of property, plant and equipment is measured by comparing its carrying value to the undiscounted projected future cash flows that the asset(s) are expected to generate. If the carrying amount of an asset is not recoverable, we recognize an impairment loss based on the excess of the carrying amount of the long-lived asset over its respective fair value, which is generally determined as the present value of estimated future cash flows or at the appraised value. The impairment analysis is based on significant assumptions of future results made by management, including revenue and cash flow projections. Circumstances that may lead to impairment of property, plant and equipment include a significant decrease in the market price of a long-lived

asset, a significant adverse change in the extent or manner in which a long-lived asset is being used or in its physical condition and a significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset including an adverse action or assessment by a regulator. We performed a recoverability test during the fourth quarter of 2008 in consideration of certain regulatory changes affecting Medicare reimbursement in 2009 and beyond and determined the carrying value of our long-lived assets are recoverable from undiscounted projected future cash flows.

Contingencies

We are involved in certain claims and legal matters arising in the ordinary course of business. The Financial Accounting Standards Board's Statement of Financial Accounting Standards ("SFAS") No. 5, "Accounting for Contingencies," provides guidance on the application of generally accepted accounting principles related to contingencies. We evaluate and record liabilities for contingencies based on known claims and legal actions when it is probable a liability has been incurred and the liability can be reasonably estimated.

Results of Operations

Net Revenues

The following table sets forth for the periods indicated a summary of our net
revenues by product category:



                                                    Year Ended December 31,
                                               2008          2007          2006
                                                        (In thousands)
     Oxygen and other respiratory therapy   $ 1,526,737   $ 1,470,363   $ 1,295,983
     Home medical equipment and other           137,843       125,627       113,812

     Total                                  $ 1,664,580   $ 1,595,990   $ 1,409,795

Net revenues for the year ended December 31, 2008 increased by $68.6 million, an increase of 4.3% above net revenues for 2007. The 4.3% increase in net revenues in 2008 was comprised of 9.1% internal growth and 0.3% acquisition growth, partially offset by $80.9 million of Medicare price reductions taking effect in 2008 (see "Medicare Reimbursement"). Net revenues for the year ended December 31, 2007 increased by $186.2 million, an increase of 13.2% above net revenues for 2006. The 13.2% increase in net revenues in 2007 was comprised of 11.3% internal growth and 3.5% acquisition growth partially offset by $22.3 million of Medicare price reductions taking effect in 2007. The internal growth in net revenues is attributable to underlying growth in the market for our products and increased market share resulting primarily from our reputation for high quality equipment and customer service. Growth in net revenues from acquisitions is attributable to the effects of acquisitions of local and regional companies and is estimated based on the contribution to net revenues for the four quarters following such acquisitions. During 2008 and 2007, we completed the acquisition of three businesses with annual revenues of approximately $13.3 million and three businesses with annual revenues of approximately $4.3 million, respectively.

The contribution of oxygen and other respiratory therapy products to our net revenues was 91.7%, 92.1% and 91.9%, respectively, for the years ended December 31, 2008, 2007 and 2006. Our strategy is to focus on the provision of oxygen and other respiratory therapy services to patients in the home and to provide home medical equipment and other services where we believe such services will enhance our core respiratory business.

Cost of Goods and Services

Cost of goods and services as a percentage of net revenues was 24.1% for the year ended December 31, 2008, 24.4% for the year ended December 31, 2007 and 22.4% for the year ended December 31, 2006. Cost of goods and services increased by $10.9 million, or 2.8%, in 2008 and $73.8 million, or 23.3% in 2007. The increase in cost of

goods and services in 2008 is attributable primarily to higher oxygen costs related to an increase in the number of oxygen customers on service and higher costs of CPAP supplies and accessories due to growth in our sleep therapy product lines. We also experienced an increase in enteral nutrition and infusion therapy costs associated with higher customer volumes. The increase in cost of goods and services in 2007 is attributable primarily to an increase in drug purchasing costs due to a product mix shift away from compounded to higher cost commercially-available products in our inhalation drug business as a result of a determination by CMS to eliminate Medicare coverage of compounded medications as of July 1, 2007. Also contributing to higher cost of goods and services in 2007 were increased sales of medical supplies and nutritional products to pediatric customers associated with our acquisition of the business of a pediatric respiratory provider in the fourth quarter of 2006.

Cost of goods and services includes the cost of equipment (excluding depreciation of $83.1 million, $82.6 million and $68.6 million in 2008, 2007 and 2006, respectively), drugs and supplies sold to patients and certain operating costs related to the Company's respiratory drug product line. These costs include an allocation of customer service, distribution and administrative costs relating to the respiratory drug product line of approximately $47.5 million, $48.8 million and $49.2 million in 2008, 2007 and 2006, respectively. Included in cost of goods and services for the year ended December 31, 2008 are salary and related expenses of pharmacists and pharmacy technicians of $11.7 million. Such salary and related expenses for the years ended December 31, 2007 and 2006 were $10.5 million and $10.3 million, respectively.

Operating and Other Expenses

Operating expenses as a percentage of net revenues for the years ended December 31, 2008, 2007 and 2006 were 23.8%, 22.9% and 23.5%, respectively. Operating expenses in 2008 and 2007 increased by $30.7 million, or 8.4%, and $33.1 million, or 10.0%, respectively, when compared with the prior year periods. The increase in operating expenses in 2008 is attributable to higher payroll and related expenses from employee headcount increases, partially offset by gains in productivity, and significantly higher vehicle and related expenses caused primarily by higher fuel prices. The increase in operating expenses in 2007 resulted from higher payroll and related expenses, partially attributable to the acquisition of a business at the end of 2006, and an increase in rent and other facility expenses due to expansion in the number of operating centers.

The Company manages over 1,000 operating centers from which customers are provided equipment, supplies and services. An operating center averages approximately seven to eight employees and is typically comprised of a center manager, two customer service representatives (referred to as "CSR's"-telephone intake, scheduling, documentation), two or three service representatives (referred to as "Service Reps"-delivery, maintenance and retrieval of equipment and delivery of disposables), a respiratory therapist (non-reimbursable and discretionary clinical follow-up with the customer and communication to the prescribing physician) and a sales representative (marketing calls to local physicians and other referral sources).

The Company includes in operating expenses the costs incurred at the Company's operating centers for certain service personnel (center manager, CSR's and Service Reps), facilities (rent, utilities, communications, property taxes, etc.), vehicles (vehicle leases, gasoline, repair and maintenance), and general business supplies and miscellaneous expenses. Operating expenses for the years ended December 31, 2008, 2007 and 2006 within these major categories were as follows:

                                                 Year Ended December 31,
           Operating Expenses                 2008        2007        2006
                                                     ( in thousands)
           Salary and related               $ 250,970   $ 232,579   $ 208,994
           Facilities                          57,605      55,617      51,914
           Vehicles                            52,678      45,120      40,598
           General supplies/miscellaneous      34,453      31,700      30,391

           Total                            $ 395,706   $ 365,016   $ 331,897

Included in operating expenses during the year ended December 31, 2008 are salary and related expenses for Service Reps in the amount of $108.9 million. Such salary and related expenses for the years ended December 31, 2007 and 2006 were $100.0 million and $91.2 million, respectively.

Selling, general and administrative expenses ("SG&A") as a percentage of net revenues for the years ended December 31, 2008, 2007 and 2006, were 19.6%, 19.9%, and 20.7%, respectively. SG&A expenses in 2008 increased by $9.2 million, or 2.9%, compared with the prior year period. Contributing to the increase in SG&A expenses in 2008 were higher payroll costs included in selling and field administration and higher stock-based compensation expense, partially offset by cost controls at our corporate administration and billing office locations and lower advertising expenses. SG&A expenses in 2007 increased by $26.1 million, or 8.9%, compared with the prior year period. Contributing to the increase in SG&A expenses in 2007 were higher payroll costs included in selling expenses and higher liability insurance expenses, partially offset by cost controls at our administrative, field overhead and billing office locations and lower stock-based compensation expense.

SG&A expenses include costs related to sales and marketing activities, clinical respiratory services, corporate overhead and other business support functions. Included in SG&A during the year ended December 31, 2008 are salary and related expenses of $238.4 million. These salary and related expenses include the cost of the Company's respiratory therapists in the amount of $66.4 million during 2008. The Company's respiratory therapists generally provide non-reimbursable and discretionary clinical follow-up with the customer and communication, as appropriate, to the prescribing physician with respect to the customer's plan of care. The Company includes the salaries and related expenses of its respiratory therapist personnel (licensed respiratory therapists or, in some cases, registered nurses) in SG&A because it believes that these personnel enhance the Company's business relative to its competitors that do not employ respiratory therapists. Included in SG&A during the years ended December 31, 2007 and 2006 are salary and related expenses of $226.2 million and $207.9 million, respectively. These salary and related expenses include the cost of the Company's respiratory therapists in the amount of $63.0 million and $54.0 million during the respective years.

Bad debt expense as a percentage of net revenues was 1.5% for the years ended December 31, 2008, 2007 and 2006. Days sales outstanding ("DSO") were 38 days at December 31, 2008, compared with 43 days and 42 days at December 31, 2007 and 2006, respectively. While we have achieved consistent results in managing bad debt expense over the past three years, the general economic climate and business acquisition activities may contribute to an increase in our bad debt expense in the future. The collection of deductible balances and co-payment amounts due directly from customers may be negatively affected by weakening economic conditions in the U.S. The integration of acquired companies into our regional billing and collections offices may temporarily disrupt collections, increasing the amount of accounts receivable written off as uncollectible.

Depreciation and amortization expense as a percentage of net revenues was 7.1% for the year ended December 31, 2008 compared with 7.3% and 7.2% for the years ended December 31, 2007 and 2006, respectively. Included in depreciation and amortization expense in the year ended December 31, 2008 is depreciation of medical equipment of $83.1 million and depreciation of other property and equipment of $34.3 million. Included in depreciation and amortization expense in the years ended December 31, 2007 and 2006 is depreciation of medical equipment of $82.6 million and $68.6 million, respectively, and depreciation of other property and equipment of $33.4 million and $31.9 million, respectively.

During 2008, we amortized $0.1 million of intangible assets compared with $0.3 million in 2007 and $1.5 million in 2006. Our net intangible assets were $1.2 billion as of December 31, 2008. Of this total, $0.3 million (consisting of various covenants not-to-compete) is being amortized over periods of one to seven years, $2.0 million (consisting of customer contracts and relationships) is being amortized over a period of 11 years and the remainder represents goodwill.

Operating Income

As shown in the table below, operating income for the years ended December 31, 2008 and 2007 increased $15.5 million and $36.1 million, respectively, when compared to the prior year periods. The increases in operating income in 2008 and 2007 are attributable primarily to revenue growth from increases in customer volumes partially offset by Medicare price reductions impacting the respective periods and by higher costs and expenses as noted above.

                                                Year Ended December 31,
                                           2008          2007          2006
                                                    (In thousands)
            Operating income             $ 398,680     $ 383,148     $ 347,059
            Percentage of net revenues        24.0 %        24.0 %        24.6 %

Other Income (Expense)

Interest expense for the year ended December 31, 2008 was $23.9 million, compared to $26.5 million and $9.9 million for the years ended December 31, 2007 and 2006, respectively. Interest expense in 2008 was lower than interest expense in 2007 due to the redemption of our $275.0 million of 3.0% convertible debentures in June 2008. Interest expense in 2007 was higher than interest . . .