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SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 Form 10-K (Mark One)þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 for the fiscal year
ended December 31, 2004 oro
    
    TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
for the transition period from  to
 Commission File No. 0-20619 (MATRIA HEALTHCARE LOGO) MATRIA HEALTHCARE, INC.  Delaware
(State or other jurisdiction of
incorporation or organization)
    
    20-2091331
(IRS Employer Identification No.)1850 Parkway Place
Marietta, Georgia
(Address of principal executive offices)
    
    30067
(Zip Code)
 Registrants telephone number, including area code (770) 767-4500 Securities registered pursuant to Section 12(b) of the Act: Title of each class
    
    Name of each exchange on which registeredNone
    
    None
 Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $0.01 per share, together with associated Common Stock Purchase Rights
(Title of class) 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 þ No o Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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. o Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes þ No o As of June 30, 2004, the last business day of the registrants most recently completed second
fiscal quarter, there were 15,478,294 shares of common stock outstanding. The aggregate market
value of common stock held by nonaffiliates was approximately $243,985,315 based upon the closing
sale price on June 30, 2004. As of March 1, 2005, there were 15,954,473 shares of common stock
outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrants definitive Proxy Statement for
the 2005 Annual Meeting of Shareholders are incorporated by
reference into Part III.   1




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MATRIA HEALTHCARE, INC.
2004 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS PART IItem 1.
    
    Business
    
    
    3Item 2.
    
    Properties
    
    
    16Item 3.
    
    Legal Proceedings
    
    
    17Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    17Special Item
    
    Executive Officers of the Company
    
    
    18PART IIItem 5.
    
    Market for
Registrants Common Equity, Related Stockholder Matters and Purchases of Equity Securities
    
    
    20Item 6.
    
    Selected Financial Data
    
    
    22Item 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    23Item 7A.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    40Item 8.
    
    Financial Statements and Supplementary Data
    
    
    41Item 9.
    
    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    41Item 9A.
    
    Controls and Procedures
    
    
    41Item 9B.
    
    Other Information
    
    
    42PART IIIItem 10.
    
    Directors and
Executive Officers of the Registrant
    
    
    43Item 11.
    
    Executive Compensation
    
    
    43Item 12.
    
    Security Ownership of Certain Beneficial Owners and Management
    
    
    43Item 13.
    
    Certain Relationships and Related Transactions
    
    
    43Item 14.
    
    Principal Accountant Fees and Services
    
    
    43PART IVItem 15.
    
    Exhibits and Financial Statement Schedules
    
    
    44SIGNATURES
    
    
    
    
    51EX-11 Computation of Earnings (Loss) per ShareEX-21 List of SubsidiariesEX-23 Consent of Independent Registered Pulic Accounting FirmEX-31.1 302 Certification of CEOEX-31.2 302 Certification of CFOEX-32.1 906 Certification of CEOEX-32.2 906 Certification of CFO
 2




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PART I 
 Item 1. Business General.Matria Healthcare, Inc. (Matria or the Company) provides comprehensive,
integrated disease management services and related products that offer cost-saving solutions for
many of the most costly medical conditions and chronic diseases, including diabetes, cardiovascular
diseases, respiratory disorders, obstetrical conditions, cancer, obesity, depression, chronic pain
and hepatitis C. We seek to improve patient outcomes and lower healthcare costs through a broad
range of disease management programs and direct clinical services. We emphasize a
multidisciplinary approach to care that involves our clinicians working with physicians to oversee
the adherence to treatment plans. We focus on the management of patients between visits to their
physician, the improvement of the patients compliance with the physicians care plan and the
avoidance of controllable and costly events, such as emergency room visits and hospital admissions.
To serve this critical aspect of patient care, we have invested heavily in disease management
information technology, care center infrastructure and a national network of skilled
multidisciplinary clinicians. We provide services to self-insured employers, private and government sponsored health plans,
pharmaceutical companies and patients. Our employer clients are primarily Fortune 1000 companies
that self-insure the medical benefits provided to their employees, dependents and retirees. Our
health plan customers are regional and national health plans, as well as government-sponsored
health plans, such as state Medicaid programs. Our business strategy is described under Managements Discussion & Analysis of Financial
Condition and Results of Operations in Item 7 of this Report. Holding
Company Reorganization. On December 31, 2004, our predecessor, Matria Healthcare, Inc. (the Predecessor
Registrant) adopted a holding company form of organizational structure. In order to implement the
reorganization, the Predecessor Registrant incorporated a new holding company as a wholly owned
subsidiary of the Predecessor Registrant and merged with an indirect, wholly owned subsidiary of
the new holding company. Pursuant to Section 251(g) of the Delaware General Corporation Law, the
merger was effected without a vote of the Predecessor Registrants stockholders. In connection
with the merger, all of the issued common stock of the Predecessor Registrant was converted into a
like number of shares of our common stock. Our capital structure is the same as that of the
Predecessor Registrant prior to the merger. We were incorporated under the laws of the state of Delaware on December 28, 2004 in
connection with the Predecessor Registrants adoption of the holding company structure. The
Predecessor Registrant was incorporated under the laws of the state
of Delaware on March 8, 1996 in connection with the merger of
Tokos Medical Corporation and Healthdyne Maternity Management.
Our headquarters are located at 1850 Parkway Place, Marietta, GA 30067, and our telephone number is
(770) 767-4500. Our website address is www.matria.com. Business Segments and Geographic Areas.In 2004, our operations consisted of two reportable
business segments: Health Enhancement and Womens and Childrens Health. Information regarding
revenues, operating earnings, and identifiable assets (including intangibles) for each of the
business segments in which we operated in fiscal years 2002 through 2004, as well as information
regarding our revenues attributable to the geographic areas in which we operated during those
years, is in Note 11 of Notes to Consolidated Financial Statements on pages F-25 through F-26 of
this Report. Health Enhancement.At December 31, 2004, our Health Enhancement segment was comprised of our
disease management business, our foreign diabetes business and Facet Technologies, LLC (Facet),
our diabetes product design, development, assembly and distribution operation. 3




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The disease management component of our Health Enhancement segment currently offers disease
management services to employers and health plans for diabetes, cardiovascular disease, respiratory
disorders, cancer, obesity, depression, and chronic pain. We began our disease management business
in 1998, focusing solely on respiratory disease management. In 1999, we added diabetes disease
management through an acquisition in which we acquired our former pharmacy and supplies business,
as well as Facet. In 2002, we developed programs for cardiac, depression and chronic pain disease
management and expanded into cancer disease management with the acquisition of Quality Oncology,
Inc. In 2003, we launched an initiative to offer disease management services through
pharmaceutical corporations in support of complex drug therapies and began to offer disease
management services for hepatitis C. In 2004, we added obesity to our disease management programs. Our disease management programs seek to reduce medical costs and improve patient care for the
chronically ill as well as those who are at the highest risk for significant and costly episodes of
illness. We use our proprietary technology platform, which we refer to as TRAXTM, to
identify patients with the potential for high-cost events and to proactively manage the care of the
patients identified. We help these individuals take more responsibility for their disease and avoid
expensive medical events. Cost savings generally are realized through a reduction in emergency
room visits and admissions to the hospital and shorter hospital stays. Our programs, which were
developed in accordance with national clinical standards, are designed to increase patient
compliance with the physicians plan of care. Our disease management process includes the
following steps:  
    Medical claims, laboratory and prescription data from multiple providers are
analyzed to identify and preliminarily stratify individuals at risk for chronic
diseases and high cost conditions.
    Health specialists contact participants by phone to conduct a multi-condition risk
assessment. The responses build a detailed medical profile in our TRAXTM
information system.
    Predictive modeling determines the probability that a given individual has a chronic
condition or is at risk of a significant health event that will result in substantial
healthcare costs in the near and longer-term future.
    TRAXTM develops a risk-specific plan of care based on national clinical
standards that includes ongoing support, regular interventions and patient education.
    Our clinicians make proactive contact depending on the patients stratification
level and take calls from patients to counsel and educate them, as necessary. Care
plans are provided to the patient and their physician as clinical counseling begins.
    Compliance management is enhanced through the monitoring of the patients
utilization of medication and supplies and the frequency of periodic laboratory
testing.
    Clinical and financial outcomes are reported to the customer on a routine basis. Our disease management programs are built on a sophisticated and advanced technology platform
and infrastructure, TRAXTM. Often, the most expensive patients in terms of past claims
history are not necessarily those who will cost the most in the future. TRAXs predictive modeling
capabilities allow us to identify the potential of high-cost events and help us proactively manage
the care of these identified participants. Effective October 1, 2003, we purchased certain assets of Options Unlimited Comprehensive
Rehabilitative Services, Inc., now Matria Case Management, a company specializing in case
management for health plans, third-party administrators and employers. We have integrated this
companys case management services with our existing disease management services and are offering
these services to employers and health plans. 4




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The disease management programs serve patients in the United States through our facilities in
Atlanta, Georgia, McLean, Virginia, Sunrise, Florida, El Sequndo, California, Houston, Texas, and
Huntington, New York. Our foreign diabetes division provides diabetes products and supplies and certain value-added
services directly to patients in Germany through its main facilities in Neumünster and Dresden,
Germany and depots maintained in physician offices and clinics. Most revenues are received directly
from the German national healthcare system. Our Health Enhancement segment also includes Facet, a leading designer, developer, assembler
and distributor of products for the diabetes market, which we acquired in 1999. Facet has 30% to
50% of the world market share in each of the three major product lines used by patients with
diabetes to obtain blood samples for testing blood glucose levels: standard lancets, lancing
devices and safety lancets. Facet operates from facilities in Marietta, Georgia, McDonough,
Georgia, and Northhampton, England. Its products are shipped primarily to North and South America,
Europe and Asia. On June 30, 2004, the Company completed the sale of substantially all of the assets, excluding
trade and certain other receivables, of our domestic direct to consumer pharmacy and supplies
business to DEGC Enterprises (U.S.), Inc. The Company operated the divested business through our
wholly-owned subsidiaries, Diabetes Management Solutions, Inc. and Diabetes Self Care, Inc. As
part of the transaction, the Company and DEGC Enterprises entered into a strategic relationship
whereby DEGC Enterprises will provide diabetes and respiratory supplies to our disease management
customers. As part of the sale, DEGC had the option to buy Matria Labs, Inc., a direct-to-consumer
laboratory business, for $1. The purchase option expired, unexercised, in November 2004. The
Company had previously made the decision to exit the lab business in the event DEGC did not
exercise the purchase option. As a result of the sale of the domestic pharmacy and supplies
business and the discontinuance of the lab business, the accompanying consolidated financial
statements reflect the operations of these divisions as discontinued operations for all periods
presented. Approximately 41%, 41% and 44% of the Health Enhancement segments revenues were derived from
customers outside of the United States in 2004, 2003 and 2002, respectively. Approximately 33%,
35% and 37% of the segments revenues in 2004, 2003 and 2002, respectively, were from customers in
Germany. Womens and Childrens Health.Our Womens and Childrens Health segment offers a wide range
of clinical and disease management services designed to assist physicians and payors in the
cost-effective management of maternity patients. The segment manages patients with gestational
diabetes, hypertension, hyperemesis, and anticoagulation disorders, as well as patients
experiencing or at risk for preterm labor. In addition, this segment recently launched a strategic
initiative to provide services for children through neonatal intensive care case management. In
connection with this initiative, in 2004, we changed the name of our Womens Health segment to
Womens and Childrens Health. Our Womens and Childrens Health segment is headquartered in
Marietta, Georgia and has 39 sites of service throughout the United States, seven of which are
monitoring centers. All 39 sites are fully accredited as home care organizations by the Joint
Commission on Accreditation of Health Care Organizations. In addition, the segment has two
after-hours centers. Most revenues are received directly from the patients health plan. Customers, Suppliers and Third-Party Payors.In 2004, revenues from continuing operations
were derived from the following types of customers and third-party payors: 48% from direct payors
(including corporations and health plans), 25% from third-party private payors, 22% from foreign
healthcare systems and 5% from domestic government payors. We market our disease management services to self-insured employers, health plans (both
commercial and governmental) and pharmaceutical companies. We market our clinical services to
self-insured employers, health plans (both commercial and governmental) and physicians. Both
business units market their services 5




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primarily through our employee sales force. Our foreign diabetes division also markets it
products through an employee sales force, primarily to physicians who, in turn, make the products
available for sale to patients. Our clinical services and foreign diabetes businesses are reimbursed on a fee-for-service or
per item basis. Our disease management services, however, are paid for primarily on the basis of
(i) monthly fees for each employee or member enrolled in a health plan, (ii) each member identified
with a particular chronic disease or condition under contract, (iii) each member enrolled in our
program or (iv) a fixed rate per case. In some cases, a portion
of our disease management fees are at risk based on our
performance. Similarly, in some cases, we are entitled to bonuses for
exceeding our performance goals. Facet markets its products to large medical device manufacturers and distributors through its
employee sales force. Its customers include original equipment manufacturers and distributors of
blood glucose and other point-of-care test kits. Five major original equipment manufacturer
customers represented approximately 92% of Facets total sales in 2004. Risk Factors.Our business is subject to certain risks, including the risks described under
the headings Seasonality, Trademarks, Licenses and Patents, Competition and Regulation and
Healthcare Industry Changes in this Item 1, Item 3 Litigation and those described below.
Readers of this Annual Report on Form 10-K should take such risks into account in evaluating any
investment decision involving our common stock. This Item 1 does not describe all risks applicable
to our business and is intended only as a summary of certain material factors that affect our
operations in the industries in which we operate. More detailed information concerning these and
other risks is contained in other sections of this Annual Report on Form 10-K. The disease management business is an evolving component of the overall healthcare industry. Disease management services are a relatively new component of the overall healthcare industry.
Accordingly, some of our potential customers have not had significant experience in purchasing,
evaluating or monitoring such services, which can result in a lengthy sales cycle. The success of
our business plan relative to our disease management operations depends on a number of factors.
These factors include:  
    Our ability to differentiate our products and service offerings from those of our
competitors;
    The extent and timing of the acceptance of our services as a replacement for, or
supplement to, traditional managed care offerings;
    Our ability to implement new and additional services beneficial to health plans and
employers;
    Our ability to effect cost savings for health plans and employers through the use of
our programs; and
    Our ability to improve patient compliance with the complex drug therapies offered by
our pharmaceutical customers. Since the disease management business is continually evolving, we may not be able to
anticipate and adapt to the developing market. Moreover, we cannot predict with certainty the
future growth rate or the ultimate size of the disease management market. We are highly dependent on payments from third-party healthcare payors, which may implement cost
reduction measures that adversely affect our business and operations. Third-party private and governmental payors exercise significant control over patient access
and use their enhanced bargaining power to secure discounted rates and other concessions from
providers. Changes in reimbursement rates, policies or payment practices by third-party and
governmental payors (whether initiated by the payor or legislatively mandated) could have an
adverse impact on our business. Government regulations may adversely affect our business. We are subject to extensive and frequently changing federal, state, local and foreign
regulation. Changes in laws or regulations or new interpretations of existing laws or regulations
can have a dramatic effect on operating methods, costs and reimbursement amounts provided by
government and third-party payors. There 6




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can be no assurance that we are or have been in compliance
with all applicable existing laws and regulations or that we will be able to comply with new laws
or regulations. Changes in applicable laws or any failure to comply with existing or future laws,
regulations or standards could have a material adverse effect on our results of operations,
financial condition, business and prospects . Many of our disease management fees are contingent upon performance. Many of our existing disease management agreements contain savings or other guarantees, which
typically provide that we will repay all or some of our fees if the payors cost savings as a
result of our disease management programs do not meet expectations or if other quality performance
measures are not met. Some contracts also provide that we will receive bonus compensation by
meeting certain performance criteria. There is no guarantee that we will accurately forecast cost
savings and clinical outcome improvements under our disease management agreements or meet the
performance criteria necessary to receive the designated bonus compensation or to avoid repayment
of fees under the agreements. Facet is substantially dependent on a few customers. Facets revenues are substantially dependent on sales to five customers. In 2004, these five
customers represented approximately 92% of Facets revenues, which in turn represented
approximately 26% of our total revenues. We have multiple contracts covering various products with
these customers that have expirations ranging from October 2005 to March 2009. Certain contracts
may be terminated prior to expiration without cause and there is no guarantee that these contracts
will be renewed on favorable terms, if at all, or that these customers will continue to purchase
products and services at prior levels. If we do not generate as much revenue from our major
customers as we expect, or if we lose certain of them as customers, our total revenue could be
significantly reduced. Facet and our Womens and Childrens Health segment are both highly dependent on supplies from
limited sources. Facets business is highly dependent on its exclusive supply relationship with Nipro
Corporation, from which it purchases virtually all of the components for its products on terms we
view as favorable. Under the agreement, some terms, such as pricing, are negotiated annually while
others, such as the exclusivity arrangement, are renewable after longer periods. The exclusivity
provisions of our agreement with Nipro will expire in December 2005. Although Nipro has been a
supplier to Facets business for more than 15 years, there can be no assurance that we will be able
to negotiate a renewal of the exclusivity arrangement on favorable terms, if at all. In addition,
there are an extremely limited number of suppliers of terbutaline sulfate, a prescription drug used
in large supply by our Womens and Childrens Health segment, and price increases in this drug
during the second and third quarter of 2002 adversely affected the segments cost of revenues. In
September 2002, we entered into a three-year arrangement for the supply of this drug which has
reduced its cost to us. We purchase substantially all of our requirements for this drug under this
arrangement. We currently are negotiating an extension of this agreement through 2005 on favorable
pricing terms. Termination of any of these supply arrangements or failure to continue any of them
on favorable terms could have a material adverse effect on the business of Facet or the Womens and
Childrens Health segment, as applicable, as would any interruption in the supply or significant
increase in the price of these products, whatever the cause. Our operating results have fluctuated in the past and could fluctuate in the future. Our operating results have varied in the past and may fluctuate significantly in the future
due to a variety of factors, many of which are outside of our control. These factors include: 
    impact of substantial divestitures and acquisitions;
    loss or addition of customers and referral sources;
    investments required to support growth and expansion;
    changes in the mix of our products and customers;
    changes in healthcare reimbursement policies and amounts; 7




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
    length of sales cycle and implementation process for new disease management customers;
    increases in costs of revenues and operating expenses;
    increases in selling, general and administrative expenses;
    increased or more effective competition; and
    regulatory changes. In addition, revenues from our Womens and Childrens Health segment are historically less
during the first and fourth calendar quarters than during the second and third calendar quarters.
The seasonal variability of demand for these services significantly affects, and we believe will
continue to affect, our quarterly operating results. Our profit margin may be adversely affected by the product mix and pricing pressure in the Womens
and Childrens Health segment. Although our Womens and Childrens Health segment is a leading provider in its market, its
revenues have been reduced and its cost of revenues as a percentage of revenues has increased over
the past several years. These trends, which have reduced our profit margins, are largely a
function of price pressure and physician prescription patterns towards the use of higher cost,
lower margin therapies. If these trends continue, the profit margins for this business will
continue to decline. Facet operates in an industry that is becoming increasingly dominated by price competition. In all of our product and service lines, we face strong competition from companies, both large
and small, located in the United States and abroad, on factors including quality of care and
service, reputation within the medical community, scope of products and services, geographical
scope and price. Facet operates in an industry where price competition is becoming increasingly
dominant over other factors, which has created downward pressure on pricing on this portion of our
business. If this trend toward price dominated competition continues, the resulting downward
pricing pressure may have a material adverse effect on Facets business. If our costs of providing products or services increase, we may not be able to pass these cost
increases on to our customers. In many of our markets, due to competitive pressures or the fact that reimbursement rates are
set by law, we have very little control over the price at which we sell our products and services.
If our costs increase, we may not be able to increase our prices, which would adversely affect
results of operations. Accordingly, any increase in the cost of such products and services could
reduce our overall profit margin. Future acquisitions may cause integration problems, disrupt our business and strain our resources. In the past we have made several significant business acquisitions, and may continue with such
acquisitions in the future. Our success will depend, to a certain extent, on the future
performance of these acquired business entities. These acquisitions, either individually or as a
whole, could divert management attention from other business concerns and expose us to unforeseen
liabilities or risks associated with entering new markets and integrating those new entities.
Further, the integration of these entities may cause us to lose key employees or key customers.
Integrating newly acquired organizations and technologies could be expensive and time consuming and
may strain our resources. Consequently, we may not be successful in integrating these acquired
businesses or technologies and may not achieve anticipated revenue and cost benefits. We may face costly litigation that could force us to pay damages and harm our reputation. Like other participants in the healthcare market, we are subject to lawsuits alleging
negligence, product liability or other similar legal theories, many of which involve large claims
and significant defense costs. Any of these claims, whether with or without merit, could result in
costly litigation, and divert the time, attention, 8




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and resources of our management. Although we
currently maintain liability insurance intended to cover such claims, there can be no assurance
that the coverage limits of such insurance policies will be adequate or that all such claims will
be covered by the insurance. In addition, these insurance policies must be renewed annually.
Although we have been able to obtain liability insurance, such insurance may not be available in
the future on acceptable terms, if at all. A successful claim in excess of the insurance coverage
could have a material adverse effect on our results of operations or financial condition. The outcome of the pendingqui tamclaim filed against us could result in the imposition of
material liabilities or penalties and could result in our exclusion from participation in federal
healthcare programs. The Federal False Claims Act allows actions to be brought on the governments behalf by
individuals under the Federal False Claims Acts qui tamprovision. A qui tamclaim has been filed
against the Company and our former subsidiary, Diabetes Self-Care,
Inc., alleging improper claims for
Medicare payments in the pharmacy, laboratory and supplies division of our Health Enhancement
segment. Although, we recently sold that business, the purchaser did not assume liability for the
qui tamclaim. As is required by law, the federal government is conducting an investigation into
the complaint to determine if it will intervene or join in this suit.
We are cooperating fully with the investigation. The matter is
still in its preliminary stages, and we are unable to predict the ultimate disposition of the
action or the investigation. An unfavorable outcome in the action could subject us to repayment
obligations, loss of reimbursement, exclusion from participation in Medicare and Medicaid,
substantial fines or penalties and other sanctions, which could have a material adverse effect on
our business, financial position and results of operations. Defending a qui tamclaim, even when
there is little or no merit to the allegation, can be expensive and time consuming. If we do not manage our growth successfully, our growth and profitability may slow, decline or
stop. If we do not manage our growth successfully, our growth and profitability may slow or stop.
We have expanded our operations rapidly and plan to continue to expand. This expansion has created
significant demands on our administrative, operational and financial personnel and other resources.
Additional expansion
in existing or new markets could strain our resources and increase our need for capital. Our
personnel, systems, procedures, controls and existing space may not be adequate to support further
expansion. In addition, because our business strategy emphasizes growth, the failure to achieve
our stated growth objectives or the growth expectations of investors could cause our stock price to
decline. Our data management and information technology systems are critical to maintaining and growing our
business. Our disease management services are dependent on the effective use of information technology.
We use our proprietary TRAX and Integrated Care Management systems in the provision of our disease
management services. Although we believe that our systems provide us with a competitive advantage,
we are exposed to technology failure or obsolescence. In addition, data acquisition, data quality
control and data analysis, which are a cornerstone of our disease management programs, are intense
and complex processes subject to error. Untimely, incomplete or inaccurate data, flawed analysis
of such data or our inability to properly identify, implement and update systems could have a
material adverse impact on our business and results of operations. The development of improved technologies for glucose monitoring that eliminate the need for
consumable testing supplies could adversely affect our business. All of Facets revenues are from the sale of consumable testing supplies used to draw and test
small quantities of blood for the purpose of measuring and monitoring blood glucose levels.
Numerous research and development efforts are underway to develop more convenient and less
intrusive glucose measurement 9




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techniques. The commercialization and widespread acceptance of new
technologies that eliminate or reduce the need for consumable testing supplies could negatively
affect Facets business. Our foreign operations are subject to additional risks. Although the majority of our operations are in the United States, the Health Enhancement
segment derives substantial revenue from outside of the United States. The risks of doing business
in foreign countries include potential adverse changes in the stability of foreign governments and
their diplomatic relations, hostility from local populations, adverse effects of currency
fluctuations and exchange controls, deterioration of foreign economic conditions and changes in tax
laws. Due to the foregoing risks, any of which, if realized, could have a material adverse effect
on us, we believe that our business activities outside of the United States involve a higher degree
of risk than our domestic activities. Our diabetes supply business in Germany distributes its products to customers primarily from
physician offices, and substantially all of its revenues are received from the German national
healthcare system. Doctors participating in this method of distribution, both for us and other
providers, have been the subject of lawsuits brought by pharmacies alleging that this practice
constitutes a violation by such doctors of German law. There is a split of authority among German
courts on this issue. Although we have not been a party to any of these lawsuits or claims, such
lawsuits could indirectly affect our operations, and unfavorable resolution of this issue could
require us to seek alternative channels of distribution and could have a material adverse effect on
our German operations. We have recorded a significant amount of intangible assets, the value of which could become
impaired. Our acquisitions have resulted in the recognition of intangible assets, primarily goodwill.
Goodwill, which represents the excess of cost over the fair value of net assets of businesses
acquired, and other intangible assets was approximately $135.3 million, net of amortization, at
December 31, 2004, representing approximately 44% of our total assets. On an ongoing basis, we
will make an evaluation to determine whether events and circumstances indicate that all or a
portion of the carrying value of intangible assets may no longer be recoverable, in which case an
additional charge to earnings may be necessary. Any future determinations
requiring an asset impairment of a significant portion of intangible assets could materially affect
our results of operations for the period in which the adjustment occurs. Our inventory management is complex, and excess inventory may harm our results of operations. Our management makes estimates regarding our inventory requirements based on assumptions about
future demand. Furthermore, a substantial portion of products supplied by Facet are tailored to
the specifications of particular customers. If future demand changes or actual market conditions
are less favorable than as projected by management, we may become subject to inventory obsolescence
and may have to sell excess inventory at reduced prices, or, in the case of products tailored to
specific customers, excess inventory may not be marketable at all. Any excess inventory held by us
may, therefore, adversely affect our results of operations. The competition for staff may cause us to restrict growth in certain areas or to realize increased
labor costs in existing areas. Our operations are dependent on the services provided by qualified management and staff,
including nurses and other healthcare professionals, for which we compete with other health care
providers. In addition, our opportunities for growth are limited by our ability to attract and
retain such personnel. In certain markets, there is a shortage of nurses and other medical
providers, thereby increasing competition and requiring us to improve working conditions, including
wages and benefits, for such personnel. Our potential inability to maintain and grow an
appropriate workforce may inhibit our expansion and even have a material adverse effect on our
financial results. 10




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Impairment of our intellectual property rights could negatively affect our business or allow
competitors to minimize any advantage that our proprietary technology may give us. We own a number of trademarks and service marks which, in the aggregate, are important to the
marketing and promotion of our products and services. Patents owned by Facet or its suppliers are
material to the continued marketing of those products. Also, we consider our disease management
programs to be proprietary and material to the portion of our business to which they relate. In
addition, our future success depends in part upon our proprietary technology and product
development, and our ability to obtain patent and other intellectual property rights with respect
to such technology and development. We hold patents or have an exclusive, perpetual right to use the only uterine activity
monitors that have received pre-market approval from the Food and Drug Administration (FDA) for
home use on patients with a history of previous preterm birth. Our rights to the monitors had been
a material competitive advantage in marketing our uterine activity monitoring services. In 2001,
the FDA reclassified the monitors from Class III into Class II devices, which makes substantially
equivalent devices available to our competitors, without their having to receive pre-market
approval. As part of the reclassification, the FDA may impose special controls on the use of such
devices. Although these developments have not had a negative impact on our home uterine activity
monitoring business, we cannot predict what future impact these changes may have. Patent positions are uncertain and involve complex legal, scientific and factual questions.
Our patent positions might not protect us against competitors with similar products or technologies
because competing products or technologies may not infringe our patents. For certain of our
products in development, there may be third parties who have patents or pending patents that they
may claim effectively prevent us from commercializing these products in certain territories. If our
patent or other intellectual property rights or positions are infringed, challenged, invalidated,
prevented or otherwise impaired, or we fail to prevail in any future intellectual property
litigation, our business could be adversely affected. Effective trademark and other intellectual property protection may not be available in every
country in which our products are made available. This could have a material adverse effect on our
business, results of
operations and financial condition. To date, we have not been notified that our products
infringe the proprietary rights of third parties, but we cannot assure you that third parties will
not claim infringement by us with respect to past, current and future products. We expect that
participants in our markets increasingly will be subject to infringement claims as the number of
competitors in our industry segment grows. Any such claim, whether or not it has merit, could be
time-consuming, result in costly litigation, cause product delays or require us to enter into
royalty or licensing agreements. As a result, any such claim could have a material adverse effect
on our business, results of operations and financial condition. Our actual financial results might vary from our publicly disclosed forecasts. Our actual financial results might vary from those anticipated by us, and these variations
could be material. Our forecasts reflect numerous assumptions concerning our expected performance,
as well as other factors, which are beyond our control, and which might not turn out to have been
correct. Although we believe that the assumptions underlying the projections are reasonable, actual
results could be materially different. Our financial results are subject to numerous risks and
uncertainties, including those identified throughout these Risk Factors and elsewhere in this
prospectus and the documents incorporated by reference. Forward-Looking Statements.This Annual Report on Form 10-K, including the information
incorporated by reference herein, contains various forward-looking statements and information that
are based on our beliefs and assumptions, as well as information currently available to us. From
time to time, the Company and its officers, directors or employees may make other oral or written
statements (including statements in press releases or other announcements) that contain
forward-looking statements and information. Without limiting the generality of the foregoing, the
words believe, anticipate, estimate, expect, 11




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intend, plan, seek and similar
expressions, when used in this Form 10-K and in such other statements, are intended to identify
forward-looking statements, although some statements may use other phrasing. All statements that
express expectations and projections with respect to future matters, including, without limitation,
statements relating to growth, new lines of business and general optimism about future operating
results, are forward-looking statements. All forward-looking statements and information in this
Annual Report are forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934 (the Exchange
Act), as amended, and are intended to be covered by the safe harbors created thereby. Such
forward-looking statements are not guarantees of future performance and are subject to risks,
uncertainties and other factors that may cause the actual results, performance or achievements of
the Company to differ materially from historical results or from any results expressed or implied
by such forward-looking statements. Such factors include, without limitation: (i) changes in
reimbursement rates, policies or payment practices by third-party payors, whether initiated by the
payor or legislatively mandated, or uncollectible accounts in excess of current estimates; (ii) the
loss of major payors or customers; (iii) termination of Facets exclusive supply agreement with
Nipro Corporation or failure to continue the agreement on the terms currently in effect; (iv)
impairment of the Companys rights in intellectual property; (v) increased or more effective
competition; (vi) new technologies that render obsolete or non-competitive products and services
offered by the Company; (vii) changes in or new interpretations of laws or regulations applicable
to the Company, its customers or referral sources or failure to comply with existing laws and
regulations; (viii) increased exposure to professional negligence liability; (ix) difficulties in
successfully integrating recently acquired businesses into the Companys operations and
uncertainties related to the future performance of such businesses; (x) losses due to foreign
currency exchange rate fluctuations or deterioration of economic conditions in foreign markets;
(xi) changes in company-wide or business unit strategies and changes in patient therapy mix; (xii)
the effectiveness of the Companys advertising, marketing and promotional programs; (xiii) market
acceptance of the Companys disease management products and the Companys ability to sign and
implement new disease management contracts; (xiv) inability to successfully manage the Companys
growth; (xv) acquisitions that strain the Companys financial and operational resources; (xvi)
inability to forecast accurately or effect cost savings and clinical outcomes improvements or
penalties for non-performance under the Companys disease management contracts or to reach
agreement with the Companys disease management customers with respect to the same; (xvii)
inability of the Companys disease management customers to provide timely and accurate data that is
essential to the operation and measurement of the
Companys performance under its disease management contracts; (xviii) increases in interest
rates (xix) financial penalties for failure to achieve expected cost savings or clinical outcomes
in the Companys disease management business; (xx) changes in the number of covered lives enrolled
in the health plans with which the Company has agreements for payment; (xxi) the availability of
adequate financing and cash flows to fund the Companys capital and other anticipated expenditures;
(xxii) higher than anticipated costs of doing business that cannot be passed on to customers;
(xxiii) pricing pressures; (xxiv) interruption in the supply or increase in the price of drugs used
in the Companys Womens and Childrens Health business; (xxv) information technology failures or
obsolescence or the inability to effectively integrate new technologies; (xxvi) inventory
obsolescence; (xxvii) the outcome of legal proceedings or investigations involving the Company, and
the adequacy of insurance coverage in the event of an adverse judgment; (xxviii) competition for
staff, and (xxix) the risk factors discussed from time to time in the Companys Securities and
Exchange Commission (SECor the Commission) reports, including but not limited to, this Annual
Report on Form 10-K for the year ended December 31, 2004. Many of such factors are beyond the
Companys ability to control or predict, and readers are cautioned not to put undue reliance on
such forward-looking statements. The Company disclaims any obligation to update or review any
forward-looking statements contained in this Annual Report or in any statement referencing the risk
factors and other cautionary statements set forth in this Annual Report, whether as a result of new
information, future events or otherwise, except as may be required by the Companys disclosure
obligations in filings it makes with the SEC under federal securities laws. Seasonality.Revenues of our Womens and Childrens Health segment tend to be seasonal.
Revenues typically begin to decrease with the onset of the holiday season starting with
Thanksgiving, causing the fourth quarter and first quarter revenues of each year to be less than
those of the second and third quarters. Our other businesses currently do not reflect any
significant degree of seasonality. 12




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Trademarks, Licenses and Patents.We own a number of trademarks and service marks which, in
the aggregate, are important to the marketing and promotion of our products and services. Patents
owned by Facet or its suppliers are material to the continued marketing of many of Facets
products. Also, we consider our disease management programs to be proprietary and material to the
portion of our business to which they relate. In addition, our future success depends in part upon
our proprietary technology and product development, and our ability to obtain patent and other
intellectual property rights with respect to such technology and development. We hold patents or have an exclusive, perpetual right to use the only uterine activity
monitors that have received pre-market approval from the Food and Drug Administration, or FDA, for
home use on patients with a history of previous preterm birth. Our rights to the monitors had been
a material competitive advantage in marketing our uterine activity monitoring services. In 2001,
the FDA reclassified the monitors from Class III into Class II devices, which makes substantially
equivalent devices available to our competitors, without their having to receive pre-market
approval. As part of the reclassification, the FDA may impose special controls on the use of such
devices. Although these developments have not had a negative impact on our home uterine activity
monitoring business, we cannot predict what future impact these changes may have. Patent positions are uncertain and involve complex legal, scientific and factual questions.
Our patent positions might not protect us against competitors with similar products or technologies
because competing products or technologies may not infringe our patents. For certain of our
products in development, there may be third parties who have patents or pending patents that they
may claim prevent us from commercializing these products in certain territories. If our patent or
other intellectual property rights or positions are infringed, challenged, invalidated, prevented
or otherwise impaired, or we fail to prevail in any future intellectual property litigation, our
business could be adversely affected. Effective trademark and other intellectual property protection may not be available in every
country in which our products are made available. This could have a material adverse effect on our
business, results of operations and financial condition. To date, we have not been notified that
our products infringe the proprietary rights of third parties, but we cannot assure you that third
parties will not claim infringement by us with respect
to past, current and future products. We expect that participants in our markets increasingly
will be subject to infringement claims as the number of competitors in our industry segment grows.
Any such claim, whether or not it has merit, could be time-consuming, result in costly litigation,
cause product delays or require us to enter into royalty or licensing agreements. As a result, any
such claim could have a material adverse effect on our business, results of operations and
financial condition. Competition.The medical industry is characterized by rapidly developing technology and
increased competition. In all our product and service lines, we compete with companies, both large
and small, located in the United States and abroad. Competition is strong in all lines, without
regard to the number and size of the competing companies involved. Certain of our competitors and
potential competitors have significantly greater financial and sales resources than we do and may,
in certain locations, possess licenses or certificates that permit them to provide products and
services that we cannot currently provide. Although we believe our Womens and Childrens Health segment has a dominant market share, we
have a large number of competitors. Competitors of our Womens and Childrens Health segment
include national, regional and local home health agencies, hospitals and other companies devoted
primarily to providing services for the management of maternity patients. Our disease management
businesses compete with pharmaceutical companies, case management companies and other companies
engaged principally in the business of providing disease management services for one or more
diseases or conditions. These businesses compete on a number of factors, including quality of care
and service, reputation within the medical community, scope of products and services, geographical
scope and price. 13




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Competition in the diabetes product design, development and assembly component of our Health
Enhancement segment also is based on quality, service and price. In addition, competition in
research involving the development of new products and the improvement of existing products is
particularly significant. Our foreign diabetes business competes with a large number of companies
specifically involved in the distribution of diabetes supplies, as well as local pharmacies. We believe that our ability to offer customers an integrated health enhancement solution of
services across chronic medical conditions is an increasingly important competitive requirement.
We believe that our clinical expertise, advanced technology and coordinated approach to patient
services will enable our Womens and Childrens Health segment and the disease management component
of our Health Enhancement segment to compete effectively. Similarly, we believe that the quality
of Facets products, as well as its strong distribution system, value-added approach to customer
service, and design and development expertise will continue to enable this business to maintain its
significant market share, notwithstanding the highly competitive environment in which it operates.
We also believe that the convenience of purchasing diabetes supplies through our foreign diabetes
company will continue to be a competitive advantage for that business. There can be no assurance,
however, that we will not encounter increased or more effective competition in the future, which
could limit our ability to maintain or increase our business or render some products and services
we offer obsolete or non-competitive and which could adversely affect our operating results. Research and Development. Facet maintains a dedicated research and development staff at its
headquarters in Marietta, Georgia. This businesss research and development activities are key
factors in its ability to stay abreast of its competition. Program development and refinements in our Womens and Childrens Health segment and the
disease management component of our Health Enhancement segment result from the cooperative efforts
of the businesses information technology, clinical, operating and marketing staff. The costs of all of our research and development efforts are charged to earnings when
incurred. However, we capitalize development costs incurred for internal-use software under the
provisions of AICPA Statement of Position 98-1, Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use. Regulation and Healthcare Industry Changes.We are subject to extensive and frequently
changing federal, state, local and foreign regulation. Changes in laws or regulations or new
interpretations of existing laws or regulations can have a dramatic effect on operating methods,
costs and reimbursement amounts provided by government and third-party payors. We believe our
current arrangements and practices are in material compliance with applicable laws and regulations.
There can be no assurance that we are in compliance with all applicable existing laws and
regulations or that we will be able to comply with new laws or regulations. Changes in applicable
laws or any failure to comply with existing or future laws, regulations or standards could have a
material adverse effect on our results of operations, financial condition, business and prospects. Many states require providers of home health services, such as our Womens and Childrens
Health segment, to be licensed as home health agencies and to have medical waste disposal permits.
Also, many states require QO, our cancer disease management subsidiary, to be licensed as a
utilization review provider. Moreover, certain of our employees are subject to state laws and
regulations regarding the ethics and professional practice of pharmacy and nursing. We may also be
required to obtain certification to participate in governmental payment programs, such as state
Medicaid programs. Some states have established Certificate of Need (CON) programs regulating
the expansion of healthcare operations. The failure to obtain, renew or maintain any of the
required licenses, certifications or CONs could adversely affect our business. Many of the products utilized by us for the provision of our services are classified as
medical devices under the Federal Food, Drug and Cosmetic Act, or the FDC Act, and are subject to
regulation by the FDA. In addition some of our services involve the use of drugs that are
regulated by the FDA under the FDC Act. 14




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Although medical devices and drugs used by us are labeled
for specific indications and cannot be promoted for any other indications, the FDA allows
physicians to prescribe drugs and medical devices for off-label indications under the practice
of medicine doctrine. Negative publicity concerning the off-label use of drugs and devices may
adversely affect our Womens and Childrens Health segments business. Our Facet business serves
as an original equipment manufacturer for FDA regulated products which must comply with good
manufacturing practice regulations. Our failure to comply with FDA requirements could result in
FDA enforcement actions, which could include, but are not limited to, recalls, warning letters,
fines, injunctions, and criminal prosecution. Any such enforcement actions could have a material
adverse effect on our business, financial condition and results of operations. The
Health Insurance Portability and Accountability Act of 1996, or HIPPA, governs electronic
healthcare transactions and the privacy and security of medical records and other individually
identifiable patient data. Healthcare providers and other affected entities had until April 2003
to comply with these privacy regulations. Further regulations establishing healthcare information
security requirements have been issued with compliance required by April 2005. Any failure to
comply with HIPPA could result in criminal penalties and civil sanctions. Although a very small component of our business relies on reimbursement by government payors,
such as state Medicaid, that business is subject to particularly pervasive regulation by those
agencies. In addition, our former pharmacy, lab and supplies businesses received reimbursement
from both Medicare and state Medicaid, and we will continue to be exposed to claims related to
those businesses until all applicable statutes of limitation have run. These regulations impose
stringent requirements for provider participation in those programs and for reimbursement of
products and services. We are subject to periodic audits or investigation by the Centers for
Medicare and Medicaid Services, or CMS and/or its intermediaries, of our compliance with those
requirements, and any deficiencies found may be extrapolated to cover a larger number of
reimbursement claims. Additionally, many applicable laws and regulations are aimed at curtailing
fraudulent and abusive practices in relation to those programs. These rules include the illegal
remuneration provisions of the Social Security Act (sometimes referred to as the Anti-Kickback
statute), which impose criminal and civil sanctions on persons who knowingly and willfully solicit,
offer, receive or pay any remuneration, whether directly or indirectly, in return for, or to
induce, the referral of a patient covered by a federal healthcare program to a particular provider
of healthcare products or services. Related federal laws make it unlawful, in certain
circumstances, for a physician to refer patients covered by federal healthcare programs to a
healthcare entity with which the physician and/or the physicians family have a financial
relationship. Additionally, a large number of states have laws similar to the federal laws aimed
at curtailing fraud and abuse and physician self-referrals. These rules have been interpreted
broadly such that any financial arrangement between a provider and potential referral source may be
suspect. While we believe our former and existing arrangements are proper, the government could
take a contrary position or could investigate our practices. In addition to the laws described above, the Federal False Claims Act imposes civil liability
on individuals or entities that submit false or fraudulent claims for payment to the government.
HIPAA created two new federal crimes: Healthcare Fraud and False Statements Relating to
Healthcare Matters. The Healthcare Fraud statute prohibits knowingly and willfully executing a
scheme or artifice to defraud any healthcare benefit program. The False Statements Relating to
Healthcare Matters statute prohibits knowingly and willfully falsifying, concealing or covering up
a material fact by any trick, scheme or device or making any materially false, fictitious or
fraudulent statement in connection with the delivery of or payment for healthcare benefits, items
or services. The Federal False Claims Act allows actions to be brought on the governments behalf
by individuals under the Federal False Claims Acts qui tam provision. A qui tamclaim has been
filed against the Company and our former subsidiary, Diabetes
Self-Care, Inc., alleging improper claims for Medicare payments in the former pharmacy, laboratory
and supplies division of our Health Enhancement segment. Although we
recently sold that business, the purchaser did not assume liability
for the qui tam claim. As is required by law, the federal
government is conducting an investigation into the complaint to determine if it will intervene or
join in this suit. We cooperating fully with the investigation. The matter is still in its preliminary stages, and we
are unable to predict the ultimate disposition of the action or the investigation. An unfavorable
outcome in the action could subject us to repayment obligations or loss of 15




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reimbursement, exclusion
from participation in Medicare or Medicaid, substantial fines or penalties and other sanctions,
which could have a material adverse effect on our financial position and results of operations.
Defending a qui tamclaim, even where there is little or no merit to the allegations, can be
expensive and time consuming. Violation of these and other applicable rules can result in substantial fines and penalties,
required repayment of monies previously recognized as income, as well as exclusion from future
participation in government-sponsored healthcare programs. There can be no assurance that we will not become the subject of a regulatory or other
investigation or proceeding or that our interpretations of applicable laws and regulations will not
be challenged. The defense of any such challenge could result in adverse publicity, substantial
cost to us and diversion of managements time and attention. Thus, any such challenge could have a
material adverse effect on our business, regardless of whether it ultimately is sustained. The Medicare Prescription Drug Improvement and Modernization Act of 2003 (the Act), which
was signed into law on December 8, 2003, provided funding for disease management demonstration
programs to be implemented in targeted geographic areas across the country, and indicates that if
the programs are successful, the programs will be expanded nationwide. The expansion of these
programs could represent a significant opportunity for our disease management business. Employees.As of December 31, 2004, we employed a total of 1,162 full-time employees and 50
regular part-time employees. In addition, we employ an additional 826 part-time clinical employees
to provide, among other things, patient training and backup support on an as needed basis. None
of our employees are represented by a union. We consider our relationship with our employees to be
good. Available Information. The Companys annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of
the Exchange Act, as amended, will be made available free of charge on or through the Companys
website at
www.matria.comas soon as reasonably practicable after the reports are filed with, or furnished to,
the Commission. Matrias Corporate Governance Guidelines and Code of Conduct were filed as an
exhibit to its Annual Report on Form 10-K for the year ended December 31, 2003 and are available on
its website. Waivers of the Guidelines or Code will be disclosed in an SEC filing on Form 8-K. 
 Item 2. Properties Our principal executive and administrative offices are located at 1850 Parkway Place,
Marietta, Georgia, and total approximately 91,000 square feet. The facility is leased through
February 28, 2010. Certain of our information technology departments occupy offices of
approximately 12,400 square feet in Alpharetta, Georgia, with a lease term expiring December 2006. Our Health Enhancement disease management business has six locations, with its main care
centers in Marietta, Georgia and Sunrise, Florida. These locations total approximately 104,000
square feet and have lease terms expiring on various dates through June 2009. Additional properties also are leased for our other operations. The Womens and Childrens
Health segments patient service centers are typically located in suburban office parks and range
between 250 and 5,500 square feet of space, with an average of approximately 1,500 square feet.
Total square footage for these facilities is approximately 54,000 square feet. These facilities
are leased for various terms through 2008. Additionally, the Womens and Childrens Health segment
leases approximately 10,000 square feet for its customer support center. 16




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Facets assembly and packaging facility consists of approximately 70,000 square feet of office
and warehouse space in McDonough, Georgia. The lease term on this facility will expire in 2008.
Facet also occupies approximately 12,500 square feet of space in the Matria headquarters building.
This lease expires on February 28, 2010. In addition, Facet leases a 200 square foot office in
Northampton, England under a lease that expires in July 2005, with automatic annual renewals. Our foreign disease management operations lease office facilities in Neumünster and Dresden,
Germany, consisting of approximately 3,000 and 8,550 square feet, respectively. The Neumünster
facility, which also includes warehouse space, is leased through December 2005, with automatic one
year renewals. The Dresden facility, which also houses a retail shop, is leased for a term
expiring in 2005, with automatic one year renewals. The business also leases an approximately 900
square foot office, warehouse and training facility in Kobande, Germany under a lease expiring in
July 2006. In addition, this business operates numerous retail, training and footcare facilities
throughout Germany in leased space ranging from 100 to 1,700 square feet,with remaining lease terms
of two years or less. The business also leases warehouse space throughout Germany ranging from 125
to 6,300 square feet under leases with terms expiring in two years or less. These facilities are generally in good condition, and we believe that they are adequate for
and suitable to our requirements. 
 Item 3. Legal Proceedings A qui tamaction has been
filed in the United States District Court for the Western District
of Virginia by Sandra J. Clark, a former employee of the Companys former domestic pharmacy and
supplies division, against the Company and our subsidiary, Diabetes Self-Care, Inc. The complaint
alleges improper claims by Diabetes Self-Care, Inc. for Medicare payments and seeks treble damages
and civil penalties in unspecified amounts. As is
required by law, the federal government is conducting an investigation of the complaint to
determine if it will intervene or join in this suit. We are cooperating fully with the
investigation. This matter is still in its preliminary stages, and we are unable to predict the
ultimate disposition of the action or the investigation. We are subject to various legal claims and actions incidental to our business and the
businesses of our predecessors, including product liability claims and professional liability
claims. We maintain insurance, including insurance covering professional and product liability
claims, with customary deductible amounts. There can be no assurance, however, that (i) additional
suits will not be filed against us in the future, (ii) our prior experience with respect to the
disposition of litigation is representative of the results that will occur in pending or future
cases or (iii) adequate insurance coverage will be available at acceptable prices for incidents
arising or claims made in the future. There are no other pending legal or governmental proceedings
to which we are a party that we believe would, if adversely resolved, have a material adverse
effect on us. 
 Item 4. Submission of Matters to a Vote of Security Holders Not applicable. 17




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Special Item. Executive Officers of the Company The following sets forth certain information with respect to the executive officers of the Company: Name
    
    Age
    
    Position with the CompanyParker H. Petit
    
    
    65
    
    
    Chairman of the Board and Chief Executive OfficerThomas S. Hall
    
    
    44
    
    
    President and Chief Operating OfficerStephen M. Mengert
    
    
    55
    
    
    Vice President  Finance and Chief Financial OfficerYvonne V. Scoggins
    
    
    55
    
    
    Vice President  Corporate FinanceRoberta L. McCaw
    
    
    49
    
    
    Vice President  Legal, General Counsel and SecretaryThornton A. Kuntz, Jr
    
    
    51
    
    
    Vice President  Administration
 The executive officers of the Company are elected annually and serve at the pleasure of the
Board of Directors. Mr. Petit has
served as Chairman of the Board of the Company since the formation of the
Company through the merger of Healthdyne Maternity Management, a division of Healthdyne, Inc.
(Healthdyne) and Tokos Medical Corporation on March 8, 1996 and as Chief
Executive Officer
since October 5, 2000, and as President and Chief Executive Officer from October 5, 2000, to
February 22, 2003. In addition, he served as a member of the three-person Office of President
during a brief period in 1997. Mr. Petit was the founder of Healthdyne and served as its Chairman
of the Board of Directors and Chief Executive Officer from 1970 until 1996. Mr. Petit
is also a director of Intelligent Systems Corp. and Logility, Inc. Mr. Hall has been President and Chief Operating Officer since February 22, 2003, and
previously served as Executive Vice President and Chief Operating Officer of the Company from
October 22, 2002 to February 22, 2003. From 2000 to 2002, he was President and Chief Executive
Officer of TSH & Associates, an independent consulting and management services company. From 1997
to 1999, Mr. Hall held executive positions that included President of ADP TotalSource, a division
of Automated Data Processing, Inc. (ADP). Mr. Mengert was appointed Vice President  Finance and Chief Financial Officer of the Company
on September 3, 2002. From 2000 to 2002, he was a partner with Tatum CFO Partners, L.L.P., and
prior to joining the Company, served as Chief Financial Officer of Tatum client companies in the
technology and healthcare sectors. From 1996 to 1999, Mr. Mengert served as Senior Vice President
of Finance and Chief Financial Officer of Pediatric Services of America, a company specializing in
pediatric homecare for medically fragile children. Ms. Scoggins was appointed Vice President  Corporate Finance of the Company on July 22, 2004,
and also was Vice President  Financial Planning and Analysis from February 28, 2001, to July 22,
2004, and previously was Vice President, Treasurer and Chief Accounting Officer of the Company from
December 15, 1997, to February 28, 2001, and also Vice President and Controller from March 8, 1996,
to December 15, 1997. Prior thereto, she was Vice President and Controller of Healthdyne from May
1995 to March 8, 1996; Vice President  Planning and Analysis of Healthdyne from May 1993 to May
1995; and Vice President and Chief Financial Officer of Home Nutritional Services, Inc., a former
majority owned subsidiary of Healthdyne, from February 1990 to April 1993. Ms. McCaw has been Vice President  Legal, General Counsel and Secretary of the Company since
April 23, 1998, and previously was Assistant General Counsel and Assistant Secretary of the Company
from
December 15, 1997 to April 23, 1998, and Assistant General Counsel from July 1996 to December
1997. Prior thereto, Ms. McCaw was a partner at Tyler, Cooper & Alcorn, a Connecticut-based law
firm, from January 1990 to July 1996. 18




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Mr. Kuntz has been Vice President  Administration since February 24, 1998, and previously was
Vice President  Human Resources of the Company from March 8, 1996 to February 24, 1998. Prior
thereto, he served as Vice President  Administration of Healthdyne from August 1992 to March 1996. 19




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PART II 
  Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Purchases of
Equity Securities (a) Market Information.Matrias common stock is traded in the over-the-counter market and
is quoted on the Nasdaq National Market (NASDAQ) under the symbol MATR. The following table sets forth, for the calendar quarters indicated, the high and low sales
prices of Matria common stock as quoted on NASDAQ from January 1, 2003 through December 31, 2004
(adjusted to reflect the three-for-two stock split effected on February 4, 2005): Quarter
    
    Low
    
    
    High2003First
    
    $
    4.47
    
    
    $
    7.50Second
    
    
    6.50
    
    
    
    11.83Third
    
    
    9.61
    
    
    
    14.96Fourth
    
    
    10.65
    
    
    
    14.672004First
    
    $
    14.25
    
    
    $
    21.17Second
    
    
    11.93
    
    
    
    17.35Third
    
    
    15.33
    
    
    
    19.73Fourth
    
    
    18.09
    
    
    
    26.43
 (b) Holders.The approximate number of stockholders of the Company as of March 1, 2005 was
1,750 record holders and 5,500 street holders. (c) Dividends.Matria has not paid any cash dividends with respect to its common stock and
does not intend to declare any dividends in the near future. The Company is a party to a Loan and
Security Agreement and an Indenture, each of which contains covenants restricting the payment of
dividends on and repurchases of the Companys common stock. 20




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(d) Equity Compensation Plan Information. The following table gives information about the Companys common stock that may be issued upon
the exercise of options, warrants and rights under all existing equity compensation plans as of
December 31, 2004, adjusted to reflect the three-for-two stock split effected on February 4, 2005. Number of SecuritiesNumber of Securities to
    
    
    
    
    
    
    Remaining Available forbe Issued Upon
    
    
    Weighted-Average
    
    
    Future Issuance UnderExercise of
    
    
    Exercise Price of
    
    
    Equity CompensationOutstanding
    
    
    Outstanding
    
    
    Plans (ExcludingOptions, Warrants and
    
    
    Options, Warrants
    
    
    Securities Reflected in 1stPlan Category
    
    Rights
    
    
    and Rights
    
    
    Column)Equity compensation
plans approved by
security holders
    
    
    2,407,272
    
    
    $
    12.49
    
    
    
    209,897
    (1)Equity
compensation plans
not approved by
security holders
(2)
    
    
    90,881
    
    
    $
    16.09
    
    
    
    Total
    
    
    2,498,153
    
    
    $
    12.62
    
    
    
    209,897
   (1)
    
    Includes securities available for future issuance under shareholder-approved compensation
plans as follows: 103,122 shares under the 2004 Stock Incentive Plan, 4,506 shares under the
2002 Stock Incentive Plan, 4,376 shares under the 2001 Stock Incentive Plan, 18,687 shares
under the 2000 Directors Non-qualified Stock Option Plan, 910 shares under the 2000 Stock
Incentive Plan, 420 shares under the 1997 Stock Incentive Plan and 411 shares under the 1996
Stock Incentive Plan. Also includes 77,465 shares that remain available for purchase under
the 2002 Stock Purchase Plan.(2)
    
    This total includes options for: (1) 22,500 shares granted to Robert F. Byrnes, former
President and CEO of the Company, on October 1, 1997 pursuant to the terms of a settlement
agreement between Mr. Byrnes and the Company. These options were immediately exercisable by
Mr. Byrnes; (2) 36,704 shares granted to certain key employees (other than executive
officers) on October 20, 1997 and 22,500 shares granted to non-employee members of the
Companys Board of Directors on February 24, 1998. All of these options were granted at
exercise prices which were the fair market value of a share of the Companys stock on the date
of grant and all expire ten years from the date of the grant. The October 20, 1997 grants
vested 33% a year and became fully exercisable on October 20, 2000. The February 24, 1998
grants vested on February 24, 1999; (3) 31,797 shares assumed by the Company in connection
with the acquisition of MarketRing, which options were granted by MarketRing under the
MarketRing 1999 Stock Option and Stock Appreciation Rights Plan prior to the acquisition. The
exercise price for these options, originally set by MarketRing, has been determined by
reference to the exchange ratio prescribed for converting shares of MarketRing common stock
into shares of the Companys common stock pursuant to the acquisition. The assumed options
generally vest in increments of 25% annually, beginning on the second anniversary of the date
of grant, with such options expiring five to ten years from the date of grant or upon
termination of employment. 21




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##### Table of Contents



Item 6. Selected Financial Data The following sets forth selected consolidated financial data with respect to the Companys
operations. The data should be read in conjunction with Managements Discussion and Analysis of
Financial Condition and Results of Operations and the consolidated financial statements and related
notes thereto. The statement of operations data for the five years ended December 31, 2004 and the
related balance sheet data have been derived from the audited consolidated financial statements of
the Company. Years Ended December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(In thousands, except per share data)Consolidated statements of operations data:Revenues from continuing operations (1)
    
    $
    294,382
    
    
    $
    252,323
    
    
    $
    212,612
    
    
    $
    208,944
    
    
    $
    200,933Earnings (loss) from continuing operations (2)(3)(4)(5)(6)
    
    
    (3,214
    )
    
    
    6,010
    
    
    
    (15,040
    )
    
    
    5,112
    
    
    
    12,978Earnings (loss) from continuing operations per
common share:Basic
    
    $
    (0.21
    )
    
    $
    0.40
    
    
    $
    (1.08
    )
    
    $
    0.30
    
    
    $
    0.68Diluted
    
    
    (0.21
    )
    
    
    0.39
    
    
    
    (1.08
    )
    
    
    0.30
    
    
    
    0.65
 December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(In thousands)Consolidated balance sheets data:Total assets
    
    $
    304,482
    
    
    $
    333,482
    
    
    $
    291,407
    
    
    $
    260,623
    
    
    $
    268,850Long-term debt, excluding current installments
    
    
    85,751
    
    
    
    121,005
    
    
    
    118,215
    
    
    
    114,575
    
    
    
    76,996Redeemable preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    41,446
   (1)
    
    Revenues in 2002, 2003 and 2004 included Quality Oncology, Inc., acquired September 2002. See Notes to
Consolidated Financial Statements included herein.(2)
    
    Other expense for 2004 included a $22,886 charge resulting from the retirement of $120 million in aggregate
principal amount of the Companys 11% Senior Notes. See Notes to Consolidated Financial Statements included herein.(3)
    
    In 2002, the Company recorded a charge of $14,247 in connection with the termination and restructuring of its
split-dollar life insurance plan. See Notes to Consolidated Financial Statements included herein.(4)
    
    As a result of implementing Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible
Assets,in January 2002, the Company discontinued amortization of goodwill. Amortization of goodwill was approximately
$8,224 and $8,205 in 2001 and 2000, respectively.(5)
    
    Restructuring charges in 2000 of $1,599 related to costs of exiting the clinical patient records software business.(6)
    
    Other income for 2000 included a gain on the sale of short-term investments of $6,077. 22




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Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis should be read in conjunction with the other financial
information and consolidated financial statements and related notes appearing elsewhere in this
Annual Report. The discussion contains forward-looking statements that involve risks and
uncertainties. Actual results could differ materially from those anticipated in the
forward-looking statements as a result of a variety of factors, including those discussed in Risk
Factors in this Annual Report. The historical results of operations are not necessarily
indicative of future results. Executive Overview We provide comprehensive, integrated disease management services and related products
that offer cost-saving solutions for many of the most costly medical conditions and chronic
diseases, including diabetes, cardiovascular diseases, respiratory disorders, obstetrical
conditions, cancer, obesity, depression, chronic pain and hepatitis C. We seek to improve patient
outcomes and lower healthcare costs through a broad range of disease management programs and direct
clinical services. We emphasize a multidisciplinary approach to care that involves our clinicians
working with physicians to oversee the adherence to treatment plans. We focus on the management of
patients between visits to their physician, the improvement of the patients compliance with the
physicians care plan and the avoidance of controllable and costly events, such as emergency room
visits and hospital admissions. To serve this critical aspect of patient care, we have invested
heavily in disease management information technology, care center infrastructure and a national
network of skilled multidisciplinary clinicians. We provide services to self-insured employers, private and government sponsored health plans,
pharmaceutical companies and patients. Our employer clients are primarily Fortune 1000 companies
that self-insure the medical benefits provided to their employees, dependents and retirees. Our
health plan customers are regional and national health plans, as well as government-sponsored
health plans, such as state Medicaid programs. We have two reportable business segments: Health Enhancement and Womens and Childrens
Health.  
    Health Enhancement.At December 31, 2004, our Health Enhancement segment
was comprised of our disease management business, our foreign diabetes business and
Facet Technologies, LLC (Facet), our diabetes product design, development, assembly
and distribution operation.The disease management component of our Health Enhancement segment currently offers
disease management services to employers and health plans for diabetes, cardiovascular
disease, respiratory disorders, cancer, obesity, depression, and chronic pain. We began
our disease management business in 1998, focusing solely on respiratory disease
management. In 1999, we added diabetes disease management through an acquisition in
which we acquired our former pharmacy and supplies business, as well as Facet. In 2002,
we developed programs for cardiac, depression and chronic pain disease management and
expanded into cancer disease management with the acquisition of Quality Oncology, Inc.
(QO). In 2003, we launched an initiative to offer disease management services through
pharmaceutical corporations in support of complex drug therapies and began to offer
disease management services for Hepatitis C. In 2004, we added obesity to our disease
management programs.Our disease management programs seek to reduce medical costs and improve patient care for
the chronically ill as well as those who are at the highest risk for significant and
costly episodes of illness. We use our proprietary technology platform, which we refer
to as TRAXTM, to identify patients with the potential for high-cost events and
to proactively manage the care of the patients 23




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identified. We help these individuals take more responsibility for their disease and
avoid expensive medical events. Cost savings generally are realized through a reduction
in emergency room visits and admissions to the hospital and shorter hospital stays. Our
programs, which were developed in accordance with national clinical standards, are
designed to increase patient compliance with the physicians plan of care. Effective October 1, 2003, we purchased certain assets of Options Unlimited Comprehensive
Rehabilitative Services, Inc., now Matria Case Management, a company specializing in case
management for health plans, third-party administrators and employers. We have
integrated this companys case management services with our existing disease management
services and are offering these services to employers and health plans. The disease management programs serve patients in the United States through our
facilities in Atlanta, Georgia, McLean, Virginia, Sunrise, Florida, El Sequndo,
California, Houston, Texas, and Huntington, New York. Our foreign diabetes division provides diabetes products and supplies and certain
value-added services directly to patients in Germany through its main facilities in
Neumünster and Dresden, Germany and depots maintained in physician offices and clinics.
Most revenues are received directly from the German national healthcare system. Our Health Enhancement segment also includes Facet, a leading designer, developer,
assembler and distributor of products for the diabetes market, which we acquired in 1999.
Facet has 30% to 50% of the world market share in each of the three major product lines
used by patients with diabetes to obtain blood samples for testing blood glucose levels:
standard lancets, lancing devices and safety lancets. Facet operates from facilities in
Marietta, Georgia, McDonough, Georgia, and Northhampton, England. Its products are
shipped primarily to North and South America, Europe and Asia. On June 30, 2004, we completed the sale of substantially all of the assets, excluding
trade and certain other receivables, of our domestic direct to consumer pharmacy and
supplies business. As part of the transaction, the Company and the buyer entered into a
strategic relationship whereby the buyer will provide diabetes and respiratory supplies
to our disease management customers. As part of the sale, the buyer had the option to buy
Matria Labs, Inc., a direct-to-consumer laboratory business, for $1. The purchase option
expired, unexercised, in November 2004. The Company had previously made the decision to
exit the lab business in the event buyer did not exercise the purchase option. As a
result of the sale of the domestic pharmacy and supplies business and the discontinuance
of the lab business, the accompanying consolidated financial statements reflect the
operations of these divisions as discontinued operations for all periods presented.  
    Womens and Childrens Health.Our Womens and Childrens Health segment
offers a wide range of clinical and disease management services designed to assist
physicians and payors in the cost-effective management of maternity patients. The
segment manages patients with gestational diabetes, hypertension, hyperemesis, and
anticoagulation disorders, as well as patients experiencing or at risk for preterm
labor. In addition, this segment recently launched a strategic initiative to provide
services for children through neonatal intensive care case management. In connection
with this initiative, in 2004, we changed the name of our Womens Health segment to
Womens and Childrens Health. Our Womens and Childrens Health segment is
headquartered in Marietta, Georgia and has 39 sites of service throughout the United
States, seven of which are monitoring centers. All 39 sites are fully accredited as
home care organizations by the Joint Commission on Accreditation of Health Care
Organizations. In addition, the segment has two after-hours centers. Most revenues
are received directly from the patients health plan. 24




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Industry Factors Total healthcare spending in the United States is expected to exceed $1.9 trillion in 2005,
with predictions that healthcare spending will increase to $3.3 trillion in 2013. According to the
Centers for Disease Control, a majority of that spending is attributed to the more than 125 million
Americans suffering from chronic diseases. In particular, patients with chronic conditions account
for 96% of all home healthcare visits, 88% of all prescriptions, 76% of all in-patient hospital
stays and 72% of all physician visits. Moreover, healthcare spending to treat chronic diseases is
rapidly rising due to noncompliant patients, uninformed patients who select expensive drug
therapies, lack of coordinated systems and protocols to track and follow-up with high-acuity
patients and the inability of medical professionals to fully address the day-to-day challenges
faced by their patient populations. All of these trends are causing healthcare industry
participants to focus on solutions that lower costs through improved patient health and outcomes. Employers are especially affected by these trends. In addition to double digit increases in
direct healthcare costs, employers are experiencing an increase in indirect costs associated with
absenteeism and other lost employee productivity. The National Academy on Aging has found that
chronic diseases are now recognized as a major source of lost productivity, estimating that the
total dollar loss from chronic conditions ranges from $200 billion to $300 billion annually.
Employers are seeking solutions to the impact healthcare is having on their profit margins and the
additional financial burden being placed on their employees through increased premiums, co-pays,
coinsurance and deductibles. Employers are more proactive in their management of healthcare costs
and increasingly view disease management as a meaningful and effective tool to address their
healthcare problems. The Medicare program has also been significantly affected by the rising costs of healthcare
due to the general aging of the population and the increased prevalence of chronic and high cost
conditions among the elderly. Studies have shown that a relatively small number of beneficiaries
with certain chronic illnesses  asthma, diabetes, congestive heart failure and related cardiac
conditions, hypertension, coronary artery disease, cardiovascular and cerebrovascular conditions,
and chronic lung disease  account for a disproportionate share of Medicare fee-for-service
expenditures. Patients with these conditions typically receive fragmented care from providers at
multiple sites and require repeated hospitalization. Pursuant to recent Medicare reform
legislation, disease management demonstration programs will be established in ten regions of the
country to test whether providing coordinated-care services to Medicare fee-for-service
beneficiaries with complex chronic conditions can yield better clinical outcomes without increasing
program costs. In addition, a number of states are pursuing disease management pilots in their
Medicaid programs. Last year, the Centers for Medicare and Medicaid Services, or CMS, issued a
release urging states to adopt disease management programs and announcing the availability of
federal matching funding. Business Strategy Our goal is to further expand our position as a leading provider of disease management
services. We seek to achieve this goal by pursuing the following strategies: Capitalize on our Position as an Industry Leader in the Disease Management Market.We believe
our extensive experience, established infrastructure and list of existing customers provide us a
significant competitive advantage as we seek to capitalize on the growing market for disease
management. We have more than 15 years of experience in providing disease management and related
services. Our established infrastructure includes our proprietary TRAXTM technology
platform, care center operations located throughout the United States, supply distribution channels
and a national network of skilled multi-disciplinary clinicians. Leverage Our TRAXTMTechnology.We will continue to make significant investments
in TRAXTM in order to better identify patients for intervention and improve treatment
plans for these identified patients. A 25




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major challenge of disease management programs is to link the design and monitoring of treatment
plans with the actual clinical services and fulfillment of drugs and related supplies. We believe
that our TRAXTM technology platform is uniquely capable of addressing this issue and
coordinating both treatment objectives and treatment activities. Further Penetrate All Key Segments of the Growing Disease Management Market.We intend to
expand our customer base within the employer, health plan, state and federal governments, and
pharmaceutical markets.  
    Employers.We have identified this sector as a prime customer target as employers
seek to improve employee productivity by reducing absenteeism and other forms of lost
productivity.
    Regional and National Health Plans.Although health plans have been in the medical
management business for several years, they increasingly are seeking disease management
as an opportunity to minimize medical cost inflation.
    Medicaid.In August 2003, we entered into an agreement with Pfizer Inc.s Health
Solutions Group to provide disease management services to state Medicaid programs under
contract with Pfizer. We believe this alliance represents a significant market
opportunity.
    Pharmaceutical Companies.We implemented a contract with Schering Plough Corp. to
provide disease management services for patients infected with the hepatitis C virus.
The program helps patients complete their individualized Peg-Intron therapy regimen,
providing their best chance for achieving sustained viral response. Continue to Expand Our Service Offering.We believe that the ability to offer customers an
integrated health enhancement solution of services across multiple chronic medical conditions is an
increasingly important competitive requirement. We are continuously seeking to expand our product
and service offerings. For example, we entered the cancer disease management field by acquiring
Quality Oncology in 2002, and in 2003 we developed our depression and low back pain management
programs, and expanded our case management services through the acquisition of Options Unlimited.
In 2004, we added obesity management to our disease management services. Cross-Selling Within Our Company. We believe there is a significant opportunity to expand our
disease management business by cross-selling other products and services to existing customers as
they realize the cost savings and better patient outcomes that our programs provide. While the magnitude of growth in new accounts provides us with challenges, we have an
established framework for assisting employers and health plans in managing and integrating their
disease management programs. We have expansion capacity in our care centers and have continued the
rapid development of our TRAXTMtechnology platform and capabilities for the disease
management processes and related connectivity and integration. We do not foresee any abnormal
pricing pressure relative to our disease management programs over the next year. Medical statistics indicate that one in eight births is preterm, with that number on the rise.
Preterm delivery is the leading cause of neonatal mortality and birth-related morbidity and
results in significantly higher cost than full-term pregnancies. Our Womens and Childrens Health
segments services have proven effective in extending pregnancy and reducing costs. However, the
reimbursement rates have been decreasing for certain services, and patient access to services that
manage high-risk pregnancies has been reduced. We have 29.8 million covered lives under all our contracts as of December 31, 2004 compared
with 14.2 million and 7.2 million as of December 31, 2003 and 2002, respectively. 26




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Components of Revenues and Expenses Revenues Our Health Enhancement segment provides services through its patient service
centers and designs, develops, assembles, packages and distributes diabetes products. Revenues
for services are recognized when services are provided, and revenues from product sales are
recognized when products are shipped. Our disease management services are billed and paid for
primarily on the basis of (i) monthly fees for each employee or member enrolled in a health plan,
(ii) each member identified with a particular chronic disease or condition under contract, (iii)
each member enrolled in our program or (iv) a fixed rate per case. Billings for certain services
occur in advance of services being performed. Such amounts are recorded as unearned revenues in
the balance sheet, and revenues are recognized as services are performed. Our Womens and Childrens Health segment revenues are generated by providing services
through patient service centers. Revenues from this segment are recognized as the related
services are rendered and are net of contractual allowances and related discounts. Our clinical
services business is reimbursed on a fee-for-service or per item basis. In 2004, revenues from continuing operations were derived from the following types of
customers and third-party payors: approximately 48% from direct payors (including corporations and
health plans), 25% from third-party private payors, 22% from foreign healthcare systems and 5%
from domestic government payors. Cost of Revenues Cost of revenues consists primarily of clinical labor and supplies related
to the provision of services, and cost of materials purchased and labor in the assembly and
distribution operations. Selling and Administrative Expenses Selling and administrative expenses include salaries,
incentives, benefits and related expenses for personnel in sales, customer service and
administrative activities, facility and marketing costs and legal, accounting and other
professional fees. 27




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##### Table of Contents



Results of Operations 2004 Compared to 2003 The following table summarizes key components and variations in our financial statements to
facilitate understanding of our results of operations. An explanation of the results follows the
table. Twelve Months Ended December 31,2004
    
    
    2003
    
    
    Variance
    
    
    Variance %(Amounts in thousands)Revenues
    
    $
    294,382
    
    
    $
    252,323
    
    
    $
    42,059
    
    
    
    16.7
    %Health Enhancement
    
    
    201,639
    
    
    
    157,929
    
    
    
    43,710
    
    
    
    27.7
    %Womens
and Childrens Health
    
    
    92,768
    
    
    
    94,423
    
    
    
    (1,655
    )
    
    
    (1.8
    )%Cost of revenues
    
    
    169,745
    
    
    
    148,067
    
    
    
    21,678
    
    
    
    14.6
    %% of revenues
    
    
    57.7
    %
    
    
    58.7
    %Health Enhancement
    
    
    125,592
    
    
    
    105,524
    
    
    
    20,068
    
    
    
    19.0
    %% of revenues
    
    
    62.3
    %
    
    
    66.8
    %Womens
and Childrens Health
    
    
    44,178
    
    
    
    42,602
    
    
    
    1,576
    
    
    
    3.7
    %%
 of revenues
    
    
    47.6
    %
    
    
    45.1
    %Selling and administrative expenses
    
    
    95,898
    
    
    
    78,236
    
    
    
    17,662
    
    
    
    22.6
    %% of revenues
    
    
    32.6
    %
    
    
    31.0
    %Provision for doubtful accounts
    
    
    2,550
    
    
    
    3,413
    
    
    
    (863
    )
    
    
    (25.3
    )%% of revenues
    
    
    0.9
    %
    
    
    1.4
    %Interest expense, net
    
    
    9,793
    
    
    
    13,842
    
    
    
    (4,049
    )
    
    
    (29.3
    )%Other income, net
    
    
    939
    
    
    
    1,466
    
    
    
    (527
    )
    
    
    (35.9
    )%Loss on retirement of 11% Senior Notes
    
    
    (22,886
    )
    
    
    
    
    
    
    (22,886
    )
    
    
    N/MEarnings (loss) from continuing operations before
income taxes
    
    
    (5,551
    )
    
    
    10,231
    
    
    
    (15,782
    )
    
    
    N/MIncome tax benefit (expense)
    
    
    2,337
    
    
    
    (4,221
    )
    
    
    6,558
    
    
    
    N/MEarnings (loss) from continuing operations
    
    
    (3,214
    )
    
    
    6,010
    
    
    
    (9,224
    )
    
    
    N/M% of revenues
    
    
    (1.1
    )%
    
    
    2.4
    %Discontinued operations:Earnings (loss) from discontinued operations, net of
income taxes
    
    
    (658
    )
    
    
    1,296
    
    
    
    (1,954
    )
    
    
    N/MGain on disposal of discontinued
operations, net of income taxes
    
    
    30,938
    
    
    
    
    
    
    
    30,938
    
    
    
    N/MNet earnings
    
    $
    27,066
    
    
    $
    7,306
    
    
    $
    19,760
    
    
    
    270.5
    %
   N/M  Not Meaningful
 28




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Revenues increased $42.1 million, or 16.7%, in 2004 compared to 2003. This increase
resulted from strong growth in our Health Enhancement segment, where revenues increased $43.7
million, or 27.7%. The growth was attained primarily in the disease management component of this
segment, which experienced a $23.3 million, or 80.1%, increase over 2003. The increase was
primarily due to new disease management contracts and an increase in performance based revenues
from existing contracts. Our foreign diabetes division revenues increased $10.4 million, or 19.5%,
compared to 2003. In addition, Facets revenues increased $9.8 million, or 12.9%, over the prior
year, primarily due to higher sales volume. Revenues in our Womens and Childrens Health segment
decreased $1.7 million, or 1.8%, in 2004 compared to 2003, due primarily to a continued decline in
the patient census for preterm labor management services and lower rates of revenue per day of
service in 2004. Health plans have been limiting patient access to services that manage high-risk
pregnancies. Cost of revenues as a percentage of revenues decreased to 57.7% in 2004, from 58.7% in 2003.
The cost of revenues as a percentage of revenues in our Health Enhancement segment decreased due to
the improved margins in our domestic disease management services and the leveraging impact of
higher revenues. The decreases in our Health Enhancement segment were partially offset by an
increase in the cost of revenues as a percentage of revenues in our Womens and Childrens Health
segment. The Womens and Childrens Health increase in cost of revenues as a percentage of
revenues was primarily the result of a change in the patient drug therapy mix and lower rates of
revenue per day of service in 2004. Selling and administrative expenses increased $17.7 million to $95.9 million in 2004, compared
to $78.2 million in 2003. Selling and administrative expenses as a percentage of revenues increased
to 32.6% in 2004, from 31.0% in 2003. This increase was largely attributable to increased overhead
expenses needed to manage the Companys revenue growth and additional spending in the information
technology area. In addition, the Company experienced higher public company expenses in 2004. We provide for estimated uncollectible accounts as revenues are recognized. The provision for
doubtful accounts was 0.9% of revenue in 2004, compared with 1.4% of revenues in 2003. Collection
experience in our Womens and Childrens Health segment is trending favorably, resulting in a
decrease in the provision in 2004. The provision is adjusted periodically based upon our quarterly
evaluation of historical collection experience, recoveries of amounts previously provided, industry
reimbursement trends, audit activity and other relevant factors. Interest expense, net, decreased by $4.0 million, or 29.3%, in 2004 compared to 2003. The
decrease is related primarily to the reduction in interest rate due to the issuance of 4.875%
convertible debt in May and June 2004 and the retirement of substantially all of the 11% Senior
Notes in June 2004. Weighted average interest rates, including amortization of debt discount and
expense and gains from terminated interest rate swap transactions, were 8.62% and 11.34% for 2004
and 2003, respectively. Other income, net, included income of $939,000 for 2004, compared to income of $1.5 million
for 2003. Other income includes collections of notes and receivables that were previously
written-off, royalties and other miscellaneous items and favorable currency adjustments on a
euro-denominated receivable. On
March 29, 2004, we commenced a tender offer for all of our unsecured
11% Senior Notes, which had an aggregate principal amount of
$122 million. We received valid tenders from holders of
$120 million in aggregate principal amount of the 11% Senior
Notes. On June 30, 2004, we completed the repurchase of the 11%
Senior Notes tendered in the tender offer with proceeds from the
issuance of convertible senior subordinated debt and with the
proceeds from the sale of assets of the pharmacy and supplies
business. The retirement of the 11% Senior Notes resulted in a loss
of $22.9 million. The income tax benefit was $2.3 million for 2004, compared to an income tax expense of $4.2
million for 2003. Reflected in 2004 and 2003 were various non-deductible permanent differences
between tax and financial reporting. Cash outflows for income taxes in 2004 and 2003 totaled $7.7
million and $1.2 million, respectively, being comprised of federal alternative minimum taxes, state
and foreign taxes. As of December 31, 2004, our remaining net operating losses of $36.5 million,
the tax effect of which are reflected on the balance sheet in the deferred tax asset, will be
available to offset future taxable income. 29




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##### Table of Contents



On June 30, 2004, we completed the sale of substantially all of the assets, excluding trade
and certain other receivables, of our domestic direct to consumer pharmacy and supplies business.
In 2004, we recorded a gain on the sale of $30.9 million, net of
income taxes of $20.9 million.
Goodwill of $16.3 million related to the disposition was charged against the gain. In connection
with the sale, the Company increased the allowance for doubtful accounts for the retained
receivables by $11.9 million to provide for the estimated effect the sale of the business and the
fourth quarter decision to outsource the collection effort to a third party could have on
collections. Also related to the sale, liabilities totaling $1.5 million were recorded for
employee termination benefits and other costs related to the discontinued operations. Both charges
are a direct result of the decision to dispose of the business and are included as part of the gain
on sale. Loss from discontinued operations, net of income taxes, was $658,000 in 2004, compared
to earnings of $1.3 million in 2003. 30




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2003 Compared to 2002 The following table summarizes key components and variations in our financial statements to
facilitate understanding of our results of operations. An explanation of the results follows the
table. Twelve Months Ended December 31,2003
    
    
    2002
    
    
    Variance
    
    
    Variance %(Amounts in thousands)Revenues
    
    $
    252,323
    
    
    $
    212,612
    
    
    $
    39,711
    
    
    
    18.7
    %Health Enhancement
    
    
    157,929
    
    
    
    114,514
    
    
    
    43,415
    
    
    
    37.9
    %Womens and Childrens Health
    
    
    94,423
    
    
    
    98,161
    
    
    
    (3,738
    )
    
    
    (3.8
    )%Cost of revenues
    
    
    148,067
    
    
    
    125,189
    
    
    
    22,878
    
    
    
    18.3
    %% of revenues
    
    
    58.7
    %
    
    
    58.9
    %Health Enhancement
    
    
    105,524
    
    
    
    81,707
    
    
    
    23,817
    
    
    
    29.1
    %% of revenues
    
    
    66.8
    %
    
    
    71.4
    %Womens and Childrens Health
    
    
    42,602
    
    
    
    43,544
    
    
    
    (942
    )
    
    
    (2.2
    )%% of revenues
    
    
    45.1
    %
    
    
    44.4
    %Selling and administrative expenses
    
    
    78,236
    
    
    
    84,538
    
    
    
    (6,302
    )
    
    
    (7.5
    )%% of revenues
    
    
    31.0
    %
    
    
    39.8
    %Provision for doubtful accounts
    
    
    3,413
    
    
    
    5,554
    
    
    
    (2,141
    )
    
    
    (38.5
    )%% of revenues
    
    
    1.4
    %
    
    
    2.6
    %Interest expense, net
    
    
    13,842
    
    
    
    13,624
    
    
    
    218
    
    
    
    1.6
    %Other income (expense), net
    
    
    1,466
    
    
    
    (3,160
    )
    
    
    4,626
    
    
    
    N/MEarnings (loss) from continuing operations before income
taxes
    
    
    10,231
    
    
    
    (19,453
    )
    
    
    29,684
    
    
    
    N/MIncome tax benefit (expense)
    
    
    (4,221
    )
    
    
    4,413
    
    
    
    (8,634
    )
    
    
    N/MEarnings (loss) from continuing operations
    
    
    6,010
    
    
    
    (15,040
    )
    
    
    21,050
    
    
    
    N/M% of revenues
    
    
    2.4
    %
    
    
    (7.1
    )%Discontinued operations:Earnings (loss) from discontinued operations, net of income
taxes
    
    
    1,296
    
    
    
    (728
    )
    
    
    2,024
    
    
    
    N/MLoss on disposal of discontinued operations,
net of income taxes
    
    
    
    
    
    
    (558
    )
    
    
    558
    
    
    
    N/MNet earnings (loss)
    
    $
    7,306
    
    
    $
    (16,326
    )
    
    $
    23,632
    
    
    
    N/M
   N/M  Not Meaningful 31




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In 2003, revenues increased $39.7 million, or 18.7%, compared to 2002. This increase
resulted from strong growth in our Health Enhancement segment, where revenues increased $43.4
million, or 37.9%, partially offset by a decrease in our Womens and Childrens Health segment. Of
the Health Enhancement segment increase, $12.7 million was attributable to the acquisition of QO,
effective October 2002. The remaining growth was attained primarily in the disease management and
foreign diabetes business components of this segment, which experienced an additional $23.5 million
increase over 2002. The increase was due to an increase in covered lives of new and existing
accounts, along with a favorable exchange rate impact. In addition, Facets revenues increased
$7.3 million over the prior year, primarily due to higher sales volume. Revenues in our Womens
and Childrens Health segment decreased $3.7 million, or 3.8%, in 2003 compared to 2002, due
primarily to a continued decline in the patient census for preterm labor management services and
lower rates of revenue per day of service in 2003. Health plans have been limiting patient access
to services that manage high-risk pregnancies. Cost of revenues as a percentage of revenues decreased slightly to 58.7% in 2003, from 58.9%
in 2002. The cost of revenues as a percentage of revenues in our Health Enhancement segment
decreased due to the following factors: the effects of our acquisition of QO, whose cost of
revenues as a percentage of revenues was lower than for other components of this segment; and
improved margins in disease management services due to the leveraging impact of higher revenues.
The decreases in our Health Enhancement segment were partially offset by an increase in the cost of
revenues as a percentage of revenues in our Womens and Childrens Health segment. Our Womens and
Childrens Health increase in cost of revenues as a percentage of revenues was primarily the result
of a change in the patient drug therapy mix and lower rates of revenue per day of service in 2003. Selling and administrative expenses as a percentage of revenues decreased to 31.0% in 2003,
from 39.8% in 2002. The decrease in this percentage was primarily due to higher revenue in 2003
and to special items in 2002. Selling and administrative expenses in 2002 included a charge of
$14.2 million for the termination and restructuring of a retirement plan, as discussed below. Also
in 2002, the Company recorded a non-cash charge of $2.5 million related to the retirement of a $3.5
million note receivable from a former executive. The note, which was acquired from a predecessor
organization and matured on June 30, 2002, stipulated that the balance could be settled in full by
surrender of collateral consisting of 187,500 shares of our common stock, generating a charge equal
to the difference between the book value of the note and the closing market value on June 30, 2002
of the 187,500 shares. Selling and administrative expenses for 2002 also included $2.9 million of
severance costs. Other fluctuations in 2003 and 2002 generally offset each other. On December 31, 2002, we terminated and restructured our split-dollar insurance retirement
plan for certain former and current employees and recorded charges totaling approximately $14.2
million. The decision to terminate the program, which utilized split-dollar life insurance as the
funding mechanism, was prompted in part by concerns that such a vehicle may no longer be permitted
for some current officers under certain provisions of the Sarbanes-Oxley Act of 2002, as well as
anticipation that additional funding, in excess of amounts originally contemplated, would have been
required under the former plan. The plan was terminated for the group including certain former
employees and Matrias Chairman and Chief Executive Officer. The plan for the other current
employees was replaced by a Supplemental Executive Retirement Plan. The expense of $14.2 million
recognized in 2002 represents the net present value of the targeted benefits under the plan
(including tax mitigation amounts) of approximately $13.6 million, and $575,000 related to
transaction costs and the net shortfall in the refund of cumulative premiums paid by us. We
satisfied our obligations to participants by relinquishing our collateral interests in the
split-dollar policies and through net incremental payments of approximately $3.1 million (the
effect of which was mitigated by the elimination of future premium obligations of $3.7 million). We provide for estimated uncollectible accounts as revenues are recognized. The provision for
doubtful accounts was 1.4% of revenues in 2003, compared with 2.6% of revenues in 2002. The
provision for 32




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##### Table of Contents



doubtful accounts as a percentage of revenues in our Health Enhancement segment was
0.1% in 2003, compared to 0.3%
in 2002. The provision for doubtful accounts as a percentage of revenues in our Womens and
Childrens Health segment was 3.4% in 2003, compared to 5.3% in 2002. Collection experience in our
Womens and Childrens Health segment trended favorably in 2003, resulting in a decrease in the
provision. The provision is adjusted periodically based upon our quarterly evaluation of
historical collection experience, recoveries of amounts previously provided, industry reimbursement
trends, audit activity and other relevant factors. Interest expense, net, increased by $218,000, or 1.6%, in 2003 compared to 2002, due to a
higher average outstanding debt balance offset somewhat by a lower average interest rate. The
weighted average interest rates (including amortization of debt discount and expense and gains from
terminated interest rate swap transactions) on all outstanding indebtedness were 11.34% and 11.89%
for 2003 and 2002, respectively. Other income (expense), net, included income of $1.5 million for 2003, compared to expense of
$3.2 million for 2002. Included in 2003 was income from favorable currency adjustments on a
euro-denominated receivable, joint ventures, royalties, collections of accounts receivable of a
former business that had previously been written off and other miscellaneous items. Other expense
in 2002 included the write-off of approximately $2.5 million related to the original TRAXÔ
platform, which was made obsolete due to the latest generation of this software, which was put
into production on July 1, 2002. The 2002 amount also included a charge of $692,000 to write-off
unamortized loan origination costs associated with the cancellation of our former bank credit
agreement (see Liquidity and Capital Resources below where the replacement facility is
discussed). The income tax expense of $4.2 million for 2003 reflected a higher expense than the statutory
rate due to state income taxes, various non-deductible permanent differences between tax and
financial reporting and a higher foreign income tax rate. The income tax benefit of $4.4 million
for 2002 reflected a lower benefit than the statutory tax rate due to state income taxes and
various non-deductible permanent differences between tax and financial reporting. Cash outflows
for income taxes in 2003 and 2002 totaled $1.2 million and $247,000, respectively, being comprised
of federal alternative minimum taxes, state and foreign taxes. 33




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Liquidity and Capital Resources Operating Activities As of December 31, 2004, we had cash and cash equivalents of $37.4 million. Net cash
provided by continuing operations decreased from $15.5 million in 2003 to $5.7 million in 2004.
The decrease was primarily due to increases in accounts receivable and inventories and a decrease
in accounts payable. The increase in accounts receivable was primarily attributable to the
revenue growth in our Health Enhancement segment. Inventory increased primarily due to shortened
lead-times in our Facet division and to meet revenue growth. In addition, accounts payable
decreased due to reduced payment cycles for one of Facets major vendors. Net cash provided by
continuing operations was $23.2 million in 2002. This was attributable to an increase in accounts
payable and other accrued liabilities and a decrease in accounts receivable. Our accounts receivable days sales outstanding, or DSO, were 52 days as of December 31,
2004, compared to 50 days as of December 31, 2003. The 2004 DSO amount consists of 45 days for
our Health Enhancement segment, compared to 40 days in 2003, and 67 days for our Womens and
Childrens Health segment, compared to 68 days in 2003. The increase in our Health Enhancement
segment was attributable to increased days sales outstanding in our health plan customer
receivables. Net cash flows provided by (used in) operating activities related to the discontinued
operations of our direct to consumer pharmacy, laboratory and supplies business and our former
cardiac event monitoring company, Quality Diagnostic Services, Inc. (QDS), were $3.6 million,
$(3.4) million and $(2.7) million in 2004, 2003 and 2002, respectively. Investing Activities Net cash provided by (used in) investing activities totaled $67.8 million in 2004, $(13.3)
million in 2003 and $(19.6) million in 2002. On June 30, 2004, we completed the sale of substantially all of the assets, excluding trade
and certain other receivables, of our direct-to-consumer diabetic and respiratory supplies
business. At the closing, we received cash proceeds, net of transaction costs, of approximately
$101.1 million. We used approximately $20.5 million of the proceeds we received from the sale to
satisfy the earn-out payment owed to Quality Oncology, and we used
approximately $53 million of
the proceeds we received from the sale to complete the funding of our tender offer for our 11%
Senior Notes. Continuing operations capital expenditures of $9.7 million in 2004, $8.1 million in 2003 and
$9.9 million in 2002 relate primarily to the replacement and enhancement of computer information
systems. Discontinued operations capital expenditures of $456,000 in 2004, $3.4 million in 2003
and $6.2 million in 2002 relate primarily to the pharmacy, laboratory and supplies computer
information systems. The 2003 cash used in investing activities included $603,000 related to our acquisition of
Options Unlimited. In 2004, we paid additional consideration to Options Unlimited of $200,000. In
2002, cash used in investing activities included $3.5 million for the acquisition of two
businesses. In February 2002, we acquired certain assets of ChoicePoints lab business for
$650,000 in cash. After a 120-day period, ChoicePoint reimbursed us $143,000 under a guarantee of
collection of acquired accounts receivable. On September 30, 2002, we acquired QO for initial
consideration of approximately $20 million, consisting of $3 million in cash and approximately
1,335,000 shares of common stock. The common stock is reflected on our balance sheet at a price
of $12.545 per share. The price is the 5-day average of the closing stock prices between June 3
and June 7, 2002, based on a measurement date of June 5, which was the date that the closing stock
price fell below the
$12.765 minimum price in the purchase and sale agreement and the number of shares became
fixed. An 34




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additional 63,000 shares were issued in February 2003 pursuant to a purchase price
adjustment. Additional consideration of $20.5 million cash was paid in 2004 based upon QOs 2003
operating results. In addition, we acquired MarketRing in June 2002 in a non-cash transaction. Our Chairman and
Chief Executive Officer and four other directors of Matria were stockholders of MarketRing. The
terms of the MarketRing acquisition were negotiated by an independent committee of our Board of
Directors and approved by the vote of our disinterested directors. The purchase price was paid by
the issuance of approximately 402,000 shares of our common stock valued at approximately $3.8
million (based on the average closing price of our common stock during the three-day trading
period ended June 14, 2002). In 2003, we issued approximately 39,000 additional shares related
to the acquisition. Restricted
cash increased to $3.8 million in 2004, compared to $455,000 in 2003. In September
2004, we set aside $3.0 million pledged as collateral in an agreement with one of our major
suppliers. The agreement expires in May 2005. Other restricted funds are collateral for
insurance policies and amounts held in escrow related to customer contracts. Generally, such
funds are held in interest-bearing investment accounts or certificates of deposit. Financing Activities Net cash used in financing activities was $49.1 million for 2004, compared to cash provided
by financing activities of $3.2 million and $1.3 million in 2003 and 2002, respectively. On March 29, 2004, we commenced a tender offer for all of our unsecured 11% Senior Notes,
which had an aggregate principal amount of $122 million. We received valid tenders from holders
of $120 million in aggregate principal amount of our 11% Senior Notes. On June 30, 2004, we
completed the repurchase of our 11% Senior Notes tendered in the tender offer with proceeds from
the issuance of convertible senior subordinated notes as described below and with the proceeds
from the sale of assets of the pharmacy and supplies business. The retirement of the 11% Senior
Notes resulted in a net cash payment of $136.5 million. On May 5, 2004, we completed the sale of $75 million in aggregate principal amount of 4.875%
convertible senior subordinated notes due 2024. On June 3, 2004, the initial purchaser of the
notes exercised its option to purchase an additional $11.3 million in aggregate principal amount
of the notes. We received proceeds, net of discount, of $83.2 million from the issuance of the
convertible senior subordinated notes. Under certain circumstances, the convertible senior
subordinated notes are convertible into shares of our common stock at a conversion rate of 50.873
shares per $1,000 principal amount of the notes (equal to an initial conversion price of approximately
$19.64 per share). Interest is payable on May 1 and November 1 of each year, beginning in
November 2004. The convertible senior subordinated notes are unsecured and are guaranteed by
certain of our domestic subsidiaries. We used the proceeds, net of discount, of $83.2 million from
the issuance of the convertible senior subordinated notes and proceeds from the sale of
substantially all of the assets of our direct to consumer diabetic and respiratory supplies
business to fund the repurchase of $120 million in aggregate principal amount of 11% Senior Notes
tendered in the tender offer as described above. In October 2002, we entered into a new revolving credit facility with a borrowing capacity of
the lesser of $35 million or 80% of eligible accounts receivable. The facility is collateralized
by cash, accounts receivable, inventories, intellectual property and certain other of our assets.
Borrowings under this facility bear interest at the LIBOR rate plus
2.9% (5.18% at December 31, 2004), and the facility requires
a non-utilization fee of 0.5% of the unused borrowing capacity. Interest and the commitment fee
are payable monthly. The facility is effective until October 2005. Thereafter, the term will be
automatically extended for annual successive periods unless either party provides notice to the
contrary not less than 60 days prior to the end of the period. We plan to extend the revolving
credit facility or replace it in 2005. As of December 31, 2004, there was no outstanding balance
under this agreement, and approximately $23.1 million was available for borrowing under this credit
facility. Under the revolving credit
facility, we are required to maintain certain financial ratios. As of December 31, 2004, we
were in compliance with the financial covenants in all of our credit instruments. 35




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Proceeds were received from participants under our stock purchase and stock option plans
totaling $6.6 million, $816,000 and $1.9 million in 2004, 2003 and 2002, respectively. We believe that our cash, other liquid assets, operating cash flows and revolving credit
facility, taken together, will provide adequate resources to fund ongoing operating requirements,
planned capital expenditures and contractual obligations through at least 2005. Contractual Obligations, Commitments and Off-Balance Sheet Arrangements We
have various contractual obligations that are appropriately recorded
as liabilities in our
consolidated financial statements. Certain other items, such as operating lease obligations, are
not recognized as liabilities in our consolidated financial statements but are required to be
disclosed. The following sets forth our future minimum payments required under contractual
obligations as of December 31, 2004: Payments Due by Year(Amounts in thousands)Total
    
    
    2005
    
    
    2006-2007
    
    
    2008-2009
    
    
    ThereafterLong-term debt obligations (1)
    
    $
    89,042
    
    
    $
    792
    
    
    $
    
    
    
    $
    2,000
    
    
    $
    86,250Capital lease obligations
    
    
    107
    
    
    
    73
    
    
    
    34
    
    
    
    
    
    
    
    Operating lease obligations
    
    
    19,258
    
    
    
    5,016
    
    
    
    7,863
    
    
    
    5,295
    
    
    
    1,084Other
long-term obligations
    
    
    4,568
    
    
    
    
    
    
    
    
    
    
    
    2,295
    
    
    
    2,273Total
    
    $
    112,975
    
    
    $
    5,881
    
    
    $
    7,897
    
    
    $
    9,590
    
    
    $
    89,607
   (1)
    
    Does not include the interest expense associated with the long-term debt obligations. Interest payments of $4.4 million under our 11% Senior Notes and our convertible senior
subordinated notes will be payable in 2005. Capital expenditures of approximately $11 million are
estimated in 2005 as we continue to enhance our computer information systems. In September 2004, we set aside $3.0 million pledged as collateral in an agreement with one
of our major suppliers. The agreement expires in May 2005. We have other restricted
funds of $823,000 as of December 31, 2004, that are used as collateral for insurance policies and
amounts held in escrow related to customer contracts. Funds are held in interest-bearing
investment accounts or certificates of deposit. As of December 31, 2004, we did not have any significant off-balance sheet arrangements, as
defined in Item 303(a)(4)(ii) of SEC Regulation S-K. Other Factors Affecting Liquidity On October 3, 2003, we filed with the Commission a universal shelf registration statement on
Form S-3 relating to $150 million of common stock, preferred stock, debt securities, depositary
shares, warrants and units. The registration statement became effective on October 28, 2003. We
may publicly offer these securities from time to time at prices and on terms to be determined at
the time of the relevant offerings. We believe that the shelf registration statement will assist
in providing us with flexibility in raising debt and/or equity financing. There can be no
assurance, however, that financing will be available in amounts or on terms acceptable to us, if at
all. Any
sale of additional equity or convertible securities covered by the registration statement
could result in additional dilution to our stockholders. 36




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##### Table of Contents



Uncertainties A qui tamaction has been filed in the United States District Court for the Western District
of Virginia by a former employee of our former domestic pharmacy
and supplies division, against the Company and our subsidiary,
Diabetes Self-Care, Inc. The complaint alleges improper claims by
Diabetes Self-Care, Inc. for Medicare payments and seeks treble
damages and civil penalties in unspecified amounts. As is required by
law, the federal government is conducting an investigation of the complaint to determine if it will
intervene or join in this suit. We are cooperating fully with the investigation. This matter is
still in its preliminary stages, and we are unable to predict the ultimate disposition of the
action or the investigation. We are subject to various legal claims and actions incidental to our business and the
businesses of our predecessors, including product liability claims and professional liability
claims. We maintain insurance, including insurance covering professional and product liability
claims, with customary deductible amounts. There can be no assurance, however, that (i) additional
suits will not be filed against us in the future, (ii) our prior experience with respect to the
disposition of litigation is representative of the results that will occur in pending or future
cases or (iii) adequate insurance coverage will be available at acceptable prices for incidents
arising or claims made in the future. There are no other pending legal or governmental proceedings
to which we are a party that we believe would, if adversely resolved, have a material adverse
effect on us. For a discussion of other risks and uncertainties that may affect our business, see Risk
Factors in Item 1 of this Annual Report. Critical Accounting Estimates A critical accounting estimate meets two criteria: (1) it requires assumptions about highly
uncertain matters; and (2) there would be a material effect on the financial statements from
either using a different, also reasonable, amount within the range of the estimate in the current
period or from reasonably likely period-to-period changes in the estimate. Our critical
accounting estimates are as follows: Revenue Recognition and Allowances for Uncollectible Accounts.Revenues for our Womens and
Childrens Health segment are generated by providing services through patient service centers.
Revenues from this segment are recognized as the related services are rendered and are net of
contractual allowances and related discounts. Our Health Enhancement segment provides services
through its patient service centers, provides supplies to patients, and designs, develops,
assembles, packages and distributes diabetes products. Revenues for services are recognized when
services are provided, and revenues from product sales are recognized when products are shipped.
Revenues from this segment are recorded net of contractual allowances and other discounts. Our clinical services and our foreign supply businesses are reimbursed on a fee-for-service or
per item basis. Other aspects of disease management, however, are paid for primarily on the basis
of (i) monthly fees for each employee or member enrolled in a health plan, (ii) each member
identified with a particular chronic disease or condition under contract, (iii) each member
enrolled in our program or (iv) a fixed rate per case. Billings for certain services occur in
advance of services being performed. Such amounts are recorded as unearned revenues in the balance
sheet, and revenues are recognized as services are performed. Some of the contracts for these
services provide that a portion of our fees is at risk subject to our performance against financial
cost savings and clinical criteria. Thus, a portion of our revenues are accrued in the period the
services are provided and adjusted in future periods when final settlement is determined. These
estimates are continually reviewed and adjusted as information related to performance levels and
associated fees become available. These reviews and adjustments have not resulted in a material
reduction in any recent period of revenue previously reported. In 2004, 3.6% of our revenues
recognized were at risk under these arrangements. A significant portion of our revenues is billed to third-party reimbursement sources.
Accordingly, the ultimate collectibility of a substantial portion of our trade accounts receivable
is susceptible to changes in third-party reimbursement policies. In addition, the collectibility
of all of our accounts receivable varies based on 37




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payor mix, general economic conditions and other
factors. A provision for doubtful accounts is made for revenues estimated to be uncollectible and
is adjusted periodically based upon our evaluation of current industry conditions, historical
collection experience, recoveries of amounts previously provided, industry reimbursement trends,
audit activity and other relevant factors which, in the opinion of management, deserve recognition
in estimating the allowance for uncollectible accounts. The evaluation is performed at each
reporting period for each operating unit with an overall assessment at the consolidated level. The
evaluation of the monthly estimates of revenues estimated to be uncollectible has not resulted in
material adjustments in any recent period; however, special charges have resulted from certain
specific circumstances affecting collectibility. While estimates and judgments are involved and
factors impacting collectibility may change, management believes adequate provision has been made
for any adjustments that may result from final determination of amounts to be collected. Goodwill and Identifiable Intangible Assets.As of December 31, 2004, we reported goodwill
and identifiable intangible assets at carrying amounts of $134.2 million and $1.1 million,
respectively. The total of $135.3 million represents approximately 44% of total assets as of
December 31, 2004. Our identifiable intangible assets are amortized over their respective
estimated useful lives. Our goodwill is no longer amortized to expense. We review goodwill and identifiable intangibles for impairment annually and whenever events or
changes in circumstances indicate that the carrying value may not be recoverable. In testing for
impairment, we calculate the fair value of the reporting units to which the goodwill and
identifiable intangibles relate based on the present value of estimated future cash flows. Based
on the evaluation, management concluded that no impairment of recorded goodwill and intangibles
exists at December 31, 2004. The approach utilized is dependent on a number of factors including
estimates of future revenues and costs, appropriate discount rates and other variables. We base
our estimates on assumptions that we believe to be reasonable, but which are unpredictable and
inherently uncertain. Therefore, future impairments could result if actual results differ from
those estimates. Accounting for Income Taxes.We account for income taxes using an asset and liability
approach. Deferred income taxes are recognized for the tax consequences of temporary
differences by applying enacted statutory tax rates applicable to future years to differences
between the financial statement carrying amounts and the tax bases of existing assets and
liabilities and net operating loss and tax credit carryforwards. Additionally, the effect on
deferred taxes of a change in tax rates is recognized in earnings in the period that includes the
enactment date. The income tax benefit was $2.3 million for 2004 compared to an income tax expense of $4.2
million for 2003. Reflected in 2004 and 2003 were various non-deductible permanent differences
between tax and financial reporting. As of December 31, 2004, our remaining net operating losses
of $36.5 million, the tax effect of which is reflected on the balance sheet in the deferred tax
asset, will be available to offset future taxable income liabilities. Based on projections of
taxable income in 2005 and future years, management believes that it is more likely than not that
we will fully realize the value of the recorded deferred income tax assets. The amount of the
deferred tax asset considered realizable, however, could be reduced if estimates of future taxable
income during the carryforward period are reduced. The above listing is not intended to be a comprehensive list of all of our accounting
policies. In many cases, the accounting treatment of a particular transaction is specifically
dictated by generally accepted accounting principles, with no need for managements judgment in
their application. There are also areas in which managements judgment in selecting any available
alternative would not produce a materially different result. See the Notes to Consolidated
Financial Statements which contain additional accounting policies and other disclosures required
by generally accepted accounting principles. Our senior management has discussed the development and selection of our critical accounting
estimates, and this disclosure, with the Audit Committee of our Board of Directors. 38




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Recently Issued Accounting Standards In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards (SFAS) No. 123R, Share
Based-Payment (SFAS 123R). SFAS 123R establishes
standards for the accounting for transactions in which and entity exchanges its equity instruments
for goods or services. It also addresses transactions in which an entity incurs liabilities in
exchange for goods or services that are based on the fair value of the entitys equity instruments
or that may be settled by the issuance of those equity instruments. This Statement requires a
public entity to measure the costs of employee services received in exchange for an award of equity
instruments based on the grant-date fair value of the award (with limited exceptions). That cost
will be recognized over the period during which an employee is required to provide service in
exchange for the award. This Statement applies to all awards granted after the required effective date and to awards
modified, repurchased or cancelled after that date. Compensation cost will be recognized on or
after the required effective date for the portion of outstanding awards, for which the requisite
service has not been rendered, based on the grant-date fair value of those awards calculated under
SFAS No. 123 for either recognition or pro forma disclosures. The Statement is effective for the
first interim period or annual period that begins after June 15, 2005. We have concluded that SFAS
123R will have a negative impact on our financial position and results of operations. If we elect
the retrospective method, we expect that the impact of expensing existing stock options, as well as
the impact of any anticipated stock option grants and restricted stock awards, to be approximately
$0.10 to $0.15 per share in 2005. If we elect the prospective method, we expect that the impact of
expensing stock options, as well as the impact of any anticipated stock option grants and
restricted stock awards, to be approximately $0.05 to $0.08 per share in 2005. We do not expect the
impact of SFAS 123R to have a material impact on our cash flow or liquidity. See Note 6 to the
consolidated financial statements for assumptions used calculating the fair value of employee stock
options. In November 2004, the FASB issued SFAS No. 151, Inventory Costs (SFAS 151). This Statement
clarifies the accounting for the abnormal amount of idle facilities expense, freight, handling
costs and wasted material. This Statement requires that those items be recognized as
current-period expense. In addition, the Statement requires that allocation of fixed overhead to
the cost of conversion be based on the normal capacity of the production facilities. SFAS 151 is effective for inventory costs incurred after December 31, 2005. We are currently
assessing the impact of SFAS 151 on our financial condition and results of operations. In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets an Amendment of APB
Opinion No. 29 (SFAS 153). SFAS 153 amends the guidance in APB Opinion No. 29 to eliminate the
exception for nonmonetary assets of similar productive assets and replaces it with a general
exception for exchanges of nonmonetary assets that do not have commercial substance. SFAS 153
specifies that a nonmonetary asset has commercial substance if the future cash flows of the entity
are expected to change significantly as a result of the exchange. The provisions of this Statement
shall be effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June
15, 2005 and shall be applied prospectively. We do not expect the impact of SFAS 153 on our
financial position, results of operations or cash flows to be material. In September 2004, the Emerging Issues Task Force reached a consensus on Issue No. 04-08, The
Effect of Contingently Convertible Debt on Diluted Earnings per Share(EITF 04-08) where
contingently convertible instruments should be included in diluted earnings per share, if dilutive,
regardless of whether the market price trigger has been met. This required us to include in the
diluted earnings per share calculation the effect of our issuance of 4.875% convertible senior
subordinated notes in 2004. EITF 04-08 had a $0.01 and $0.02 dilutive effect on our third and
fourth quarters of 2004, respectively, but no effect in our annual calculation since the inclusion
of the shares would have been antidilutive. 39




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Item 7A. Quantitative and Qualitative Disclosure about Market Risk We are exposed to market risk from changes in foreign currency exchange rates. Our operations
outside the United States, with sales denominated in currencies other than the U.S. dollar
(primarily in Germany), generated approximately 22% of total revenues in the year ended December
31, 2004. In the normal course of business, these operations are exposed to fluctuations in
currency values. In addition, we have certain receivables and payables denominated in currencies
other than the U.S. dollar, primarily the euro. We do not consider the impact of currency
fluctuations to represent a significant risk and have chosen not to hedge our foreign currency
exposure. Based on our results for 2004 and balances as of December 31, 2004, a hypothetical 10%
change in the currency exchange rates would impact annual pre-tax earnings by approximately $1.1
million. 40




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Item 8. Financial Statements and Supplementary Data The following Consolidated Financial Statements of the Company and its subsidiaries
 are included as pages
F-1 through F-35 of this Annual Report on Form 10-K: PAGEReport of Independent Registered Public Accounting Firm on
Consolidated Financial Statements
    
    F-1Report of Independent Registered Public Accounting Firm
on Managements Assessment of Internal Controls
    
    F-2Managements Report on Internal Controls Over
Financial Reporting
    
    F-3Consolidated Balance Sheets - December 31, 2004 and 2003
    
    F-4Consolidated Statements of Operations - Years EndedDecember 31, 2004, 2003 and 2002
    
    F-5Consolidated Statements of Shareholders Equity andComprehensive Earnings (Loss) - Years Ended December 31, 2004, 2003 and 2002
    
    F-6Consolidated Statements of Cash Flows - Years EndedDecember 31, 2004, 2003 and 2002
    
    F-7Notes to Consolidated Financial Statements
    
    F-8
 
 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. 
 Item 9A. Controls and Procedures Evaluation of Disclosure Controls and Procedures The Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of
the design and operation of our disclosure controls and procedures (as such term is defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange
Act)) as of December 31, 2004. No process, no matter how well designed and operated, can provide
absolute assurance that the objectives of the process are met in all cases. However, our
disclosure controls and procedures are designed to provide reasonable assurance that the certifying
officers will be alerted on a timely basis to material information relating to the Company
(including the Companys consolidated subsidiaries) required to be included in our reports filed or
submitted under the Exchange Act. Based on such evaluation, such officers have concluded that our disclosure controls and
procedures were effective as of December 31, 2004, to provide reasonable assurance that the
objectives of the disclosure controls and procedures were met. 41




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Managements Report on Internal Control Over Financial Reporting and Report of Independent
Registered Public Accounting Firm Report of Independent Registered Public Accounting Firm on Managements Assessment of Internal
Controls and Managements Report on Internal Control Over Financial Reporting and are included
on pages F-2 and F-3 of this Report. Changes in Internal Control over Financial Reporting There have been no significant changes in the Companys internal control over financial
reporting during the year ended December 31, 2004 that have materially affected, or are reasonably
likely to materially affect, the Companys internal control over financial reporting. 
 Item 9B. Other Information None. 42




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PART III 
 Item 10. Directors and Executive Officers of the Registrant. Information concerning the directors of the Company will be included under the caption
Election of Directors of the Companys Proxy Statement for the 2005 Annual Meeting of
Stockholders to be held on June 1, 2005, to be filed with the Commission and incorporated by
reference herein. Additional information relating to the executive officers of the Company is
included as a Special Item in Part I of this Annual Report on Form 10-K. 
 Item 11. Executive Compensation. Information required by this item will be contained in the Companys Proxy Statement for the
2005 Annual Meeting of Stockholders to be held on June 1, 2005, to be filed with the Commission and
incorporated by reference herein. 
 Item 12. Security Ownership of Certain Beneficial Owners and Management. Information required by this item will be contained in the Companys Proxy Statement for the
2005 Annual Meeting of Stockholders to be held on June 1, 2005, to be filed with the Commission and
incorporated by reference herein. For purposes of determining the aggregate market value of the Companys common stock held by
non-affiliates as shown on the cover page of this report, shares held by all directors and
executive officers of the Company have been excluded. The exclusion of such shares is not intended
to, and shall not, constitute a determination as to which persons may be affiliates of the
Company as defined by the rules of the Commission. 
 Item 13. Certain Relationships and Related Transactions. Information required by this item will be contained in the Companys Proxy Statement for the
2005 Annual Meeting of Stockholders to be held on June 1, 2005, to be filed with the Commission and
incorporated by reference herein. 
 Item 14. Principal Accountant Fees and Services Information required by this item will be contained in the Companys Proxy Statement for the
2005 Annual Meeting of Stockholders to be held on June 1, 2005, to be filed with the Commission and
incorporated by reference herein. 43




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##### Table of Contents



PART IV 
 Item 15. Exhibits and Financial Statement Schedules (a)(1)The following consolidated financial statements of the Company and its subsidiaries
are included as pages F-1 through F-35 of this Annual Report on Form 10-K: PAGEReport
of Independent Registered Public Accounting Firm on Consolidated
Financial Statements
    
    F-1Report of Independent Registered Public Accounting Firm
on Managements Assessment of Internal Controls
    
    F-2Managements Report on Internal Controls Over
Financial Reporting
    
    F-3Consolidated Balance Sheets - December 31, 2004 and 2003
    
    F-4Consolidated
Statements of Operations  Years Ended
December 31, 2004, 2003 and 2002
    
    F-5Consolidated Statements of Shareholders Equity and
Comprehensive Earnings (Loss) - Years Ended December 31, 2004, 2003 and 2002
    
    F-6Consolidated Statements of Cash Flows  Years Ended
December 31, 2004, 2003 and 2002
    
    F-7Notes to Consolidated Financial Statements
    
    F-8
 (a)(2)The following supporting financial statement schedule and report of independent
registered public accounting firm thereon are included as part of this Annual Report on Form 10-K: PAGEReport of Independent Registered Public Accounting Firm
    
    53Schedule II  Valuation and Qualifying Accounts
    
    54
 All other Schedules are omitted because the required information is inapplicable or
information is presented in the Consolidated Financial Statements or related notes. (a)(3) Exhibits: The following exhibits are incorporated by reference herein as part of this Report as
indicated: ExhibitNumber
    
    Description2.1
    
    Asset Purchase Agreement, dated June 22, 2004, by and among Matria Healthcare, Inc., Diabetes
Management Solutions, Inc., Diabetes Self Care, Inc. and DEGC Enterprises (U.S.), Inc.
(incorporated by reference to Exhibit 2.1 to the Companys Current Report on Form 8-K filed July
15, 2004).2.1.1
    
    Amendment No. 1 to Asset Purchase Agreement, dated June 30, 2004, by and among Matria
Healthcare, Inc., Diabetes Management Solutions, Inc., Diabetes Self Care, Inc. and DEGC
Enterprises
(U.S.), Inc. (incorporated by reference to Exhibit 2.2 to the Companys Current Report on Form
8-K filed July 15, 2004).
 44




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ExhibitNumber
    
    Description2.2
    
    Agreement and Plan of Merger and Plan of Reorganization among Matria Healthcare, Inc., Matria
MergerSub, Inc. and Matria Holding Company, Inc., dated December 30, 2004 (incorporated by
reference to Exhibit 10.2 to the Companys Current Report on Form 8-K filed January 6, 2005).3.1
    
    Certificate of Incorporation of Matria Holding Company, Inc., dated as of December 28, 2004
(incorporated by reference to Exhibit 3.1 to the Companys Current Report on Form 8-K filed January
6, 2005).3.2
    
    Certificate of Ownership and Merger merging Matria Mergeco, Inc. with and into Matria Holding
Company, Inc., dated December 31, 2004 (incorporated by reference to Exhibit 3.2 to the Companys
Current Report on Form 8-K filed January 6, 2004).3.3
    
    Bylaws of Matria Healthcare, Inc., dated as of December 28, 2004 (incorporated by reference
to Exhibit 3.3 to the Companys Current Report on Form 8-K filed January 6, 2004).4.1
    
    Indenture, dated as of July 9, 2001, by and among Matria Healthcare, Inc., the Guarantors
named therein and Wells Fargo Minnesota, National Association as Trustee, relating to the
Companys 11% Senior Notes due 2008 (incorporated by reference to Exhibit 99.2 to the
Companys Current Report on Form 8-K filed July 19, 2001).4.2
    
    Registration Rights Agreement, dated as of July 9, 2001, by and among Matria Healthcare,
Inc., the Guarantors named therein and the Initial Purchasers named therein, relating to the
Companys 11% Senior Notes due 2008 (incorporated by reference to Exhibit 99.3 to the
Companys Current Report on Form 8-K filed July 19, 2001).4.3
    
    Waiver and First Amendment to First Amended and Restated Credit Agreement, dated June 13,
2002, among Matria Healthcare, Inc. and certain Lenders named therein, Wachovia Bank, National
Association as the Administrative Agent and Harris Trust and Savings Bank as Co-Agent
(incorporated by reference to Exhibit 4 to the Companys Quarterly Report on Form 10-Q for the
quarter ended June 30, 2002).4.4
    
    Loan and Security Agreement, dated October 22, 2002, between Matria Healthcare, Inc. and HFG
Healthco-4, LLC (incorporated by reference to Exhibit 4 to the Companys Quarterly Report on
Form 10-Q for the quarter ended September 30, 2002).4.5
    
    Supplemental Indenture, dated June 21, 2002, between the Company and Wells Fargo Bank
Minnesota, N.A. (Incorporated by reference to Exhibit 4.10 to the Companys Annual Report on
Form 10-K for the year ended December 31, 2002).4.6
    
    Supplemental Indenture, dated August 1, 2002, between the Company and Wells Fargo Bank
Minnesota, N.A. (Incorporated by reference to Exhibit 4.11 to the Companys Annual Report on
Form 10-K for the year ended December 31, 2002).4.7
    
    Supplemental Indenture, dated October 4, 2002, between the Company and Wells Fargo Bank
Minnesota, N.A. (Incorporated by reference to Exhibit 4.12 to the Companys Annual Report on
Form 10-K for the year ended December 31, 2002).4.8
    
    Amendment No. 1, dated December 31, 2002, to the Loan and Security Agreement, between Matria
Healthcare, Inc. and HFG Healthco-4, LLC. (incorporated by reference to Exhibit 4.13 to the
Companys Annual Report on Form 10-K for the year ended December 31, 2002).
 45




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ExhibitNumber
    
    Description4.9
    
    Interest Rate Swap Agreement dated February 28, 2003, between JP Morgan Chase Bank and Matria
Healthcare, Inc. (incorporated by reference to Exhibit 4.13 to the Companys Annual Report on Form
10-K for the year ended December 31, 2003).4.10
    
    Amendment No. 2, dated December 31, 2003, to the Loan and Security Agreement, between Matria
Healthcare, Inc., and HFG Healthco  4 LLC. (incorporated by reference to Exhibit 4.14 to the
Companys Annual Report on Form 10-K for the year ended December 31, 2003).4.11
    
    Indenture, dated May 5, 2004, among Matria Healthcare, Inc., the Companys subsidiary
guarantors named therein and Wells Fargo Bank, N.A. relating to the Companys Convertible
Subordinated Notes (incorporated by reference to Exhibit 4.1 to the Companys Current Report
on Form 8-K filed May 6, 2004).4.12
    
    Supplemental Indenture, dated April 19, 2004, by and among Matria Healthcare, Inc., the
Companys subsidiary guarantors listed therein and Wells Fargo Bank, N.A. (incorporated by
reference to Exhibit 4.2 to the Companys Quarterly Report on Form 10-Q for the quarter ended June
30, 2004).4.13
    
    Consent and Waiver Agreement and Amendment No. 3, dated April 23, 2004, to the Loan and
Security Agreement between Matria Healthcare, Inc. and HFG Healthco-04, L.L.C. (incorporated by
reference to Exhibit 4.5 to the Companys Quarterly Report on Form 10-Q for the quarter ended June
30, 2004).4.14
    
    Consent and Waiver Agreement and Amendment No. 4, dated April 29, 2004, to the Loan and
Security Agreement between Matria Healthcare, Inc. and HFG Healthco-04, L.L.C. (incorporated by
reference to Exhibit 4.6 to the Companys Quarterly Report on Form 10-Q for the quarter ended June
30, 2004).4.15
    
    Consent and Waiver Agreement and Amendment No. 5, dated June 30, 2004, to the Loan and
Security Agreement between Matria Healthcare, Inc. and HFG Healthco-04, L.L.C. (incorporated by
reference to Exhibit 4.4 to the Companys Quarterly Report on Form 10-Q for the quarter ended June
30, 2004).4.16
    
    Supplemental Indenture, dated December 31, 2004 among Matria Healthcare, Inc., Matria Holding
Company, Inc., the subsidiary guarantors listed therein and Wells Fargo Bank, N.A., as Trustee,
amending the Indenture, dated May 5, 2004 by and among Matria Healthcare, Inc., the subsidiary
guarantors listed therein and Wells Fargo Bank, N.A., as Trustee (incorporated by reference to
Exhibit 4.1 to the Companys Current Report on Form 8-K filed January 6, 2005).4.17
    
    Supplemental Indenture, dated December 31, 2004 among Matria Healthcare, Inc., Matria Holding
Company, Inc., the subsidiary guarantors listed therein and Wells Fargo Bank, N.A., as Trustee,
amending the Indenture, dated July 9, 2001 by and among Matria Healthcare, Inc., the subsidiary
guarantors listed therein and Wells Fargo Bank, N.A., as Trustee (incorporated by reference to
Exhibit 4.2 to the Companys Current Report on Form 8-K filed January 6, 2005).4.18
    
    Rights Agreement between Matria Healthcare, Inc. (formerly Matria Holding Company, Inc.) and
SunTrust Bank, dated December 31, 2004 (incorporated by reference to Exhibit 4.3 to the Companys
Current Report on Form 8-K filed January 6, 2005).*10.1
    
    1996 Stock Incentive Plan (incorporated by reference to Appendix
F-1 to the Joint Proxy Statement/Prospectus filed as a part of the
Companys Registration Statement No. 333-781 on Form S-4 filed on
February 7, 1996).*10.2
    
    1996 Directors Non-Qualified Stock Option Plan (incorporated by
reference to Appendix F-11 to the Joint Proxy Statement/Prospectus
filed as a part of the Companys Registration Statement No. 333-781
on Form S-4 filed on February 7, 1996).
 46




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##### Table of Contents



ExhibitNumber
    
    Description*10.3
    
    2002 Employee Stock Purchase Plan (incorporated by reference to
Appendix D to the Proxy Statement/Prospectus/Solicitation Statement
filed as a part of the Companys Registration Statement No.
333-90944 on Form S-4 filed June 30, 2002).*10.4
    
    1997 Stock Incentive Plan (incorporated by reference to Exhibit A
to the Companys Definitive Proxy Statement filed with the
Commission on April 16, 1998).*10.5
    
    2000 Stock Incentive Plan (incorporated by reference to Exhibit A
to the Companys Definitive Proxy Statement filed with the
Commission on April 14, 2000).*10.6
    
    2000 Directors Non-Qualified Stock Option Plan (incorporated by
reference to the Companys Definitive proxy Statement filed with
the Commission on April 14, 2000).*10.7
    
    Amendment to the 1996 Directors Non-Qualified Stock Option Plan
approved by the Companys stockholders on May 18, 1998
(incorporated by reference to Exhibit 10.23 to the Companys Form
10-K for the year ended December 31, 2000).*10.8
    
    Amendment to the 2000 Directors Non-Qualified Stock Option Plan,
approved by the Companys stockholders on May 24, 2001
(incorporated by reference to the Companys Definitive Proxy
Statement filed with the Commission April 26, 2001).*10.9
    
    2001 Stock Incentive Plan (incorporated by reference to the
Companys Definitive Proxy Statement filed with the Commission
April 26, 2001).*10.10
    
    2002 Stock Incentive Plan (incorporated by reference to Appendix C
to the Prospectus/Proxy Statement/Solicitation Statement filed as
part of the Companys Registration Statement No. 333-90944 on Form
S-4 filed June 21, 2002).*10.11
    
    MarketRing.com, Inc. 1999 Stock Option and Stock Appreciation
Rights Plan, effective September 30, 1999, assumed by the Company
(incorporated by reference to Exhibit 10.1 to the Companys
Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).*10.12
    
    MarketRing.com, Inc. Amendment No. 1 to 1999 Stock Option and Stock
Appreciation Rights Plan, dated July 14, 2000, assumed by the
Company (incorporated by reference to Exhibit 10.2 to the Companys
Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).*10.13
    
    Change in Control Severance Compensation and Restrictive Covenant
Agreement between the Company and Parker H. Petit, effective
February 19, 2002 (incorporated by reference to Exhibit 10.3 to the
Companys Quarterly Report on Form 10-Q for the quarter ended June
30, 2002).*10.14
    
    Employment Letter Agreement, dated August 5, 2002, between the
Company and Stephen M. Mengert (incorporated by reference to
Exhibit 10.1 to the Companys Quarterly Report on Form 10-Q for the
quarter ended September 30, 2002).10.15
    
    NewMarket Building Lease Agreement, dated September 4, 2002, between Matria Healthcare, Inc.
and Trizec Realty, Inc. (incorporated by reference to Exhibit 10.2 to the Companys Quarterly
Report on Form 10-Q for the quarter ended September 30, 2002).10.16
    
    One Parkway Center Lease Agreement, dated November 8, 2002, between Matria Healthcare, Inc.
and Atlanta Parkway Investment Group, Inc. (incorporated by reference to Exhibit 10.3 to the
Companys Quarterly Report on Form 10-Q for the quarter ended September 30, 2002).
 47




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ExhibitNumber
    
    Description*10.17
    
    Split Dollar Termination Agreement between the Company and Roberta
L. McCaw, dated January 1, 2003 (incorporated by reference to
Exhibit 10.27 to the Companys Annual Report on Form 10-K for the
year ended December 31, 2002).*10.18
    
    Split Dollar Termination Agreement between the Company and Thornton
A. Kuntz, Jr., dated January 1, 2003 (incorporated by reference to
Exhibit 10.28 to the Companys Annual Report on Form 10-K for the
year ended December 31, 2002).*10.19
    
    Split Dollar Termination Agreement between the Company and Parker
H. Petit, dated January 1, 2003 (incorporated by reference to
Exhibit 10.29 to the Companys Annual Report on Form 10-K for the
year ended December 31, 2002).*10.20
    
    Split Dollar Termination Agreement between the Company and Yvonne
V. Scoggins, dated January 1, 2003 (incorporated by reference to
Exhibit 10.30 to the Companys Annual Report on Form 10-K for the
year ended December 31, 2002).*10.21
    
    Supplemental Executive Retirement Plan between the Company and
Roberta L. McCaw, dated January 1, 2003 (incorporated by reference
to Exhibit 10.31 to the Companys Annual Report on Form 10-K for
the year ended December 31, 2002).*10.22
    
    Supplemental Executive Retirement Plan between the Company and
Thornton A. Kuntz, Jr., dated January 1, 2003 (incorporated by
reference to Exhibit 10.32 to the Companys Annual Report on Form
10-K for the year ended December 31, 2002).*10.23
    
    Supplemental Executive Retirement Plan between the Company and
Yvonne V. Scoggins, dated January 1, 2003 (incorporated by
reference to Exhibit 10.33 to the Companys Annual Report on Form
10-K for the year ended December 31, 2002).*10.24
    
    Change in Control Severance Compensation and Restrictive Covenant
Agreement between the Company and Thomas S. Hall, dated March 14,
2003 (incorporated by reference to Exhibit 10.34 to the Companys
Annual Report on Form 10-K for the year ended December 31, 2002).*10.25
    
    Change in Control Severance Compensation and Restrictive Covenant
Agreement between the Company and Stephen M. Mengert, dated March
17, 2003 (incorporated by reference to Exhibit 10.35 to the
Companys Annual Report on Form 10-K for the year ended December
31, 2002).*10.26
    
    Employment Letter Agreement, dated October 22, 2002, between the
Company and Thomas S. Hall (incorporated by reference to Exhibit
10.36 to the Companys Annual Report on Form 10-K for the year
ended December 31, 2002).*10.27
    
    Trust Under the Matria Healthcare, Inc. Supplemental Executive
Retirement Plan, dated February 4, 2003 (incorporated by reference
to Exhibit 10.37 to the Companys Annual Report on Form 10-K for
the year ended December 31, 2002).*10.28
    
    First Amendment to the Trust under the Matria Healthcare, Inc. Supplemental Retirement Plan
effective February 4, 2003 (incorporated by reference to Exhibit 10 to the Companys Quarterly
Report on Form 10-Q for the quarter ended March 31, 2003.)10.29
    
    First Amendment of Lease, dated May 9, 2003, to the New Market Building Lease Agreement
between Matria Healthcare, Inc. and Trizec Realty, Inc. (incorporated by reference to Exhibit 10 to
the Companys Quarterly Report on Form 10-Q for the quarter ended June 30, 2003).
 48




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ExhibitNumber
    
    Description10.30
    
    First Amendment to Lease Agreement dated December 11, 2003, by and between Atlanta Parkway
Investment Group, Inc., and Matria Healthcare, Inc. (incorporated by reference to Exhibit 10.34 to
the Companys Annual Report on Form 10-K for the year ended December 31, 2003).10.31
    
    Second Amendment to Lease Agreement dated December 11, 2003, between Atlanta Parkway
Investment Group, Inc., and Matria Healthcare, Inc. (incorporated by reference to Exhibit 10.35 to
the Companys Annual Report on Form 10-K for the year ended December 31, 2003).10.32
    
    Matrias Board of Directors Corporate Governance and Nominating Charter (incorporated by
reference to Exhibit 10.36 to the Companys Annual Report on Form 10-K for the year ended December
31, 2003).10.33
    
    Matrias Corporate Governance Guidelines (incorporated by reference to Exhibit 10.37 to the
Companys Annual Report on Form 10-K for the year ended December 31, 2003).10.34
    
    Matrias Charter of the Audit Committee of the Board of Directors (incorporated by reference
to Exhibit 10.38 to the Companys Annual Report on Form 10-K for the year ended December 31, 2003).*10.35
    
    Change in Control Severance Compensation and Restrictive Covenant Agreement dated as of
February 19, 2002 between the Company and Thornton A. Kuntz, Jr., (incorporated by reference to
Exhibit 10.39 to the Companys Annual Report on Form 10-K for the year ended December 31, 2003).*10.36
    
    Change in Control Severance Compensation and Restrictive Covenant Agreement dated as of
February 19, 2002 between the Company and Roberta L. McCaw (incorporated by reference to Exhibit
10.40 to the Companys Annual Report on Form 10-K for the year ended December 31, 2003).*10.37
    
    Change in Control Severance Compensation and Restrictive Covenant Agreement dated as of
February 19, 2002 between the Company and Yvonne V. Scoggins (incorporated by reference to Exhibit
10.41 to the Companys Annual Report on Form 10-K for the year ended December 31, 2003).* 10.3
    
    8 Severance Compensation and Restrictive Covenant Agreement dated as of April 27, 2002
between the Company and Yvonne V. Scoggins (incorporated by reference to Exhibit 10.42 to the
Companys Annual Report on Form 10-K for the year ended December 31, 2003).10.39
    
    Second Amendment of Lease, dated February 3, 2004, to the New Market Building Lease between
Matria Healthcare, Inc., and Trizec Realty, Inc., (incorporated by reference to Exhibit 10.43 to
the Companys Annual Report on Form 10-K for the year ended December 31, 2003).10.40
    
    Registration Rights Agreement, dated May 5, 2004, by and among the Company, the Companys
subsidiary guarantors named therein and UBS Securities LLC (incorporated by reference to Exhibit
10.1 to the Companys Current Report on Form 8-K filed May 6, 2004).*10.41
    
    Amendment to the Severance Compensation and Restrictive Covenant Agreement between the
Company and Yvonne V. Scoggins, dated April 22, 2004 (incorporated by reference to Exhibit 10.1 to
the Companys Quarterly Report on Form 10-Q for the quarter ended June 30, 2004).*10.42
    
    Amendment to Change in Control Severance Compensation and Restrictive Covenant Agreement
between the Company and Yvonne V. Scoggins, dated April 22, 2004 (incorporated by reference to
Exhibit 10.2 to the Companys Quarterly Report on Form 10-Q for the quarter ended June 30, 2004).10.43
    
    Amendment to the Matria Healthcare, Inc. 2000 Directors Non-Qualified Stock Option Plan
(incorporated by reference to Exhibit 10.3 to the Companys Quarterly Report on Form 10-Q for the
quarter ended June 30, 2004).
 49




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ExhibitNumber
    
    Description10.44
    
    Third Amendment of Lease, dated March 30, 2004, to the New Market Building Lease between the
Company and Trizec Realty, Inc. (incorporated by reference to Exhibit 10.4 to the Companys
Quarterly Report on Form 10-Q for the quarter ended June 30, 2004).10.45
    
    Matria Healthcare, Inc. Form of Stock Option Agreement (incorporated by reference to Exhibit
10 to the Companys Quarterly Report on Form 10-Q for the quarter ended September 30, 2004).10.46
    
    Consent and Waiver Agreement and Amendment No. 6, dated December 31, 2004, to the Loan and
Security Agreement between Matria Healthcare, Inc. and HFG Healthco-04, LLC. (incorporated by
reference to Exhibit 10.1 to the Companys Current Report on Form 8-K filed January 6, 2005).10.47
    
    Guarantee, dated as of January 21, 2005, by Matria Healthcare, Inc. in favor of HFG
Healthco-4 LLC (incorporated by reference to Exhibit 10.1 to the Companys Current Report on
Form 8-K filed January 27, 2005).10.48
    
    Pledge Agreement, dated as of January 21, 2005, between Matria Healthcare, Inc., and HFG
Healthco-4 LLC (incorporated by reference to Exhibit 10.2 to the Companys Current Report on
Form 8-k filed January 27, 2005).14
    
    Code of Conduct of Matria Healthcare, Inc., as amended October 19, 2004 (incorporated by
reference to Exhibit 14 to the Companys Current Report on Form 8-K filed October 25, 2004).
 The following exhibits are filed as part of this Report: 11
    
    Computation of Earnings (Loss) per Share.21
    
    List of Subsidiaries.23
    
    Consent of Independent Registered Public Accounting Firm24
    
    Power of Attorney (included in signature page to this report).31.1
    
    Rule 13.a-15(e)/15d-15(e) Certification by Parker H. Petit31.2
    
    Rule 13.a-15(e)/15d-15(e) Certification by Stephen M. Mengert32.1
    
    Section 1350 Certification by Parker H. Petit32.2
    
    Section 1350 Certification by Stephen M. Mengert
   *Management contract or compensatory plan or arrangement 50




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##### Table of Contents



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. MATRIA HEALTHCARE, INC.March 14, 2005
    
    By:
    
    /s/ Parker H. PetitParker H. PetitChairman of the Board andChief Executive Officer(Principal Executive Officer)/s/ Stephen M. MengertStephen M. Mengert, Vice President Finance and Chief Financial Officer(Principal Financial Officer)/s/ Joseph A. BlankenshipJoseph A. BlankenshipVice President  Controller(Principal Accounting Officer)
 KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and
appoints Parker H. Petit as his or her true and lawful attorney-in-fact and agent, with full power
of substitution and re-substitution, for and in his or her name, place and stead, in any and all
capacities, to sign any and all amendments to this Annual Report on 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 unto said attorney-in-fact and agent full power and authority to
do and to perform each and every act and thing requisite and necessary to be done in and about the
premises, as fully and to all intents and purposes as he or she might or would do in person, hereby
ratifying and confirming all that said attorney-in-fact and agent, 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. Signature
    
    Title
    
    Date/s/ Parker H. Petit
    
    Chairman of the Board
    
    March 14, 2005Parker H. Petit
    
    and Chief Executive Officer/s/ Joseph G. Bleser
    
    Director
    
    March 14, 2005Joseph G. Bleser
 51




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##### Table of Contents



Signature
    
    Title
    
    Date/s/ Frederick E. Cooper
    
    Director
    
    March 11, 2005Frederick E. Cooper/s/ Guy W. Millner
    
    Director
    
    March 14, 2005Guy W. Millner/s/ Carl E. Sanders
    
    Director
    
    March 11, 2005Carl E. Sanders/s/ Thomas S. Stribling
    
    Director
    
    March 13, 2005Thomas S. Stribling/s/ Donald W. Weber
    
    Director
    
    March 11, 2005Donald W. Weber/s/ Morris S. Weeden
    
    Director
    
    March 13, 2005Morris S. Weeden/s/ Frederick P. Zuspan, M.D.
    
    Director
    
    March 13, 2005Frederick P. Zuspan, M.D./s/ Wayne P. Yetter
    
    Director
    
    March 14, 2005Wayne P. Yetter
 52




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Report of Independent Registered Public Accounting Firm The Board of Directors and Shareholders
Matria Healthcare, Inc.: Under date of March 14, 2005, we reported on the consolidated balance sheets of Matria Healthcare,
Inc. and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of
operations, shareholders equity and comprehensive earnings (loss) and cash flows for each of the
years in the three-year period ended December 31, 2004, as contained in the 2004 annual report to
shareholders. These consolidated financial statements and our report thereon are included in the
annual report on Form 10-K for the year 2004. In connection with our audits of the aforementioned
consolidated financial statements, we also audited the related financial statement schedule as
listed in the accompanying index. This financial statement schedule is the responsibility of the
Companys management. Our responsibility is to express an opinion on this financial statement
schedule based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly, in all material respects, the
information set forth therein. /s/ KPMG LLP Atlanta, GeorgiaMarch 14, 2005 53




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Matria Healthcare, Inc. and Subsidiaries 
 Schedule II
 Valuation and Qualifying Accounts
  AdditionsBalance at
    
    
    Charges to
    
    
    Charges to
    
    
    
    
    
    
    Balance atBeginning
    
    
    Costs and
    
    
    Other
    
    
    
    
    
    
    End ofDescription
    
    of Period
    
    
    Expenses
    
    
    Accounts
    
    
    Deductions
    
    
    PeriodAllowance for doubtful accountsYear ended December 31, 2002
    
    $
    3,776
    
    
    
    5,554
    
    
    
    55
    1
    
    
    (6,721
    )
    
    $
    2,664Year ended December 31, 2003
    
    $
    2,664
    
    
    
    3,413
    
    
    
    
    
    
    
    (3,017
    )
    
    $
    3,060Year ended December 31, 2004
    
    $
    3,060
    
    
    
    2,550
    
    
    
    
    
    
    
    (3,054
    )
    
    $
    2,556
   1 Represents beginning balances in allowance for doubtful accounts of acquired
companies. 54




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Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements The Board of Directors and Shareholders
Matria Healthcare, Inc.: We have audited the accompanying consolidated balance sheets of Matria Healthcare, Inc. and
subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of
operations, shareholders equity and comprehensive earnings (loss), and cash flows for each of the
years in the three-year period ended December 31, 2004. These consolidated financial statements are
the responsibility of the Companys management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Matria Healthcare, Inc. and subsidiaries as of
December 31, 2004 and 2003, and the results of their operations and their cash flows for each of
the years in the three-year period ended December 31, 2004, in conformity with

U.S. generally accepted accounting
principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the effectiveness of Matria Healthcare, Inc. and subsidiaries internal
control over financial reporting as of December 31, 2004, based on criteria established in Internal
ControlIntegrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), and our report dated March 14, 2005, expressed an unqualified opinion on
managements assessment of, and the effective operation of, internal control over financial
reporting. /s/ KPMG LLP Atlanta, Georgia
March 14, 2005 F-1




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Report of Independent Registered Public Accounting Firm on Managements Assessment of Internal
Controls The Board of Directors and Shareholders
Matria Healthcare, Inc.: We have audited managements assessment, included in the accompanying Managements Report on
Internal Control Over Financial Reporting, that Matria Healthcare, Inc. and subsidiaries maintained
effective internal control over financial reporting as of December 31, 2004, based on criteria
established in Internal ControlIntegrated Frameworkissued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). The Companys management is responsible for
maintaining effective internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting. Our responsibility is to express an
opinion on managements assessment and an opinion on the effectiveness of 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, evaluating managements assessment, testing and evaluating the
design and operating effectiveness of internal control, 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 to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles. A
companys internal control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (2) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of management and directors of the company;
and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the companys assets that could have a material effect on the
financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate. In our opinion, managements assessment that Matria Healthcare, Inc. and subsidiaries maintained
effective internal control over financial reporting as of December 31, 2004, is fairly stated, in
all material respects, based on criteria established in Internal ControlIntegrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our
opinion, Matria Healthcare, Inc. and subsidiaries maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2004, based on criteria established in
Internal ControlIntegrated Frameworkissued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the consolidated balance sheets of Matria Healthcare, Inc. and subsidiaries
as of December 31, 2004 and 2003, and the related consolidated statements of operations,
shareholders equity and comprehensive earnings (loss), and cash flows for each of the years in the
three-year period ended December 31 2004, and our report dated March 14, 2005, expressed an
unqualified opinion on those consolidated financial statements. /s/ KPMG LLP Atlanta, Georgia
March 14, 2005 F-2




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Managements Report on Internal Control Over Financial Reporting The management of Matria Healthcare, Inc. (the Company) is responsible for establishing
and maintaining adequate internal control over financial reporting
as defined in Rule 13a-15(f)
under the Securities Exchange Act of 1934. The Company maintains accounting and internal control
systems which are intended to provide reasonable assurance that assets are safeguarded against loss
from unauthorized use or disposition, transactions are executed in accordance with managements
authorization and accounting records are reliable for preparing financial statements in accordance
with accounting principles generally accepted in the United States of America. Internal control over financial reporting cannot provide absolute assurance of achieving
financial reporting objectives because of its inherent limitations. Internal control over
financial reporting is a process that involves human diligence and compliance and is subject to
lapses in judgment and breakdowns resulting from human failures. Internal control over financial
reporting also can be circumvented by collusion or improper management override. Because of such
limitations, there is a risk that material misstatements may not be prevented or detected on a
timely basis by internal control over financial reporting. However, these inherent limitations are
known features of the financial reporting process. Therefore, it is possible to design into the
process safeguards to reduce, though not eliminate, risk. The Companys management assessed the effectiveness of the Companys internal control over
financial reporting as of December 31, 2004. In making this assessment, management used the
criteria set forth by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission
in Internal Control  Integrated Framework. Based on our assessment management believes that, as of December 31, 2004, the Companys
internal control over financial reporting is effective based on those criteria. Managements assessment of the effectiveness of internal control over financial reporting as
of December 31, 2004, has been audited by KPMG LLP, the independent registered public accounting
firm who also audited the Companys consolidated financial statements. KPMG LLPs attestation
report on managements assessment of the Companys internal control over financial reporting
appears on page F-2 hereof. /s/ Parker H. Petit
    
    
    
    /s/ Stephen M. MengertParker H. Petit
    
    
    
    Stephen M. MengertChairman of the Board and
    
    
    
    Vice President  Finance andChief Executive Officer
    
    
    
    Chief Financial Officer
 F-3




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##### Table of Contents



MATRIA HEALTHCARE, INC. AND SUBSIDIARIES 
 Consolidated Balance Sheets
  December 31,2004
    
    
    2003ASSETSCurrent assets:Cash and cash equivalents
    
    $
    37,385
    
    
    $
    8,553Restricted cash
    
    
    3,823
    
    
    
    455Trade accounts receivable, less allowances of $2,556 and
$3,060 at December 31, 2004 and 2003, respectively
    
    
    45,603
    
    
    
    37,274Inventories
    
    
    25,200
    
    
    
    22,261Other receivables, net
    
    
    3,678
    
    
    
    28,888Assets of discontinued operation sold
    
    
    
    
    
    
    36,609Prepaid expenses and other current assets
    
    
    4,178
    
    
    
    3,626Deferred income taxes
    
    
    9,675
    
    
    
    6,664Total current assets
    
    
    129,542
    
    
    
    144,330Property and equipment, net
    
    
    22,881
    
    
    
    19,228Intangible assets, net
    
    
    135,309
    
    
    
    135,265Deferred income taxes
    
    
    11,704
    
    
    
    26,524Other assets
    
    
    5,046
    
    
    
    8,135$
    304,482
    
    
    $
    333,482LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Current installments of long-term debt
    
    $
    865
    
    
    $
    803Accounts payable, principally trade
    
    
    31,202
    
    
    
    40,977Accrued liabilities
    
    
    21,566
    
    
    
    41,339Total current liabilities
    
    
    53,633
    
    
    
    83,119Long-term debt, excluding current installments
    
    
    85,751
    
    
    
    121,005Other long-term liabilities
    
    
    5,438
    
    
    
    5,811Total liabilities
    
    
    144,822
    
    
    
    209,935Shareholders equity:Common stock, $.01 par value. Authorized 25,000 shares; issued and
outstanding 15,860 and 15,284 at December 31, 2004 and 2003, respectively
    
    
    159
    
    
    
    153Additional paid-in capital
    
    
    321,181
    
    
    
    313,047Accumulated deficit
    
    
    (162,989
    )
    
    
    (190,055
    )Accumulated other comprehensive earnings
    
    
    1,309
    
    
    
    402Total shareholders equity
    
    
    159,660
    
    
    
    123,547Commitments and contingencies (Notes 3, 7, 8 and 9)
    
    $
    304,482
    
    
    $
    333,482
 See accompanying notes to consolidated financial statements. F-4




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##### Table of Contents



MATRIA HEALTHCARE, INC. AND SUBSIDIARIES 
 Consolidated Statements of Operations
  Years ended December 31,2004
    
    
    2003
    
    
    2002RevenuesNet revenues from services
    
    $
    208,731
    
    
    $
    176,685
    
    
    $
    144,331Net sales of products
    
    
    85,651
    
    
    
    75,638
    
    
    
    68,281Total revenues
    
    
    294,382
    
    
    
    252,323
    
    
    
    212,612Cost of revenuesCost of services
    
    
    113,059
    
    
    
    97,742
    
    
    
    77,926Cost of goods sold
    
    
    56,686
    
    
    
    50,325
    
    
    
    47,263Total cost of revenues
    
    
    169,745
    
    
    
    148,067
    
    
    
    125,189Selling and administrative expenses
    
    
    95,898
    
    
    
    78,236
    
    
    
    70,291Charges from termination of retirement plan
    
    
    
    
    
    
    
    
    
    
    14,247Provision for doubtful accounts
    
    
    2,550
    
    
    
    3,413
    
    
    
    5,554Total operating expenses
    
    
    268,193
    
    
    
    229,716
    
    
    
    215,281Operating earnings (loss) from continuing operations
    
    
    26,189
    
    
    
    22,607
    
    
    
    (2,669
    )Interest income
    
    
    499
    
    
    
    484
    
    
    
    416Interest expense
    
    
    (10,292
    )
    
    
    (14,326
    )
    
    
    (14,040
    )Other income (expense), net
    
    
    939
    
    
    
    1,466
    
    
    
    (3,160
    )Loss on retirement of 11% Senior Notes
    
    
    (22,886
    )
    
    
    
    
    
    
    Earnings (loss) from continuing operations before income taxes
    
    
    (5,551
    )
    
    
    10,231
    
    
    
    (19,453
    )Income tax benefit (expense)
    
    
    2,337
    
    
    
    (4,221
    )
    
    
    4,413Earnings (loss) from continuing operations
    
    
    (3,214
    )
    
    
    6,010
    
    
    
    (15,040
    )Earnings (loss) from discontinued operations, net of income taxes
    
    
    (658
    )
    
    
    1,296
    
    
    
    (728
    )Earnings (loss) from disposal of discontinued operations, net of income taxes
    
    
    30,938
    
    
    
    
    
    
    
    (558
    )Net earnings (loss)
    
    $
    27,066
    
    
    $
    7,306
    
    
    $
    (16,326
    )Net earnings (loss) per common share:Basic:Continuing operations
    
    $
    (0.21
    )
    
    $
    0.40
    
    
    $
    (1.08
    )Discontinued operations
    
    
    1.95
    
    
    
    0.08
    
    
    
    (0.09
    )$
    1.74
    
    
    $
    0.48
    
    
    $
    (1.17
    )Diluted:Continuing operations
    
    $
    (0.21
    )
    
    $
    0.39
    
    
    $
    (1.08
    )Discontinued operations
    
    
    1.95
    
    
    
    0.08
    
    
    
    (0.09
    )$
    1.74
    
    
    $
    0.47
    
    
    $
    (1.17
    )Weighted average shares outstanding:Basic
    
    
    15,520
    
    
    
    15,198
    
    
    
    13,964Diluted
    
    
    15,520
    
    
    
    15,542
    
    
    
    13,964
 See accompanying notes to consolidated financial statements . F-5




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MATRIA HEALTHCARE, INC. AND SUBSIDIARIES 
 Consolidated Statements of Shareholders Equity and Comprehensive Earnings (Loss)
 (Amounts in
thousands)
 NotesAccumulated Other
    
    
    ReceivableAdditional
    
    
    
    
    
    
    Comprehensive Earnings (Loss)
    
    
    and Accrued
    
    
    TotalCommon stock
    
    
    Paid-in
    
    
    Accumulated
    
    
    Translation
    
    
    Unrealized
    
    
    Interest from
    
    
    Shareholders
    
    
    ComprehensiveShares
    
    
    Amount
    
    
    Capital
    
    
    Deficit
    
    
    Adjustment
    
    
    Appreciation
    
    
    Shareholder
    
    
    Equity
    
    
    Earnings (Loss)Balance, January 1, 2002
    
    
    13,391
    
    
    $
    134
    
    
    $
    290,025
    
    
    $
    (181,035
    )
    
    $
    (726
    )
    
    $
    34
    
    
    $
    (3,535
    )
    
    $
    104,897Issuance of common stock:Exercise of employee stock options
    
    
    122
    
    
    
    1
    
    
    
    1,715
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,716Employee stock purchase plan
    
    
    15
    
    
    
    
    
    
    
    215
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    215Acquisition of businesses
    
    
    1,737
    
    
    
    17
    
    
    
    19,823
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    19,840Tax benefit from exercise of employee stock options
    
    
    
    
    
    
    
    
    
    
    250
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    250Retirement of note receivable from shareholder
    
    
    (188
    )
    
    
    (1
    )
    
    
    (1,026
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,535
    
    
    
    2,508Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (16,326
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (16,326
    )
    
    $
    (16,326
    )Change in
foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    688
    
    
    
    
    
    
    
    
    
    
    
    688
    
    
    
    688Change in unrealized appreciation on available-for-sale securities,
net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8
    )
    
    
    
    
    
    
    (8
    )
    
    
    (8
    )Balance, December 31, 2002
    
    
    15,077
    
    
    
    151
    
    
    
    311,002
    
    
    
    (197,361
    )
    
    
    (38
    )
    
    
    26
    
    
    
    
    
    
    
    113,780
    
    
    $
    (15,646
    )Issuance of common stock:Exercise of employee stock options
    
    
    44
    
    
    
    
    
    
    
    442
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    442Employee stock purchase plan
    
    
    62
    
    
    
    1
    
    
    
    373
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    374Acquisition of businesses
    
    
    101
    
    
    
    1
    
    
    
    1,220
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,221Tax benefit from exercise of employee stock options
    
    
    
    
    
    
    
    
    
    
    10
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10Net earnings
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,306
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,306
    
    
    $
    7,306Change in foreign
currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    440
    
    
    
    
    
    
    
    
    
    
    
    440
    
    
    
    440Change in
unrealized application on available for sale securities, net of loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (26
    )
    
    
    
    
    
    
    (26
    )
    
    
    (26
    )Balance, December 31, 2003
    
    
    15,284
    
    
    
    153
    
    
    
    313,047
    
    
    
    (190,055
    )
    
    
    402
    
    
    
    
    
    
    
    
    
    
    
    123,547
    
    
    $
    7,720Issuance of common stock:Exercise of employee stock options
    
    
    527
    
    
    
    5
    
    
    
    6,014
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6 019Employee stock purchase plan
    
    
    49
    
    
    
    1
    
    
    
    588
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    589Tax benefit from exercise of employee stock options
    
    
    
    
    
    
    
    
    
    
    1,532
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,532Net earnings
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    27,066
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    27,066
    
    
    $
    27,066Change in foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    907
    
    
    
    
    
    
    
    
    
    
    
    907
    
    
    
    907Balance, December 31, 2004
    
    
    15,860
    
    
    $
    159
    
    
    $
    321,181
    
    
    $
    (162,989
    )
    
    $
    1,309
    
    
    
    
    
    
    
    
    
    
    
    159,660
    
    
    $
    27,973
 See accompanying notes to consolidated financial statements F-6




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MATRIA HEALTHCARE, INC. AND SUBSIDIARIES 
 Consolidated Statements of Cash Flows
  Years ended December 31,2004
    
    
    2003
    
    
    2002Cash Flows from Operating Activities:Net earnings (loss)
    
    $
    27,066
    
    
    $
    7,306
    
    
    $
    (16,326
    )Less, earnings (loss) from discontinued operations, net of income taxes
    
    
    30,280
    
    
    
    1,296
    
    
    
    (1,286
    )Earnings (loss) from continuing operations
    
    
    (3,214
    )
    
    
    6,010
    
    
    
    (15,040
    )Adjustments to reconcile to net cash provided by operating activities:Loss on retirement of 11% Senior Notes
    
    
    22,886
    
    
    
    
    
    
    
    Depreciation and amortization
    
    
    5,643
    
    
    
    6,126
    
    
    
    6,223Amortization of debt discount and expenses
    
    
    939
    
    
    
    1,092
    
    
    
    1,903Provision for doubtful accounts
    
    
    2,550
    
    
    
    3,413
    
    
    
    5,554Deferred tax expense (benefit)
    
    
    (5,960
    )
    
    
    1,758
    
    
    
    (5,719
    )Income (loss) from termination of interest rate swap agreements
    
    
    (993
    )
    
    
    
    
    
    
    3,053Non-cash charges from termination of retirement plan
    
    
    
    
    
    
    
    
    
    
    9,409Non-cash loss on settlement of note receivable
    
    
    
    
    
    
    
    
    
    
    2,508Non-cash write-off of computer software
    
    
    
    
    
    
    
    
    
    
    2,494Gain on sale of investment
    
    
    
    
    
    
    (56
    )
    
    
    Changes in assets and liabilities, net of effect of acquisitions:Trade accounts receivable
    
    
    (10,880
    )
    
    
    (8,004
    )
    
    
    2,178Inventories
    
    
    (2,939
    )
    
    
    421
    
    
    
    (4,858
    )Prepaid expenses
    
    
    (413
    )
    
    
    288
    
    
    
    (983
    )Other current assets
    
    
    1,403
    
    
    
    (929
    )
    
    
    1,201Intangible and other noncurrent assets
    
    
    (1,027
    )
    
    
    (1,371
    )
    
    
    (2,196
    )Accounts payable
    
    
    (2,973
    )
    
    
    5,556
    
    
    
    10,429Accrued and other liabilities
    
    
    641
    
    
    
    1,233
    
    
    
    7,067Net cash provided by continuing operations
    
    
    5,663
    
    
    
    15,537
    
    
    
    23,223Net cash provided by (used in) discontinued operations
    
    
    3,640
    
    
    
    (3,394
    )
    
    
    (2,701
    )Net cash provided by operating activities
    
    
    9,303
    
    
    
    12,143
    
    
    
    20,522Cash Flows from Investing Activities:Purchases of property and equipment
    
    
    (9,709
    )
    
    
    (8,090
    )
    
    
    (9,943
    )Purchases of property and equipment related to discontinued operations
    
    
    (456
    )
    
    
    (3,422
    )
    
    
    (6,157
    )Proceeds from disposition of business, net of transaction costs
    
    
    101,055
    
    
    
    
    
    
    
    Payment of acquisition obligation
    
    
    (20,480
    )
    
    
    
    
    
    
    Increase in restricted cash
    
    
    (3,368
    )
    
    
    (455
    )
    
    
    Net proceeds from (purchases of) investments
    
    
    927
    
    
    
    (927
    )
    
    
    Acquisition of businesses, net of cash acquired
    
    
    (200
    )
    
    
    (603
    )
    
    
    (3,526
    )Proceeds from sales of short-term investments
    
    
    
    
    
    
    154
    
    
    
    Net cash provided by (used in) investing activities
    
    
    67,769
    
    
    
    (13,343
    )
    
    
    (19,626
    )Cash Flows from Financing Activities:Proceeds from issuance of convertible senior debt, net of issuance costs
    
    
    83,210
    
    
    
    
    
    
    
    Proceeds from issuance of debt
    
    
    2,446
    
    
    
    1,919
    
    
    
    1,462Net payment for the retirement of 11% Senior Notes
    
    
    (136,518
    )
    
    
    
    
    
    
    Principal repayments of long-term debt
    
    
    (2,475
    )
    
    
    (1,973
    )
    
    
    (2,017
    )Net borrowings (repayments) under credit agreement
    
    
    (2,418
    )
    
    
    2,418
    
    
    
    Proceeds from issuance of common stock
    
    
    6,608
    
    
    
    816
    
    
    
    1,858Net cash provided by (used in) financing activities
    
    
    (49,147
    )
    
    
    3,180
    
    
    
    1,303Effect of exchange rate changes on cash and cash equivalents
    
    
    907
    
    
    
    1,073
    
    
    
    1,318Net increase in cash and cash equivalents
    
    
    28,832
    
    
    
    3,053
    
    
    
    3,517Cash and cash equivalents at beginning of year
    
    
    8,553
    
    
    
    5,500
    
    
    
    1,983Cash and cash equivalents at end of year
    
    $
    37,385
    
    
    $
    8,553
    
    
    $
    5,500Supplemental disclosures of cash paid for:Interest
    
    $
    11,642
    
    
    $
    13,970
    
    
    $
    12,445Income taxes
    
    $
    7,727
    
    
    $
    1,155
    
    
    $
    247Supplemental disclosure of noncash investing and financing activities:Equipment acquired under capital lease obligations
    
    $
    
    
    
    $
    72
    
    
    $
    255
 See accompanying notes to consolidated financial statements. F-7




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##### Table of Contents



MATRIA HEALTHCARE, INC. AND SUBSIDIARIES 
 Notes to Consolidated Financial Statements
 December 31, 2004, 2003 and 2002
 (Amounts in thousands, except share and per share amounts)  (1)
    Summary of Significant Accounting Policies  (a)
    BusinessMatria Healthcare, Inc. (the Company) is a comprehensive, integrated disease management
company, offering its services to self-insured employers, private and government
sponsored health plans, pharmaceutical companies and patients. Disease management
encompasses a broad range of services aimed at controlling healthcare costs through
proactive management of care. The Companys strategy is to provide cost-saving solutions
for many of the most costly medical conditions and chronic diseases, including, diabetes,
cardiovascular diseases, respiratory disorders, obstetrical conditions, cancer,
depression, obesity, chronic pain and hepatitis C. The Companys disease management
programs seek to lower healthcare costs and improve patient outcomes through a broad
range of disease management, supply and clinical services. The Company is also a leading
designer, developer, assembler and distributor of products for the diabetes market.On February 4, 2005, the Company effected a three-for-two stock split in the form of a
stock dividend. All amounts reflected for common stock and additional paid in capital,
and all share and per share amounts have been restated to
reflect the stock split in all periods presented (see Note 13).Effective December 31, 2004, the Company adopted a holding company form of organizational
structure. As a part of the reorganization, a new parent company was formed, and the
predecessor company became a wholly owned subsidiary of the parent company. All
outstanding shares of common stock of the predecessor company were converted into shares
of common stock of the parent company. The business operations of the Company remained
unchanged as a result of the new structure.On June 30, 2004, the Company discontinued the operations of the pharmacy, laboratory and
supplies division of the Health Enhancement segment. As a result, the accompanying
consolidated financial statements reflect the operations of this division as discontinued
operations for all periods presented (see Note 2). Also on June 30, 2004, the Company
completed the repurchase of substantially all of its 11% Senior Notes (see Note 3).See Note 11 for the detail of revenues, operating earnings, identifiable assets,
depreciation and amortization and capital expenditures of the Companys reportable
business segments.(b)
    Basis of Financial Statement PresentationThe consolidated financial statements have been prepared in conformity with accounting
principles generally accepted in the United States. In preparing the consolidated
financial statements, management is required to make estimates and assumptions that
affect the reported amounts of assets and liabilities as of the date of the consolidated
balance sheets, and revenues, other income and expenses for the periods. Actual results
could differ from those estimates.The consolidated financial statements include the accounts of the Company and all of its
majority owned subsidiaries and partnerships. All significant intercompany balances and
transactions have been eliminated in consolidation. F-8




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##### Table of Contents



(c)
    Cash and Cash EquivalentsCash and cash equivalents consist of cash and interest-bearing deposits. The Company
considers all highly liquid debt instruments with maturities of three months or less when
purchased to be cash equivalents, other than those amounts designated for other than
current operations. Cash and cash equivalents include $3,139 and $2,338 as of December
31, 2004 and 2003, respectively, for MHI Insurance, Ltd., the Companys wholly-owned
captive insurance company. Such amounts are available to settle claims for certain
insured risks.(d)
    Restricted CashRestricted cash consists of funds designated for a particular use and not available for
current operations. In September 2004, the Company set aside $3,000 pledged as
collateral in an agreement with one of its major suppliers. The
agreement expires in May 2005. Other restricted funds are collateral for insurance policies and
amounts held in escrow related to customer contracts. Funds are held in interest-bearing
investment accounts or certificates of deposit that coincide with insurance policy
termination dates.(e)
    Revenue Recognition and Allowances for Uncollectible AccountsRevenues for the Womens and Childrens Health segment are generated by providing
services through patient service centers. Revenues from this segment are recognized as
the related services are rendered and are net of contractual allowances and related
discounts. The Health Enhancement segment provides services through its patient service
centers and designs, develops, assembles, packages and distributes diabetes products to
original equipment manufacturers and distributors. Revenues for services are recognized
when services are provided and revenues from product sales are recognized when products
are shipped. Revenues from this segment are recorded net of contractual and other
discounts.The Companys clinical services and foreign supply businesses are reimbursed on a
fee-for-service or per item basis. Other aspects of disease management, however, are
paid for primarily on the basis of (i) monthly fees for each employee or member enrolled
in a health plan, (ii) each member identified with a particular chronic disease or
condition under contract, (iii) each member enrolled in the Companys program or (iv) a
fixed rate per case. Billings for certain services occur in advance of services being
performed. Such amounts are recorded as unearned revenue in the consolidated balance
sheets, and revenue is recognized as services are performed. Some of the contracts for
these services provide that a portion of the Companys fees is at risk subject to the
Companys performance against financial cost savings and clinical criteria. Thus, a
portion of the Companys revenues is subject to confirmation of the Companys performance
against these financial cost savings and clinical criteria. Estimates for performance
under the terms of these contracts and other factors affecting revenue recognition are
recognized in the period information related to performance levels becomes available and
fees are considered collectible. These estimates are continually reviewed and adjusted as
information becomes available. These reviews and adjustments have not, in any recent
period, resulted in a material reduction of revenue previously reported. In 2004, 3.6%
of our revenues recognized were at risk under these arrangements.A portion of the Companys revenues is billed to third-party reimbursement sources.
Accordingly, the ultimate collectibility of a substantial portion of the Companys trade
accounts receivable is susceptible to changes in third-party reimbursement policies. In
addition, the collectibility of all of the Companys accounts receivable varies based on
payor mix, general economic conditions and other factors. A provision for doubtful
accounts is made for revenues estimated to be uncollectible and is adjusted periodically
based upon the Companys evaluation of current industry conditions, historical collection
experience, recoveries of amounts previously provided, industry reimbursement trends,
audit activity and other relevant factors which, in the opinion of management, deserve
recognition in estimating the allowance for uncollectible accounts. F-9




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##### Table of Contents



(f)
    Other ReceivablesOther receivables include amounts due from customers, as well as other receivables not
directly related to the delivery of goods and services and receivables due from vendors
under rebate programs. Estimates of amounts due from vendors under various rebate
programs are made each reporting period. Amounts vary based on the programs offered at
the time, the volume of Company purchases and sales, as well as other factors. Other
receivables at December 31, 2004 and 2003 includes the accounts and rebates receivable of
$2,982, net allowances of $12,845, and $27,435, net allowances of $4,178, respectively,
retained by the Company from the discontinued operations of the pharmacy and supplies
business (see Note 2).(g)
    Concentration of Credit RiskFinancial instruments, which potentially expose the Company to concentrations of credit
risk, consist primarily of accounts receivable from third-party payors. The
collectibility of accounts receivable from third-party payors is directly affected by
conditions and changes in the insurance F-10




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##### Table of Contents



industry and governmental programs, which are taken into account by the Company in
computing and evaluating its allowance for uncollectible accounts.(h)
    InventoriesInventories, which consist primarily of disposable medical products, drugs and patient
supplies, are stated at the lower of cost (first-in, first-out) or market (net realizable
value).(i)
    Property and EquipmentProperty and equipment is stated at cost, less accumulated depreciation and amortization.
Depreciation is provided primarily on the straight-line method over the estimated useful
lives of the assets ranging from three to ten years. Amortization of leasehold
improvements and leased equipment is recorded over the shorter of the lives of the
related assets or the lease terms. Depreciation and amortization expense for property
and equipment was $5,182, $5,825, and $5,923 for the years ended December 31, 2004, 2003,
and 2002, respectively.Property and equipment are summarized as follows: December 31,2004
    
    
    2003Computer hardware and software
    
    $
    23,449
    
    
    $
    21,504Medical equipment
    
    
    9,490
    
    
    
    11,155Machinery, office equipment and fixtures
    
    
    9,448
    
    
    
    8,657Leasehold improvements
    
    
    2,595
    
    
    
    2,59244,982
    
    
    
    43,908Less accumulated depreciation and amortization
    
    
    22,101
    
    
    
    24,680$
    22,881
    
    
    $
    19,228
  (j)
    Intangible AssetsA summary of intangible assets follows: December 31,2004
    
    
    2003Goodwill
    
    $
    157,767
    
    
    $
    157,776Other intangible assets
    
    
    2,816
    
    
    
    2,563160,583
    
    
    
    160,339Less accumulated amortization
    
    
    25,274
    
    
    
    25,074$
    135,309
    
    
    $
    135,265
  Intangible assets consist of goodwill and other intangible assets, primarily
resulting from the Companys acquisitions (see Note 2). The net unamortized balance of
goodwill as of December 31, 2004 was $134,193.Other intangible assets consist of customer lists, executive noncompete agreements and
patents. The net unamortized balance of these identifiable intangible assets as of
December 31, 2004 was $1,116. These costs are amortized on a straight-line basis over
periods ranging from five to ten years. Amortization expense was $200, $300, and $300
for the years ended December 31, 2004, 2003, and 2002, respectively. Estimated
amortization expense for the four succeeding years is $260 each year
and $76 for the year thereafter.The Company adopted Statement of Financial Accounting Standards (SFAS) No. 142,
Goodwill and Other Intangible Assets(SFAS 142) effective January 1, 2002. SFAS 142
requires that goodwill and intangible assets with indefinite useful lives no longer be
amortized, but instead be tested for impairment at least annually at the reporting unit
level. SFAS 142 also requires that F-11




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intangible assets with estimable useful lives be amortized over their respective
estimated useful lives to their estimated residual values, and reviewed for impairment in
accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets(SFAS 144).The Company evaluated the fair values of the reporting units
identified under the provisions of SFAS 141, Business Combinations, and SFAS 142 as of
December 31, 2004 and 2003 and concluded that no impairment of recorded goodwill exists.
As a result, no impairment of goodwill was recorded in 2004 or 2003.The changes in the carrying values of goodwill for the year ended December 31, 2004 were
as follows: Womens andHealth
    
    
    ChildrensEnhancement
    
    
    Health
    
    
    TotalCarrying value at January 1, 2004
    
    $
    131,520
    
    
    $
    2,682
    
    
    $
    134,202Additional goodwill from acquisitions (Note 2)
    
    
    244
    
    
    
    
    
    
    
    244Tax benefit of additional deductible goodwill
    
    
    (253
    )
    
    
    
    
    
    
    (253
    )Carrying value at December 31, 2004
    
    $
    131,511
    
    
    $
    2,682
    
    
    $
    134,193
  In connection with the adoption of SFAS 142, the Company also reassessed the useful
lives, residual values and classification of its identifiable intangible assets and
determined that they continue to be appropriate. The components of identifiable
intangible assets were as follows: December 31,2004
    
    
    2003Gross carrying amounts:Patient lists
    
    $
    2,000
    
    
    $
    2,000Non-compete agreement
    
    
    500
    
    
    
    500Other
    
    
    316
    
    
    
    632,816
    
    
    
    2,563Accumulated amortization
    
    
    (1,700
    )
    
    
    (1,500
    )$
    1,116
    
    
    $
    1,063
  (k)
    Impairment of Long-Lived AssetsIn accordance with SFAS No. 144, the Company reviews long-lived assets, such as property
and equipment and intangibles subject to amortization, including contract acquisition
costs and certain computer software, for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by a comparison of the carrying
amount of an asset to estimated undiscounted operating cash flows expected to be
generated by the asset. If the carrying amount of an asset exceeds its estimated future
cash flows, an impairment charge is recognized by the amount by which the carrying amount
of an asset exceeds the fair value of the asset. Assets to be disposed of would be
separately presented in the balance sheet and reported at the lower of the carrying
amount or fair value less costs to sell, and would no longer be depreciated. The assets
and liabilities of a disposed group classified as held for sale would be presented
separately in the appropriate asset and liability sections of the balance sheets. F-12




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##### Table of Contents



(l)
    Income TaxesThe Company accounts for income taxes using an asset and liability approach. Deferred
income taxes are recognized for the tax consequences of temporary differences by
applying enacted statutory tax rates applicable to future years to differences between
the financial statement carrying amounts and the tax bases of existing assets and
liabilities and net operating loss and tax credit carryforwards. Additionally, the
effect on deferred taxes of a change in tax rates is recognized in earnings in the period
that includes the enactment date.(m)
    Fair Value of Financial InstrumentsThe carrying amounts and estimated fair values of the Companys financial instruments
are as follows: December 31, 2004
    
    
    December 31, 2003Carrying
    
    
    Fair
    
    
    Carrying
    
    
    FairAmount
    
    
    Value
    
    
    Amount
    
    
    ValueLiabilities:4.875% Convertible senior subordinated notes
(see Notes 3 and 4)
    
    $
    83,779
    
    
    $
    133,041
    
    
    $
    
    
    
    $
    11% Senior Notes (see Notes 3 and 4)
    
    
    1,938
    
    
    
    2,110
    
    
    
    118,477
    
    
    
    131,150Interest rate swap arrangement (see Note 4)
    
    
    
    
    
    
    
    
    
    
    1,198
    
    
    
    1,198
  At December 31, 2004, the carrying amount of the convertible senior subordinated
notes is net of the unamortized discount, and the estimated fair value is based upon the
quoted market price. The carrying amount of the 11% Senior Notes is net of unamortized
discount and unamortized net deferred gains on terminations of interest rate swaps. The
estimated fair value of the 11% Senior Notes is based upon the redemption price payable
for the 11% Senior Notes on May 1, 2005, the first date upon which the remaining 11%
Senior Notes are redeemable.At December 31, 2003, the carrying amount of the 11% Senior Notes includes a $1,198
reduction to reflect the fair value of the interest rate swap arrangement that was
effective in hedging the fair value of the Senior Notes and is net of unamortized
discount and deferred gains as described above. The estimated fair value of the 11%
Senior Notes is based on quoted market price. The estimated fair value of the interest
rate swap arrangement represented the amount that the Company would pay to terminate the
agreement, taking into account interest rates at December 31, 2003. The Companys other
financial instruments approximate fair value due to the short-term or variable rate
nature of those assets and liabilities.(n)
    Accrued LiabilitiesAccrued liabilities are summarized as follows: December 31,2004
    
    
    2003Acquisition obligation (see Note 2)
    
    $
    
    
    
    $
    20,471Accrued
compensation and related liabilities
    
    
    10,262
    
    
    
    7,719Other
    
    
    11,304
    
    
    
    13,149$
    21,566
    
    
    $
    41,339
  (o)
    Stock Option Plans F-13




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##### Table of Contents



As described in Note 6, the Company offers various stock option plans for its employees,
officers, independent contractors and consultants. The Company accounts for those plans
under the recognition and measurement principles of APB Opinion No. 25, Accounting for
Stock Issued to Employees,and related Interpretations. No stock-based employee
compensation cost is reflected in net earnings, as all options granted under those plans
had an exercise price equal to the market value of the underlying common stock on the
date of grant.The following table illustrates the effect on earnings (loss) from continuing operations
and earnings (loss) per share from continuing operations if the Company had applied the
fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based
Compensation(SFAS 123), to stock-based employee compensation. Years Ended December 31,2004
    
    
    2003
    
    
    2002Earnings (loss) from
continuing operations
available to common
shareholders
    
    $
    (3,214
    )
    
    $
    6,010
    
    
    $
    (15,040
    )Deduct: Stock-based employee
compensation expense
determined under fair value
based method for all awards,
net of related tax effects
    
    
    (1,408
    )
    
    
    (1,579
    )
    
    
    (1,290
    )Pro forma earnings (loss) from
continuing operations
available to common
shareholders
    
    $
    (4,622
    )
    
    $
    4,431
    
    
    $
    (16,330
    )Earnings (loss) per common share from
continuing operations:Basic   as reported
    
    $
    (0.21
    )
    
    $
    0.40
    
    
    $
    (1.08
    )Basic   pro forma
    
    $
    (0.30
    )
    
    $
    0.29
    
    
    $
    (1.17
    )Diluted   as reported
    
    $
    (0.21
    )
    
    $
    0.39
    
    
    $
    (1.08
    )Diluted   pro forma
    
    $
    (0.30
    )
    
    $
    0.29
    
    
    $
    (1.17
    )
  (p)
    Net Earnings (Loss) Per Share of Common StockBasic net earnings (loss) per common share are based on the weighted average number of
common shares outstanding. Diluted net earnings (loss) per common share are based on the
weighted average number of common shares outstanding and dilutive potential common
 shares, such as dilutive stock options, determined using the treasury stock method, and
dilutive contingent convertible debt, determined using the if-converted method.The computations for basic and diluted net earnings (loss) per common share are as
follows: Years ended December 31,2004
    
    
    2003
    
    
    2002BasicEarnings (loss) from continuing operations
    
    $
    (3,214
    )
    
    $
    6,010
    
    
    $
    (15,040
    )Earnings (loss) from discontinued operations
    
    
    30,280
    
    
    
    1,296
    
    
    
    (1,286
    )Net earnings (loss)
    
    $
    27,066
    
    
    $
    7,306
    
    
    $
    (16,326
    )Weighted average number of common shares outstanding
    
    
    15,520
    
    
    
    15,198
    
    
    
    13,964Net earnings (loss) per common share:Continuing operations
    
    $
    (0.21
    )
    
    $
    0.40
    
    
    $
    (1.08
    )Discontinued operations
    
    
    1.95
    
    
    
    0.08
    
    
    
    (0.09
    )$
    1.74
    
    
    $
    0.48
    
    
    $
    (1.17
    )
 F-14




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##### Table of Contents



Years ended December 31,2004
    
    
    2003
    
    
    2002DilutedEarnings (loss) from continuing operations
    
    $
    (3,214
    )
    
    $
    6,010
    
    
    $
    (15,040
    )Earnings (loss) from discontinued operations
    
    
    30,280
    
    
    
    1,296
    
    
    
    (1,286
    )Net earnings (loss)
    
    $
    27,066
    
    
    $
    7,306
    
    
    $
    (16,326
    )Shares:Weighted average number of common shares outstanding
    
    
    15,520
    
    
    
    15,198
    
    
    
    13,964Shares issuable from assumed exercise of options
    
    
    
    
    
    
    344
    
    
    
    15,520
    
    
    
    15,542
    
    
    
    13,964Net earnings (loss) per common share:Continuing operations
    
    $
    (0.21
    )
    
    $
    0.39
    
    
    $
    (1.08
    )Discontinued operations
    
    
    1.95
    
    
    
    0.08
    
    
    
    (0.09
    )$
    1.74
    
    
    $
    0.47
    
    
    $
    (1.17
    )
  The calculation of diluted earnings (loss) per share excludes 2,498,100, 847,500 and
2,062,500 shares in the years ended December 31, 2004, 2003 and 2002, respectively, since
the effect of assumed exercise of the related options would be antidilutive. In 2004,
the diluted loss per share also excludes 4,388,000 shares from the assumed conversion of
the 4.875% convertible senior subordinated notes since the effect
would be antidilutive.(q)
    Comprehensive Earnings (Loss)Comprehensive earnings (loss) generally include all changes in equity during a period
except those resulting from investments by owners and distributions to owners.
Comprehensive earnings (loss) consist of net earnings (loss), foreign currency
translation adjustments and changes in unrealized appreciation on available-for-sale
securities (net of income taxes).(r)
    ReclassificationsCertain amounts in the 2003 and 2002 consolidated financial statements have been
reclassified to conform to presentations adopted in 2004.(s)
    Recently Issued Accounting StandardsIn December 2004, the Financial Accounting Standards Board
(FASB) issued Statement of Financial Accounting Standards
(SFAS) No. 123R, Share Based-Payment
(SFAS 123R) SFAS 123R establishes standards for
the accounting for transactions in which an entity exchanges its
equity instruments for goods or services. It also addresses
transactions in which an entity incurs liabilities in exchange for
goods or services that are based on the fair value of the
entitys equity instruments or that may be settled by the
issuance of those equity instruments. This Statement requires a
public entity to measure the costs of employee services received in
exchange for an award of equity instruments based on the grant-date
fair value of the award (with limited exceptions). That cost will be
recognized over the period during which an employee is required to
provide service in exchange for the award.This Statement applies to all awards granted after the
required effective date and to awards modified, repurchased or
cancelled after that date. Compensation cost will be recognized on or
after the required effective date for the portion of outstanding
awards, for which the requisite service has not been rendered, based
on the grant-date fair value of those awards calculated under SFAS
No. 123 for either recognition or pro forma disclosures. The
Statement is effective for the first interim period or annual period
that begins after June 15, 2005. We have concluded that
SFAS 123R will have a negative impact on our financial position
and results of operations. If we elect the retrospective method, we
expect that the impact of expensing existing stock options, as well
as the impact of any anticipated stock option grants and restricted
stock awards, to be approximately $0.10 to $0.15 per share in 2005.
If we elect the prospective method, we expect that the impact of
expensing stock options, as well as the impact of any anticipated
stock option grants and restricted stock awards, to be approximately
$0.05 to $0.08 per share in 2005. We do not expect the impact of
SFAS 123R to have a material impact on our cash flow or
liquidity. See Note 6 to the consolidated financial statements
for assumptions used calculating the fair value of employee stock
options. F-15




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##### Table of Contents



(2)
    Acquisitions, Dispositions and Discontinued OperationsOn June 30, 2004, the Company completed the sale of
substantially all of the assets of its
domestic direct-to-consumer diabetic and respiratory supplies business to a private equity
firm. As a result, the accompanying consolidated financial statements reflect the operations
of this division as discontinued operations for all periods presented. The Company received
cash proceeds, net of transaction costs, of $101,055. The sale resulted in a gain of $51,812,
or $30,938 net of income taxes. The assets sold consisted primarily of property and equipment
and other assets, and are reflected as assets of discontinued operation sold on the
consolidated balance sheets. Assets of discontinued operation sold also includes goodwill
and intangible assets sold of $16,290. The buyer also assumed certain accrued liabilities.
The accounts receivable of the business and certain other assets and liabilities were excluded
from the sale and retained by the Company. The accounts and rebates receivable of $2,982, net,
and $27,435, net, are reflected in other receivables on the consolidated balance sheets at
December 31, 2004 and 2003, respectively.In connection with the sale, the Company increased the allowance for doubtful accounts for the
retained receivables by $11,900 to provide for the estimated effect the sale of the business
and the decision in the fourth quarter of 2004 to outsource the collection effort to a third
party could have on collections. Also related to the sale, liabilities totaling $1,513 were
recorded for employee termination benefits and other F-16




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##### Table of Contents



costs related to the discontinued operations. Both charges are included as part of the gain on
sale, since the effects are a direct result of the decision to dispose of the business. As of
December 31, 2004, the reserve balance of $918 for employee termination benefits and other
costs is included in accrued liabilities on the consolidated balance sheets. A
reconciliation of the beginning accrued liability and the balance at December 31, 2004
follows. Beginning
    
    
    
    
    
    
    
    
    
    
    BalanceAccrual
    
    
    
    
    
    
    
    
    
    
    DecemberType of Charge
    
    June 30, 2004
    
    
    Payments
    
    
    Adjustments
    
    
    31, 2004Employee termination benefits
    
    $
    685
    
    
    $
    (224
    )
    
    $
    (131
    )
    
    $
    330Contractual obligations
    
    
    430
    
    
    
    (100
    )
    
    
    
    
    
    
    330Transaction costs
    
    
    173
    
    
    
    (173
    )
    
    
    
    
    
    
    Other accruals
    
    
    225
    
    
    
    (111
    )
    
    
    144
    
    
    
    258Total
    
    $
    1,513
    
    
    $
    (608
    )
    
    $
    13
    
    
    $
    918
 The adjustments for employee termination benefits and other accruals relates to revisions
to estimates for future obligations. The Company estimates remaining payments on the above
liability to be paid in 2005. In February 2001, the Company completed the sale of the business and certain assets of
Quality Diagnostic Services, Inc. (QDS) and received cash proceeds totaling approximately
$18,000. The accounts receivable of QDS, were excluded from the sale. In 2002, cash flows
from collections of QDS accounts receivable, less costs of
collection, was $642. In 2002,
the Company recorded an additional loss, net of income taxes, of approximately $682 as a
result of greater than expected costs of collection and lower than expected cash receipts
from the retained receivables. Of this amount, $124 was included in earnings (loss) from
discontinued operations, and $558 was included in gain (loss) on disposal. The operating results of discontinued operations are as follows: Years Ended December 31,2004
    
    
    2003
    
    
    2002Revenues
    
    $
    41,180
    
    
    $
    74,524
    
    
    $
    65,019Earnings
(loss) from discontinued operations, net of
income tax benefit (expense) of $897,
$(1,005) and $163 in 2004, 2003 and 2002,
respectively
    
    
    (658
    )
    
    
    1,296
    
    
    
    (728
    )Gain (loss) on disposal of discontinued
operations, net of income tax benefit
(expense) of $(20,874) and $342 in 2004 and
2002, respectively
    
    
    30,938
    
    
    
    
    
    
    
    (558
    )Earnings (loss) from discontinued operations
    
    $
    30,280
    
    
    $
    1,296
    
    
    $
    (1,286
    )
 On September 30, 2002, the Company acquired all of the issued and outstanding stock of
Quality Oncology, Inc. (QO), a national provider of cancer disease management services, for
consideration valued for financial statement purposes at $19,751. Under the terms of the
agreement, the Company initially paid $3,255 in cash and issued approximately 1,335,000 shares
of common stock. An additional 63,000 shares were issued in February 2003 pursuant to a
purchase price adjustment. On June 30, 2004, the Company paid $20,480 in cash as additional
financial consideration based upon QOs 2003 operating results. Results of operations of QO
have been included in the consolidated statement of operations of the Company effective
October 1, 2002. Effective June 14, 2002, the Company acquired MarketRing.com, Inc. (MarketRing), a
healthcare information technology company. For financial statement purposes, the acquisition
was recorded at fair value of $4,087 and was paid by the issuance of approximately 402,000
shares of common stock. In 2002, the Company recorded goodwill of $2,787 related to this
acquisition. In 2003, the Company issued F-17




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approximately 39,000 additional shares related to the acquisition. An additional $419 of
goodwill was recorded in 2003 related to the acquisition. The Companys financial statements
include the operations of MarketRing commencing on June 14, 2002. In 2003, the Company purchased the assets of a healthcare management firm specializing in case
and utilization management for consideration, net of cash acquired, of $603. An additional
$200 was paid in 2004 on the anniversary of the acquisition in accordance with the terms of
the agreement.  (3)
    Long-Term DebtLong-term debt is summarized as follows: December 31,2004
    
    
    2003Unsecured 11% senior notes, net of
unamortized discount of $77 and $5,766 at
December 31, 2004 and 2003, respectively,
plus unamortized deferred gains resulting
from termination of interest rate swaps of
$15 and $2,243 at December 31, 2004 and 2003,
respectively; interest payable semi-annually
on May 1 and November 1, maturing May 2008
    
    $
    1,938
    
    
    $
    118,477Unsecured 4.875% convertible senior
subordinated notes, net of unamortized
discount of $2,471 at December 31, 2004,
interest payable semi-annually on May 1 and
November 1, maturing May 2024
    
    
    83,779
    
    
    
    Revolving credit facility; interest at LIBOR
plus 2.9% payable monthly; currently
effective until October 2005
    
    
    
    
    
    
    2,418Capital lease obligations; interest ranging
from approximately 5.5% to 18.1% with various
monthly payments and maturing at various
dates through March 2007 (Note 8)
    
    
    107
    
    
    
    240Other debt; interest rate 3.1%; payable in
monthly installments through May 2005
    
    
    792
    
    
    
    673Total long-term debt
    
    
    86,616
    
    
    
    121,808Less current installments
    
    
    (865
    )
    
    
    (803
    )Long-term debt, excluding current installments
    
    $
    85,751
    
    
    $
    121,005
 On March 29, 2004, the Company commenced a tender offer for all of its unsecured 11%
Senior Notes, which had an aggregate principal amount of $122,000. The Company received valid
tenders from holders of $120,000 in aggregate principal amount of the 11% Senior Notes. On
June 30, 2004, the Company completed the repurchase of the 11% Senior Notes tendered in the
tender offer with proceeds from the issuance of convertible senior subordinated debt as
described below and with the proceeds from the sale of assets of the pharmacy and supplies
business (see Note 2). The retirement of the 11% Senior Notes resulted in a loss of $22,886,
or $14,144 after taxes. Additionally, in connection with the tender offer, the holders of the
11% Senior Notes consented to amend the indenture governing the 11% Senior Notes to eliminate
substantially all of the restrictive covenants, certain related events of default and certain
other terms applicable to the $2,000 of 11% Senior Notes not purchased in the tender offer. On May 5, 2004, the Company completed the sale of $75,000 in aggregate principal amount of
4.875% convertible senior subordinated notes due 2024. On June 3, 2004, the initial purchaser
of the notes exercised its option to purchase an additional $11,250 in aggregate principal
amount of the notes. The notes are convertible into shares of the Companys common stock at a
conversion rate of 50.873 shares per $1 principal amount of the notes (equal to an initial
conversion price of approximately $19.64 per share). Interest is payable on May 1 and
November 1 of each year, beginning in November 2004. The notes are unsecured and are
guaranteed by certain of the Companys domestic subsidiaries. The Company used the proceeds,
net of discount, of $83,705 from the issuance of the convertible senior subordinated F-18




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##### Table of Contents



notes to partially fund the repurchase of $120,000 in aggregate principal amount of 11% Senior
Notes tendered in the tender offer as described above. The Company also has available a revolving credit facility with a borrowing capacity of the
lesser of $35,000 or 80% of eligible accounts receivable. The facility is collateralized by
cash, accounts receivable, inventories, intellectual property and certain other assets of the
Company. Borrowings under this facility bear interest at the LIBOR
rate plus 2.9% (5.18% at December 31, 2004), and the
facility requires a non-utilization fee of 0.5% of the unused borrowing capacity. Interest
and the non-utilization fee are payable monthly. The facility is effective until October
2005. Thereafter, the term will be automatically extended for annual successive periods
unless either party provides notice to the contrary not less than 60 days prior to the end of
the period. As of December 31, 2004, there was no outstanding balance, and approximately $23.1
million was available for borrowing under this credit facility. As discussed above, amendments were made to the indenture governing the 11% Senior Notes that
eliminated substantially all of the restrictive covenants and certain events of default and
related provisions related to the remaining $2,000 of 11% Senior Notes. The amendments will
provide the Company with increased operating and financial flexibility. The Company, however,
is still bound by covenants contained in the indenture for the convertible senior subordinated
notes and the revolving credit facility agreement. Covenants in these instruments limit the
ability of the Company to, among other things, incur indebtedness and liens, pay dividends,
repurchase shares, enter into merger agreements, make investments, engage in new business
activities unrelated to the Companys current business or sell assets. In addition, under the
credit facility, the Company is required to maintain certain financial ratios. As of December
31, 2004, the Company was in compliance with the financial covenants in its credit
instruments. Approximate aggregate minimum annual payments due on long-term debt, excluding the unamortized
discount and deferred gains on interest rate swaps, for the five years subsequent to December
31, 2004 and thereafter are as follows: 2005
    
    $
    8652006
    
    
    342007
    
    
    2008
    
    
    2,0002009
    
    
    Thereafter
    
    
    83,717$
    86,616
  (4)
    Derivative Financial InstrumentsThe Company has periodically used interest rate swap agreements to hedge against changes in
the fair value of the 11% fixed-rate debt obligation and to lower overall borrowing rates. Due
to the retirement of a portion of the 11% Senior Notes (see Note 3), the Company does not
intend to enter into any additional interest rate swap arrangements to hedge against the
interest on the remaining $2,000 of 11% Senior Notes.Effective March 5, 2003, the Company entered into an interest rate swap agreement with a bank
involving $50,000 of the Companys 11% Senior Notes, which were scheduled to mature in 2008.
Under this arrangement, the bank was obligated to pay the Company an 11% fixed rate of
interest semi-annually in arrears on May 1 and November 1. The Company was obligated to pay
the bank semi-annually in arrears on May 1 and November 1 a variable rate of interest based on
the six-month LIBOR rate plus 7.535% (determined at the end of the period). The variable rate
at December 31, 2003 of 8.7542% reflected a rate reduction of 2.2458%. Effective August 18,
2003, the Company entered into a second interest rate swap agreement with the same bank for an
additional $25,000 of the Companys senior notes with terms as described above, except that
the variable rate of interest for this second agreement was based on the six- F-19




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##### Table of Contents



month LIBOR rate plus 6.7450% (also determined at the end of the period). The variable rate
at December 31, 2003 of 7.9642% reflected a rate reduction of 3.0358%. In January 2004, both
interest rate swaps were terminated, and the Company paid $315 to the bank. Under the swap
agreements, the Company was required to maintain cash collateral with the bank. The
collateral requirement was determined based on an initial base amount of $1,500 and varied
based on fluctuations in market exposure. At December 31, 2003, the collateral totaled $1,742
of which $927 was included in other assets on the consolidated balance sheet, and $815 was
included in cash and cash equivalents.After the swaps were terminated in January 2004, the Company entered into a new interest rate
swap agreement with the bank with a notional amount of $75,000. Under this arrangement, the
bank was obligated to pay the Company an 11% fixed rate of interest semi-annually in arrears
on May 1 and November 1. The Company was obligated to pay the bank semi-annually in arrears
on May 1 and November 1 a variable rate of interest based on the six-month LIBOR rate plus
7.1000% (determined at the end of the period). In April 2004, this interest rate swap was
terminated, and the Company paid $214 to the bank.In May 2004, the Company entered into a new interest rate swap agreement with a bank for a
notional amount of $100,000. Under this arrangement, the bank was obligated to pay the Company
an 11% fixed rate of interest semi-annually in arrears on May 1 and November 1. The Company
was obligated to pay the bank semi-annually in arrears on May 1 and November 1 a variable rate
of interest. This interest rate swap was terminated in June 2004, prior to the retirement of
the $120,000 in principal amount of the 11% Senior Notes, and the Company paid $464 to the
bank.Due to the retirement of a portion of the 11% Senior notes a proportionate share of the net
unamortized deferred gains resulting from the termination of the interest rate swaps was
included in the loss on retirement of the 11% Senior Notes. The remaining balance of deferred
gain of $15 is being amortized as a decrease to interest expense over the remaining term of
the 11% Senior Notes (May 2008).The Company reflected interest rate swap agreements on the consolidated balance sheet at fair
value, which was based upon the estimated amount required to settle the agreement. The
carrying value of the related portion of fixed-rate debt being hedged was adjusted by the
change in fair value of the portion of the debt hedged by the interest rate swap attributable
to the interest rate risk. In addition, the change during the period in the fair value of the
interest rate swap agreements, as well as the change in the adjusted carrying value of the
related portion of the fixed-rate debt that was being hedged, had offsetting effects on net
interest expense in the consolidated condensed statements of operations, since the interest
rate swaps were fully effective. Interest expense was reduced by $685, $1,104 and $994 in
2004, 2003 and 2002, respectively as a result of the lower variable interest rates on the
swaps. There were no swap agreements in effect as of December 31, 2004. F-20




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##### Table of Contents



(5)
    Income TaxesThe components of the earnings (loss) from continuing operations before income taxes are as
follows: Years ended December 31,2004
    
    
    2003
    
    
    2002Domestic
    
    $
    (12,418
    )
    
    $
    4,821
    
    
    $
    (23,192
    )Foreign
    
    
    6,867
    
    
    
    5,410
    
    
    
    3,739Total income from continuing
operations before income
taxes
    
    $
    (5,551
    )
    
    $
    10,231
    
    
    $
    (19,453
    )
  The components of the income tax expense (benefit) from continuing operations consisted
of: Years ended December 31,2004
    
    
    2003
    
    
    2002Current tax expense:U.S. federal
    
    $
    788
    
    
    $
    
    
    
    $
    State and local
    
    
    124
    
    
    
    33
    
    
    
    21Non-U.S.
    
    
    2,711
    
    
    
    2,430
    
    
    
    1,285Total current tax expense
    
    
    3,623
    
    
    
    2,463
    
    
    
    1,306Deferred tax expense (benefit):U.S. federal
    
    
    (4,417
    )
    
    
    1,430
    
    
    
    (4,801
    )State and local
    
    
    (1,543
    )
    
    
    328
    
    
    
    (918
    )Non-U.S.
    
    
    
    
    
    
    
    
    
    
    Total deferred tax expense (benefit)
    
    
    (5,960
    )
    
    
    1,758
    
    
    
    (5,719
    )Total income tax expense (benefit)
    
    $
    (2,337
    )
    
    $
    4,221
    
    
    $
    (4,413
    )
  Below is a reconciliation of the expected income tax expense (benefit) from continuing
operations  (based on the U.S. federal statutory income tax rate of 35% in 2004 and 2003 and
34% in 2002) to the actual income tax expense (benefit): Years ended December 31,2004
    
    
    2003
    
    
    2002Computed expected income tax expense (benefit)
    
    $
    (1,943
    )
    
    $
    3,581
    
    
    $
    (6,614
    )Effect of:State and local income taxes, net of federal effect
    
    
    (922
    )
    
    
    235
    
    
    
    (592
    )Non-U.S. municipal taxes and tax rate differences
    
    
    367
    
    
    
    431
    
    
    
    150Nondeductible expenses
    
    
    435
    
    
    
    289
    
    
    
    3,074Nontaxable income of captive insurance subsidiary
    
    
    (270
    )
    
    
    (272
    )
    
    
    (266
    )Other, net
    
    
    (4
    )
    
    
    (43
    )
    
    
    (165
    )Income tax expense (benefit)
    
    $
    (2,337
    )
    
    $
    4,221
    
    
    $
    (4,413
    )
 F-21




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##### Table of Contents



At December 31, 2004 and 2003, the deferred income tax assets consist of future tax
benefits attributable
to: December 31,2004
    
    
    2003Deferred
income tax assets (liabilities):Current:Allowance for doubtful accounts and other receivables
    
    $
    6,029
    
    
    $
    2,820Accruals and reserves not deducted for tax purposes
    
    
    3,644
    
    
    
    3,646Deferred gain from terminations of interest rate swaps
    
    
    2
    
    
    
    1989,675
    
    
    
    6,664Non-current:Accruals and reserves not deducted for tax purposes
    
    
    
    
    
    
    118Depreciation and amortization
    
    
    (8,523
    )
    
    
    (6,146
    )Supplemental executive retirement plan
    
    
    1,510
    
    
    
    1,771Deferred gain from terminations of interest rate swaps
    
    
    4
    
    
    
    674Net operating loss carryforwards
    
    
    15,564
    
    
    
    27,731Credit carryforwards
    
    
    3,174
    
    
    
    2,043Other
    
    
    (25
    )
    
    
    33311,704
    
    
    
    26,524Total deferred income tax assets
    
    $
    21,379
    
    
    $
    33,188
  Based on projections of taxable income in 2005 and future years, management
believes that it is more likely than not that the Company will fully realize the value of the
recorded deferred income tax assets. The amount of the deferred tax asset considered
realizable, however, could be reduced if estimates of future taxable income during the
carryforward period are reduced.At December 31, 2004, the Company had the following estimated operating loss carryforwards
available for federal income tax reporting purposes to be applied against future taxable
income with the corresponding tax year of expiration: 2011
    
    $
    6,2462012
    
    
    1,8242018
    
    
    4142019
    
    
    3552020
    
    
    4362021
    
    
    4622022
    
    
    10,4122023
    
    
    15,9012024
    
    
    429$
    36,479
  The Company also has available alternative minimum tax (AMT) credit carryforwards of
approximately $2,831 available to offset regular income tax, if any, in future years. The
AMT credit carryforwards do not expire. The AMT net operating loss carryforward is
approximately $63,351.The Company undergoes audits of its various tax returns from time to time. The Company
records refunds from audits when receipt is assured and assessments when the loss is
probable.(6)
    Shareholders EquityStock Option PlansDuring 2004, the Board of Directors of the Company adopted the 2004 Stock Incentive Plan for
employees, officers, independent contractors and consultants of the Company. The 2004 Stock
Incentive Plan has three components: a stock option component, a stock bonus/stock purchase
component and a stock appreciation rights component. Options, stock bonuses and rights to
purchase the Companys common stock may be granted to exercise or purchase an aggregate of not
more than 375,000 shares of the Companys common stock (subject to adjustment to reflect
certain acquisitions). The 2004 Stock
Incentive Plan contains a $100 limitation on the aggregate fair market value of incentive
stock options which first become exercisable by an optionee in any calendar year. Also, the
maximum number of shares of stock with respect to which stock appreciation rights or options
to acquire stock may be granted, or sales or bonus grants of stock may be made, to any
individual per calendar year shall not exceed 100,000 shares (subject to adjustment to reflect
certain acquisitions). The term of each option is ten years from the date of grant. The
options are exercisable based on established performance goals and are fully vested at five
years.During 2002, the Board of Directors of the Company adopted the 2002 Stock Incentive Plan for
employees, officers, independent contractors and consultants of the Company. The 2002 Stock
Incentive Plan also has three components: a stock option component, a stock bonus/stock
purchase component and F-22




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##### Table of Contents



a stock appreciation rights component. Options, stock bonuses and
rights to purchase the Companys common stock may be granted to exercise or purchase an
aggregate of not more than 375,000 shares of the Companys common stock (subject to adjustment
to reflect certain acquisitions). The 2002 Stock Incentive Plan contains a $100 limitation on
the aggregate fair market value of incentive stock options which first become exercisable by
an optionee in any calendar year. Also, the maximum number of shares of stock with respect to
which stock appreciation rights or options to acquire stock may be granted, or sales or bonus
grants of stock may be made, to any individual per calendar year shall not exceed 100,000
shares (subject to adjustment to reflect certain acquisitions). The
term of each option is ten years from the date of grant. The options are exercisable based on established performance
goals and are fully vested at four years.During 2001, the Board of Directors of the Company adopted the 2001 Stock Incentive Plan for
employees, officers, independent contractors and consultants of the Company. The 2001 Stock
Incentive Plan also has three components: a stock option component, a stock bonus/stock
purchase component and a stock appreciation rights component. Under the terms of this plan, a
total of 375,000 shares of common stock were reserved for issuance. The 2001 Stock Incentive
Plan contains a $100 limitation on the aggregate fair market value of incentive stock options
that become exercisable by an individual in any calendar year. Additionally, the maximum
number of shares of stock with respect to which stock appreciation rights or options to
acquire stock may be granted, or sales or bonus grants of stock may be made, to any individual
per calendar year shall not exceed 100,000 shares. The term of each
option is ten years from
the date of grant. The options are exercisable based on established performance goals and are
fully vested at four years.During 2000, the Board of Directors of the Company adopted the 2000 Non-employee Director
Stock Option Plan, which provides for the issuance of non-qualified stock options to the
Companys non-employee directors. Under the terms of this plan, as amended in 2002, a total
of 168,750 shares of common stock were reserved for issuance. The options are granted with an
exercise price equal to the fair market value of the Companys common stock on the date of
grant and vest monthly over 12 months from the date of grant.
The term of each option is ten years from the date of grant.The weighted average fair value of the individual options granted during 2004, 2003 and 2002
is estimated at $10.53, $5.45, and $6.10, respectively, on the date of grant. The fair values
for those years were determined using the Black-Scholes option-pricing model with the
following assumptions. 2004
    
    
    2003
    
    
    2002Dividend yield
    
    None
    
    
    None
    
    
    NoneVolatility
    
    
    67%
    
    
    
    72%
    
    
    
    74%Risk-free interest rate
    
    
    3.43%
    
    
    
    2.97%
    
    
    
    3.82%Expected life
    
    5 Years
    
    
    5 Years
    
    
    5 Years
 F-23




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##### Table of Contents



A summary of stock option transactions under these plans is shown below: 2004
    
    
    2003
    
    
    2002Weighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    AverageExercise
    
    
    
    
    
    
    Exercise
    
    
    
    
    
    
    ExerciseShares
    
    
    Price
    
    
    Shares
    
    
    Price
    
    
    Shares
    
    
    PriceOutstanding at
beginning of year
    
    
    2,584,102
    
    
    $
    10.81
    
    
    
    2,062,338
    
    
    $
    12.01
    
    
    
    2,157,707
    
    
    $
    13.36Granted
    
    
    677,857
    
    
    $
    17.88
    
    
    
    845,829
    
    
    
    8.85
    
    
    
    716,151
    
    
    
    9.67Exercised
    
    
    (526,619
    )
    
    $
    11.42
    
    
    
    (44,106
    )
    
    
    10.03
    
    
    
    (121,826
    )
    
    
    14.09Canceled
    
    
    (237,187
    )
    
    $
    8.90
    
    
    
    (279,959
    )
    
    
    13.76
    
    
    
    (689,694
    )
    
    
    13.31Outstanding at end of year
    
    
    2,498,153
    
    
    $
    12.62
    
    
    
    2,584,102
    
    
    $
    10.81
    
    
    
    2,062,338
    
    
    $
    12.01Exercisable at end of year
    
    
    885,134
    
    
    $
    12.29
    
    
    
    854,874
    
    
    $
    13.30
    
    
    
    808,305
    
    
    $
    14.93
  The following table summarizes information concerning outstanding and exercisable options
at December 31, 2004: Options outstandingWeighted
    
    
    
    
    
    Options exercisableAverage
    
    
    Weighted
    
    
    
    
    
    
    WeightedRemaining
    
    
    Average
    
    
    
    
    
    
    AverageRange of
    
    Shares
    
    
    Contractual
    
    
    Exercise
    
    
    Shares
    
    
    ExerciseExercise Price
    
    Outstanding
    
    
    Life (years)
    
    
    Price
    
    
    Exercisable
    
    
    Price$4.57 - $10.00
    
    
    674,496
    
    
    
    7.6
    
    
    $
    6.87
    
    
    
    211,878
    
    
    $
    7.98$10.00 - $20.00
    
    
    1,679,517
    
    
    
    7.4
    
    
    
    14.02
    
    
    
    626,975
    
    
    
    12.94$20.00 - $30.00
    
    
    144,140
    
    
    
    7.4
    
    
    
    23.21
    
    
    
    46,281
    
    
    
    23.162,498,153
    
    
    
    
    
    
    
    12.62
    
    
    
    885,134
    
    
    
    12.29
  Employee Stock Purchase PlanThe Company maintains an Employee Stock Purchase Plan (the Purchase Plan) to encourage
ownership of its common stock by employees. The Purchase Plan provides for the purchase of up
to 187,500 shares of the Companys common stock by eligible employees of the Company and its
subsidiaries. Under the Purchase Plan, the Company may conduct an offering each fiscal
quarter of its common stock to eligible employees. The participants in the Purchase Plan can
elect to purchase common stock at the lower of 85% of the fair market value per share on
either the first or last business day of the quarter, limited to a maximum of either 10% of
the employees compensation or 375 shares of common stock per quarter. A participant
immediately ceases to be a participant in the Purchase Plan upon termination of his or her
employment for any reason. During 2004, 2003 and 2002, respectively, approximately 49,000,
62,000 and 15,000 shares of common stock were issued under the Purchase Plan.Shareholders Rights PlanIn connection with the 1996 merger of Tokos Medical Corporation (Delaware) and Healthdyne,
Inc., the Company established a Shareholders Rights Agreement. The new holding company
adopted a substantially identical Shareholders Rights Agreement in December 2004. If a person
or group acquires beneficial ownership of 15% or more of the Companys outstanding common
stock or announces a tender offer or exchange that would result in the acquisition of a
beneficial ownership of 20% or more of the Companys outstanding common stock, the rights
detach from the common stock and are distributed to shareholders as separate securities. Each
right entitles its holder to purchase one one-hundredth of a share (a unit) of common stock,
at a purchase price of $1.63 per unit. The rights, which do not have voting power, expire on
March 9, 2006 unless previously distributed and may be redeemed by the Company in whole at a
price of $0.01 per right any time before and within ten days after their distribution. If the
Company is acquired in a merger or other business combination transaction, or 50% of its
assets or earnings power are sold at any time after the rights become exercisable, the rights
entitle a holder to buy a number of common shares of the acquiring company having a market
value of twice the exercise price of the right. If a person acquires 20% of the Companys
common stock or if a 15% or larger holder merges with the Company and the common stock is not
changed or exchanged in such merger, or engages in self-
dealing transactions with the Company, each right not owned by such holder F-24




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##### Table of Contents



becomes exercisable
for the number of common shares of the Company having a market value of twice the exercise
price of the right.Retirement of Note Receivable from ShareholderSelling and administrative expenses for 2002 included a non-cash charge of $2,508 related to
the retirement of a $3,500 note receivable from a former executive acquired from a predecessor
organization. The note, which matured on June 30, 2002, stipulated that the balance could be
settled in full by surrender of collateral consisting of 187,500 shares of the Companys
common stock. The settlement generated a charge equal to the difference between the book
value of the note and the closing market value on June 30, 2002 of the 187,500 shares.(7)
    Employee Benefit PlansThe Company maintains a 401(k) defined contribution plan for the benefit of its employees.
The Companys obligation for contributions under the 401(k) plan is limited to each
participants contribution but not more than 3% of the participants compensation.
Discretionary Company contributions are allowed under the plan. Contributions to the plan in
the years ended December 31, 2004, 2003 and 2002 were approximately $1,232, $1,019 and $887,
respectively.During 1997, the Company established a split-dollar life insurance contract for the benefit of
a certain select group of senior management. Under the terms of the contract, the
participants or their beneficiaries were entitled to the greater of the contracts cash
surrender value or the contracts targeted benefit, less insurance premiums paid by the
Company. On December 31, 2002, the Company terminated the contracts for certain former
employees and the Companys Chairman and Chief Executive Officer and restructured the
contracts for other current employees by replacing the split-dollar life insurance contracts
with a Supplemental Executive Retirement Plan (SERP). Under the SERP plan, individual trust
accounts were opened and funded equal to the December 31, 2002 net present value of the
targeted benefit under the prior split-dollar plan. Benefits vest under the SERP based on age
and years of service with 100% vesting obtained at age 55 and 15 years of service. Earlier
vesting may occur upon a change in control or other events as defined in the agreement. The
Company recorded a charge of $14,247 in 2002 in connection with the termination and
restructuring of the split-dollar plan. The amount represented the net present value of the
targeted benefits under the plan (including tax mitigation amounts) of approximately $13,668,
and $579 related to transaction costs and the net shortfall in the refund of cumulative
premiums paid by the Company. The Company satisfied its obligations to participants by
relinquishing its collateral interests in the split-dollar policies and through net
incremental payments of approximately $3,086 (the effect of which was mitigated by the
elimination of future premium obligations of $3,694). During 2004 and 2003, $162 and $170,
respectively, were expensed related to the SERP and an additional $685 is expected to be
expensed over the next seven years of expected service by the respective current employees.
During 2004, the Company paid benefits of $1,200 in accordance with the plan. The liability
under the SERP plan as of December 31, 2004 and 2003 was $3,882 and $4,554,
respectively, and is recorded in other long-term liabilities on the consolidated balance
sheets. The fair value of the assets in the SERP of $3,435 and $3,949 at December 31, 2004
and 2003, respectively, is recorded in other assets in the consolidated balance sheets. F-25




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##### Table of Contents



(8)
    CommitmentsThe Company is committed under noncancelable lease agreements for facilities and equipment.
Future minimum operating lease payments and the present value of the future minimum capital
lease payments as of December 31, 2004 are as follows: Operating
    
    
    CapitalYears ending December 31,
    
    Leases
    
    
    Leases2005
    
    $
    5,016
    
    
    $
    782006
    
    
    4,128
    
    
    
    362007
    
    
    3,735
    
    
    
    2008
    
    
    2,981
    
    
    
    2009
    
    
    2,314
    
    
    
    Thereafter
    
    
    1,084
    
    
    
    $
    19,258
    
    
    
    114Less interest
    
    
    
    
    
    
    (7
    )Present value of future minimum capital lease payments
    
    
    
    
    
    $
    107
  Amortization of capital leased assets is included in depreciation expense. Rental
expense for cancelable and noncancelable leases was approximately $6,155, $5,673, and $5,666
for the years ended December 31, 2004, 2003 and 2002, respectively.(9)
    Contingencies and ConcentrationsThe Company and its subsidiaries are involved in various claims and legal actions arising in
the ordinary course of business. In the opinion of management, based in part on the advice of
counsel, the ultimate disposition of these matters will not have a material adverse effect on
the Companys consolidated balance sheet, results of operations or liquidity.A qui tam action has been filed in the United States
District Court for the Western District of Virginia by a former
employee of the Companys former domestic pharmacy and supplies
division, against the Company and its subsidiary, Diabetes Self-Care,
Inc. The complaint alleges improper claims by Diabetes Self-Care,
Inc. for Medicare payments and seeks treble damages and civil
penalties in unspecified amounts. As is required by law, the federal
government is conducting an investigation of the complaint to
determine if it will intervene or join in this suit. We are
cooperating fully with the investigation. This matter is still in its
preliminary stages, and we are unable to predict the ultimate
disposition of the action or the investigation.The Companys subsidiary, Facet Technologies, LLC (Facet), currently purchases virtually all
of the components for its products from one supplier, who has been a supplier to Facet for
more than 15 years. Under the agreement, some terms, such as pricing, are negotiated annually
while others, such as the exclusivity arrangement, are renewable after longer periods. The
exclusivity provisions of the agreement will expire December 2005. Termination of this
agreement could cause an interruption in supply and a possible loss of sales, which would
affect operating results adversely. F-26




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##### Table of Contents



(10)
    Quarterly Financial Information  UnauditedPresented below is a summary of the unaudited consolidated quarterly financial information for
the years ended December 31, 2004 and 2003. QuarterFourth
    
    
    Third
    
    
    Second
    
    
    First2004:Revenues
    
    $
    79,211
    
    
    $
    75,995
    
    
    $
    71,946
    
    
    $
    67,230Net earnings (loss)Continuing operations
    
    $
    4,155
    
    
    $
    4,210
    
    
    $
    (11,855
    )
    
    $
    276Discontinued operations
    
    
    (2,589
    )
    
    
    (917
    )
    
    
    33,132
    
    
    
    654Total
    
    $
    1,566
    
    
    $
    3,293
    
    
    $
    21,277
    
    
    $
    930Net earnings (loss) per diluted common shareContinuing operations
    
    $
    0.23
    
    
    $
    0.24
    
    
    $
    (0.77
    )
    
    $
    0.02Discontinued operations
    
    
    (0.12
    )
    
    
    (0.05
    )
    
    
    2.15
    
    
    
    0.04Total
    
    $
    0.11
    
    
    $
    0.19
    
    
    $
    1.38
    
    
    $
    0.062003:Revenues
    
    $
    67,175
    
    
    $
    63,069
    
    
    $
    61,602
    
    
    $
    60,477Net earnings (loss)Continuing operations
    
    $
    2,270
    
    
    $
    1,669
    
    
    $
    973
    
    
    $
    1,098Discontinued operations
    
    
    (204
    )
    
    
    707
    
    
    
    771
    
    
    
    22Total
    
    $
    2,066
    
    
    $
    2,376
    
    
    $
    1,744
    
    
    $
    1,120Net earnings (loss) per diluted common shareContinuing operations
    
    $
    0.14
    
    
    $
    0.11
    
    
    $
    0.06
    
    
    $
    0.07Discontinued operations
    
    
    (0.01
    )
    
    
    0.04
    
    
    
    0.05
    
    
    
    Total
    
    $
    0.13
    
    
    $
    0.15
    
    
    $
    0.11
    
    
    $
    0.07
  The sum of the four quarterly net earnings (loss) per diluted common share amounts may
not equal the annual amount reflected on the consolidated statements of operations due to the
timing of quarterly net earnings (loss), the dilutive effect of the conversion of the
4.875% convertible senior subordinated notes during certain of the quarter periods and rounding.(11)
    Business Segment InformationThe Companys operating segments represent the business units for which management regularly
reviews discrete financial information and evaluates performance based on operating earnings
of the respective business unit. The Company has aggregated the business units into
reportable business segments based on common economic and market characteristics.The Company has two reportable business segments: Health Enhancement and Womens and
Childrens Health. The Health Enhancement segment is comprised of the Companys disease
management business, its foreign diabetes supply operation and its diabetes product design,
development and assembly operation. The Health Enhancement segment currently offers disease
management services for diabetes, cardiovascular disease, respiratory disorders, cancer,
depression, chronic pain and hepatitis C. The Health Enhancement segment also includes Facet,
a leading designer, developer, assembler and distributor of products for the diabetes market.
In June 2004, the Company sold substantially all of the assets of the pharmacy and supplies
division of this segment (see note 2). The results of operations of this business are
classified as discontinued operations and are not included in the Companys segment
information.The Womens and Childrens Health segment offers a wide range of clinical and disease
management services designed to assist physicians and payors in the cost-effective management
of maternity patients, including those with gestational diabetes, hypertension, hyperemesis,
anticoagulation disorders and those F-27




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##### Table of Contents



experiencing, or at risk of, preterm labor. In addition,
the Company is developing services for infants and children through neonatal intensive care
case management and delivery of specialty pharmaceuticals.The accounting policies of the reportable business segments are the same as those described in
the summary of significant accounting policies for the consolidated entity. Severance and
related costs of $1,740 and $503 were incurred in the Health Enhancement and Womens and
Childrens Health segments, respectively, during the year ended December 31, 2002. Operating
earnings (loss) by business segment exclude interest income and interest expense. An
allocation of corporate expenses for shared services has been charged to the segments.Summarized financial information as of and for the years ended December 31, 2004, 2003 and
2002 by business segment follows: Earnings (loss) from continuingRevenues
    
    
    operations before income taxes2004
    
    
    2003
    
    
    2002
    
    
    2004
    
    
    2003
    
    
    2002Health Enhancement
    
    $
    201,639
    
    
    $
    157,929
    
    
    $
    114,516
    
    
    $
    29,701
    
    
    $
    18,669
    
    
    $
    10,451Womens and Childrens Health
    
    
    92,768
    
    
    
    94,423
    
    
    
    98,158
    
    
    
    7,072
    
    
    
    13,393
    
    
    
    12,564Intersegment sales
    
    
    (25
    )
    
    
    (29
    )
    
    
    (62
    )
    
    
    
    
    
    
    
    
    
    
    Total segments
    
    
    294,382
    
    
    
    252,323
    
    
    
    212,612
    
    
    
    36,773
    
    
    
    32,062
    
    
    
    23,015General corporate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10,584
    )
    
    
    (9,455
    )
    
    
    (25,684
    )Interest expense, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (9,793
    )
    
    
    (13,842
    )
    
    
    (13,624
    )Other income (expense), net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (21,947
    )
    
    
    1,466
    
    
    
    (3,160
    )$
    294,382
    
    
    $
    252,323
    
    
    $
    212,612
    
    
    $
    (5,551
    )
    
    $
    10,231
    
    
    $
    (19,453
    )
 Identifiable assets
    
    
    Depreciation and amortization2004
    
    
    2003
    
    
    2002
    
    
    2004
    
    
    2003
    
    
    2002Health Enhancement
    
    $
    199,151
    
    
    $
    189,575
    
    
    $
    157,988
    
    
    $
    2,845
    
    
    $
    2,286
    
    
    $
    1,712Womens and Childrens Health
    
    
    32,094
    
    
    
    31,633
    
    
    
    31,265
    
    
    
    1,683
    
    
    
    2,303
    
    
    
    2,370General corporate
    
    
    73,237
    
    
    
    75,665
    
    
    
    65,045
    
    
    
    1,115
    
    
    
    1,537
    
    
    
    2,141Assets of discontinued
operation sold
    
    
    
    
    
    
    36,609
    
    
    
    37,109
    
    
    
    
    
    
    
    
    
    
    
    $
    304,482
    
    
    $
    333,482
    
    
    $
    291,407
    
    
    $
    5,643
    
    
    $
    6,126
    
    
    $
    6,223
 Capital expenditures2004
    
    
    2003
    
    
    2002Health Enhancement
    
    $
    2,593
    
    
    $
    3,858
    
    
    $
    6,598Womens and Childrens Health
    
    
    2,129
    
    
    
    2,856
    
    
    
    2,131General corporate
    
    
    4,987
    
    
    
    1,376
    
    
    
    1,214$
    9,709
    
    
    $
    8,090
    
    
    $
    9,943
  The Companys revenues from operations outside the U.S. were approximately 24% of total
revenues in 2004 and 2003, and 22% of total revenues in 2002. Total assets for operations
outside the U.S. were $26,887 and $22,400 at December 31, 2004 and 2003, respectively. During 2004, no single customer
accounted for more than 10% of consolidated net revenues. Sales to a single customer within
the Health Enhancement segment represented approximately 10% of consolidated net revenues in
2003 and 2002. F-28




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##### Table of Contents



(12)
    Supplemental Guarantor/Non-Guarantor Financial InformationSupplemental financial information is being provided in connection with the Companys 4.875%
convertible senior subordinated notes and the 11% Senior Notes, both of which are
unconditionally guaranteed by the Company and certain of its domestic subsidiaries. All
guarantees are joint and several, and each of the subsidiaries is 100% owned by the Company.The following financial information presents the consolidating condensed balance sheets,
statements of operations and cash flows of the Company, the guarantor domestic subsidiaries
on a combined basis and the non-guarantor foreign subsidiaries on a combined basis. The
guarantor domestic subsidiaries of the convertible senior subordinated notes are also guarantor domestic
subsidiaries of the 11% Senior Notes. As a result, the financial information for these
subsidiaries is included in both columns on each statement for each period presented. Consolidating Condensed Balance Sheets
December 31, 2004
(Unaudited) Guarantor
    
    
    GuarantorDomestic
    
    
    DomesticSubsidiaries
    
    
    Subsidiaries
    
    
    Non-Matria
    
    
    for 4.875%
    
    
    for 11%
    
    
    GuarantorHealthcare,
    
    
    Convertible
    
    
    Senior
    
    
    ForeignInc.
    
    
    Notesa
    
    
    Notesb
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedASSETSCash and cash equivalents
    
    $
    34,576
    
    
    $
    599
    
    
    $
    738
    
    
    $
    2,071
    
    
    $
    
    
    
    $
    37,385Restricted cash
    
    
    823
    
    
    
    3,000
    
    
    
    3,000
    
    
    
    
    
    
    
    
    
    
    
    3,823Trade accounts receivable, net
    
    
    
    
    
    
    31,814
    
    
    
    35,644
    
    
    
    9,959
    
    
    
    
    
    
    
    45,603Inventories
    
    
    
    
    
    
    11,808
    
    
    
    11,944
    
    
    
    13,256
    
    
    
    
    
    
    
    25,200Other current assets
    
    
    15,622
    
    
    
    976
    
    
    
    1,299
    
    
    
    610
    
    
    
    
    
    
    
    17,531Total current assets
    
    
    51,021
    
    
    
    48,197
    
    
    
    52,625
    
    
    
    25,896
    
    
    
    
    
    
    
    129,542Property and equipment, net
    
    
    6,244
    
    
    
    10,250
    
    
    
    15,646
    
    
    
    991
    
    
    
    
    
    
    
    22,881Intangible assets, net
    
    
    
    
    
    
    120,884
    
    
    
    131,138
    
    
    
    4,171
    
    
    
    
    
    
    
    135,309Investment in subsidiaries
    
    
    134,993
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (134,993
    )
    
    
    Deferred income taxes
    
    
    11,702
    
    
    
    
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    11,704Other assets
    
    
    6,971
    
    
    
    172
    
    
    
    754
    
    
    
    
    
    
    
    (2,679
    )
    
    
    5,046$
    210,931
    
    
    $
    179,503
    
    
    $
    200,165
    
    
    $
    31,058
    
    
    $
    (137,672
    )
    
    $
    304,482LIABILITIES AND SHAREHOLDERS EQUITYCurrent installments of long-term debt
    
    $
    807
    
    
    $
    25
    
    
    $
    58
    
    
    $
    
    
    
    $
    
    
    
    $
    865Other current liabilities
    
    
    13,703
    
    
    
    21,691
    
    
    
    28,115
    
    
    
    10,950
    
    
    
    
    
    
    
    52,768Total current liabilities
    
    
    14,510
    
    
    
    21,716
    
    
    
    28,173
    
    
    
    10,950
    
    
    
    
    
    
    
    53,633Long-term debt, excluding current installments
    
    
    85,717
    
    
    
    
    
    
    
    34
    
    
    
    2,679
    
    
    
    (2,679
    )
    
    
    85,751Intercompany
    
    
    230,153
    
    
    
    (191,685
    )
    
    
    (214,801
    )
    
    
    (15,352
    )
    
    
    
    
    
    
    Other long-term liabilities
    
    
    5,147
    
    
    
    291
    
    
    
    291
    
    
    
    
    
    
    
    
    
    
    
    5,438Total liabilities
    
    
    335,527
    
    
    
    (169,678
    )
    
    
    (186,303
    )
    
    
    (1,723
    )
    
    
    (2,679
    )
    
    
    144,822Shareholders equity:Common stock
    
    
    159
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    159Additional paid-in capital
    
    
    323,810
    
    
    
    117,937
    
    
    
    128,191
    
    
    
    4,173
    
    
    
    (134,993
    )
    
    
    321,181Accumulated earnings (deficit)
    
    
    (452,222
    )
    
    
    239,686
    
    
    
    266,488
    
    
    
    22,745
    
    
    
    
    
    
    
    (162,989
    )Other
    
    
    3,657
    
    
    
    (8,442
    )
    
    
    (8,211
    )
    
    
    5,863
    
    
    
    
    
    
    
    1,309Total shareholders equity
    
    
    (124,596
    )
    
    
    349,181
    
    
    
    386,468
    
    
    
    32,781
    
    
    
    (134,993
    )
    
    
    159,660$
    210,931
    
    
    $
    179,503
    
    
    $
    200,165
    
    
    $
    31,058
    
    
    $
    (137,672
    )
    
    $
    304,482
   a
    
    The guarantor domestic subsidiaries of these
convertible notes are also guarantors of the 11% Senior Notes.b
    
    Includes the financial information for the
guarantor domestic subsidiaries of the 4.875% convertible notes in the
preceding column. F-29




---



##### Table of Contents



Consolidating Condensed Balance Sheets
December 31, 2003
(Unaudited) Guarantor
    
    
    GuarantorDomestic
    
    
    DomesticSubsidiaries
    
    
    Subsidiaries
    
    
    Non-Matria
    
    
    for 4.875%
    
    
    for 11%
    
    
    GuarantorHealthcare,
    
    
    Convertible
    
    
    Senior
    
    
    ForeignInc.
    
    
    Notesa
    
    
    Notesb
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedASSETSCash and cash equivalents
    
    $
    2,450
    
    
    $
    510
    
    
    $
    3,202
    
    
    $
    2,901
    
    
    $
    
    
    
    $
    8,553Restricted cash
    
    
    455
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    455Trade accounts receivable, net
    
    
    
    
    
    
    28,424
    
    
    
    30,944
    
    
    
    6,330
    
    
    
    
    
    
    
    37,274Inventories
    
    
    
    
    
    
    10,221
    
    
    
    10,262
    
    
    
    11,999
    
    
    
    
    
    
    
    22,261Assets of discontinued operation sold
    
    
    
    
    
    
    
    
    
    
    36,609
    
    
    
    
    
    
    
    
    
    
    
    36,609Other current assets
    
    
    35,992
    
    
    
    2,376
    
    
    
    2,789
    
    
    
    397
    
    
    
    
    
    
    
    39,178Total current assets
    
    
    38,897
    
    
    
    41,531
    
    
    
    83,806
    
    
    
    21,627
    
    
    
    
    
    
    
    144,330Property and equipment, net
    
    
    2,413
    
    
    
    9,679
    
    
    
    16,042
    
    
    
    773
    
    
    
    
    
    
    
    19,228Intangible assets, net
    
    
    
    
    
    
    120,900
    
    
    
    130,687
    
    
    
    4,578
    
    
    
    
    
    
    
    135,265Investment in subsidiaries
    
    
    135,202
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (135,202
    )
    
    
    Deferred income taxes
    
    
    26,522
    
    
    
    
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    26,524Other assets
    
    
    9,919
    
    
    
    162
    
    
    
    217
    
    
    
    
    
    
    
    (2,001
    )
    
    
    121,005$
    212,953
    
    
    $
    172,272
    
    
    $
    230,754
    
    
    $
    26,978
    
    
    $
    (137,203
    )
    
    $
    333,482LIABILITIES AND SHAREHOLDERS EQUITYCurrent installments of long-term debt
    
    $
    740
    
    
    $
    35
    
    
    $
    63
    
    
    $
    
    
    
    $
    
    
    
    $
    803Other current liabilities
    
    
    30,003
    
    
    
    28,835
    
    
    
    39,288
    
    
    
    13,025
    
    
    
    
    
    
    
    82,316Total current liabilities
    
    
    30,743
    
    
    
    28,870
    
    
    
    39,351
    
    
    
    13,025
    
    
    
    
    
    
    
    83,119Long-term debt, excluding current installments
    
    
    120,912
    
    
    
    25
    
    
    
    93
    
    
    
    2,001
    
    
    
    (2,001
    )
    
    
    121,005Intercompany
    
    
    154,382
    
    
    
    (183,566
    )
    
    
    (137,849
    )
    
    
    (16,533
    )
    
    
    
    
    
    
    Other long-term liabilities
    
    
    4,776
    
    
    
    855
    
    
    
    1,035
    
    
    
    
    
    
    
    
    
    
    
    5,811Total liabilities
    
    
    310,813
    
    
    
    (153,816
    )
    
    
    (97,370
    )
    
    
    (1,507
    )
    
    
    (2,001
    )
    
    
    209,935Shareholders equity:Common stock
    
    
    153
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    153Additional paid-in capital
    
    
    315,679
    
    
    
    118,205
    
    
    
    127,992
    
    
    
    4,578
    
    
    
    (135,202
    )
    
    
    313,047Accumulated earnings (deficit)
    
    
    (417,283
    )
    
    
    216,325
    
    
    
    208,342
    
    
    
    18,886
    
    
    
    
    
    
    
    (190,055
    )Other
    
    
    3,591
    
    
    
    (8,442
    )
    
    
    (8,210
    )
    
    
    5,021
    
    
    
    
    
    
    
    402Total shareholders equity
    
    
    (97,860
    )
    
    
    326,088
    
    
    
    328,124
    
    
    
    28,485
    
    
    
    (135,202
    )
    
    
    123,547$
    212,953
    
    
    $
    172,272
    
    
    $
    230,754
    
    
    $
    26,978
    
    
    $
    (137,203
    )
    
    $
    333,482
 F-30




---



##### Table of Contents



Consolidating Condensed Statements of Operations
For the Year Ended December 31, 2004
(Unaudited) Guarantor
    
    
    GuarantorDomestic
    
    
    DomesticSubsidiaries
    
    
    Subsidiaries
    
    
    Non-Matria
    
    
    for 4.875%
    
    
    for 11%
    
    
    GuarantorHealthcare,
    
    
    Convertible
    
    
    Senior
    
    
    ForeignInc.
    
    
    Notesa
    
    
    Notesb
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedRevenues
    
    $
    
    
    
    $
    189,330
    
    
    $
    222,925
    
    
    $
    71,481
    
    
    $
    (24
    )
    
    $
    294,382Cost of revenues
    
    
    
    
    
    
    100,927
    
    
    
    114,092
    
    
    
    55,677
    
    
    
    (24
    )
    
    
    169,745Selling and administrative expenses
    
    
    28,383
    
    
    
    45,844
    
    
    
    58,409
    
    
    
    9,106
    
    
    
    
    
    
    
    95,898Provision for doubtful accounts
    
    
    
    
    
    
    2,326
    
    
    
    2,424
    
    
    
    126
    
    
    
    
    
    
    
    2,550Operating earnings (loss) from continuing operations
    
    
    (28,383
    )
    
    
    40,233
    
    
    
    48,000
    
    
    
    6,572
    
    
    
    
    
    
    
    26,189Interest income (expense), net
    
    
    (9,643
    )
    
    
    (4
    )
    
    
    13
    
    
    
    (163
    )
    
    
    
    
    
    
    (9,793
    )Other income (expense), net
    
    
    (22,318
    )
    
    
    118
    
    
    
    115
    
    
    
    256
    
    
    
    
    
    
    
    (21,947
    )Earnings (loss) from continuing operations before
income taxes
    
    
    (60,344
    )
    
    
    40,347
    
    
    
    48,128
    
    
    
    6,665
    
    
    
    
    
    
    
    (5,551
    )Income tax benefit (expense)
    
    
    25,405
    
    
    
    (16,986
    )
    
    
    (20,262
    )
    
    
    (2,806
    )
    
    
    
    
    
    
    2,337Earnings (loss) from continuing operations
    
    
    (34,939
    )
    
    
    23,361
    
    
    
    27,866
    
    
    
    3,859
    
    
    
    
    
    
    
    (3,214
    )Earnings from discontinued operations
    
    
    
    
    
    
    
    
    
    
    30,280
    
    
    
    
    
    
    
    
    
    
    
    30,280Net earnings (loss)
    
    $
    (34,939
    )
    
    $
    23,361
    
    
    $
    58,146
    
    
    $
    3,859
    
    
    $
    
    
    
    $
    27,066
 Consolidating Condensed Statements of Operations
For the Year Ended December 31, 2003
(Unaudited) Guarantor
    
    
    GuarantorDomestic
    
    
    DomesticSubsidiaries
    
    
    Subsidiaries
    
    
    Non-Matria
    
    
    for 4.875%
    
    
    for 11%
    
    
    GuarantorHealthcare,
    
    
    Convertible
    
    
    Senior
    
    
    ForeignInc.
    
    
    Notesa
    
    
    Notesb
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedRevenues
    
    $
    
    
    
    $
    180,339
    
    
    $
    192,630
    
    
    $
    59,751
    
    
    $
    (58
    )
    
    $
    252,323Cost of revenues
    
    
    
    
    
    
    93,633
    
    
    
    101,594
    
    
    
    46,531
    
    
    
    (58
    )
    
    
    148,067Selling and administrative expenses
    
    
    21,550
    
    
    
    43,168
    
    
    
    49,330
    
    
    
    7,356
    
    
    
    
    
    
    
    78,236Provision for doubtful accounts
    
    
    
    
    
    
    3,214
    
    
    
    3,383
    
    
    
    30
    
    
    
    
    
    
    
    3,413Operating earnings (loss) from continuing operations
    
    
    (21,550
    )
    
    
    40,324
    
    
    
    38,323
    
    
    
    5,834
    
    
    
    
    
    
    
    22,607Interest income (expense), net
    
    
    (13,569
    )
    
    
    (3
    )
    
    
    63
    
    
    
    (336
    )
    
    
    
    
    
    
    (13,842
    )Other income (expense), net
    
    
    1,394
    
    
    
    (44
    )
    
    
    (44
    )
    
    
    116
    
    
    
    
    
    
    
    1,466Earnings (loss) from continuing operations before
income taxes
    
    
    (33,725
    )
    
    
    40,277
    
    
    
    38,342
    
    
    
    5,614
    
    
    
    
    
    
    
    10,231Income tax benefit (expense)
    
    
    13,914
    
    
    
    (16,617
    )
    
    
    (15,819
    )
    
    
    (2,316
    )
    
    
    
    
    
    
    (4,221
    )Earnings (loss) from continuing operations
    
    
    (19,811
    )
    
    
    23,660
    
    
    
    22,523
    
    
    
    3,298
    
    
    
    
    
    
    
    6,010Earnings from discontinued operations
    
    
    
    
    
    
    
    
    
    
    1,296
    
    
    
    
    
    
    
    
    
    
    
    1,296Net earnings (loss)
    
    $
    (19,811
    )
    
    $
    23,660
    
    
    $
    23,819
    
    
    $
    3,298
    
    
    $
    
    
    
    $
    7,306
 F-31




---



##### Table of Contents



Consolidating Condensed Statements of Operations
For the Year Ended December 31, 2002
(Unaudited) Guarantor
    
    
    GuarantorDomestic
    
    
    DomesticSubsidiaries
    
    
    Subsidiaries
    
    
    Non-Matria
    
    
    for 4.875%
    
    
    for 11%
    
    
    GuarantorHealthcare,
    
    
    Convertible
    
    
    Senior
    
    
    ForeignInc.
    
    
    Notesa
    
    
    Notesb
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedRevenues
    
    $
    
    
    
    $
    162,564
    
    
    $
    166,643
    
    
    $
    46,031
    
    
    $
    (62
    )
    
    $
    212,612Cost of revenues
    
    
    
    
    
    
    84,357
    
    
    
    88,467
    
    
    
    36,784
    
    
    
    (62
    )
    
    
    125,189Selling and administrative expenses
    
    
    37,152
    
    
    
    37,216
    
    
    
    41,716
    
    
    
    5,670
    
    
    
    
    
    
    
    84,538Provision for doubtful accounts
    
    
    
    
    
    
    5,367
    
    
    
    5,554
    
    
    
    
    
    
    
    
    
    
    
    5,554Operating earnings (loss) from continuing operations
    
    
    (37,152
    )
    
    
    35,624
    
    
    
    30,906
    
    
    
    3,577
    
    
    
    
    
    
    
    (2,669
    )Interest income (expense), net
    
    
    (13,251
    )
    
    
    6
    
    
    
    (4
    )
    
    
    (369
    )
    
    
    
    
    
    
    (13,624
    )Other income (expense), net
    
    
    (1,048
    )
    
    
    (68
    )
    
    
    (2,038
    )
    
    
    (74
    )
    
    
    
    
    
    
    (3,160
    )Earnings (loss) from continuing operations before
income taxes
    
    
    (51,451
    )
    
    
    35,562
    
    
    
    28,864
    
    
    
    3,134
    
    
    
    
    
    
    
    (19,453
    )Income tax benefit (expense)
    
    
    11,672
    
    
    
    (8,067
    )
    
    
    (6,548
    )
    
    
    (711
    )
    
    
    
    
    
    
    4,413Earnings (loss) from continuing operations
    
    
    (39,779
    )
    
    
    27,495
    
    
    
    22,316
    
    
    
    2,423
    
    
    
    
    
    
    
    (15,040
    )Loss from discontinued operations
    
    
    
    
    
    
    
    
    
    
    (1,286
    )
    
    
    
    
    
    
    
    
    
    
    (1,286
    )Net earnings (loss)
    
    $
    (39,779
    )
    
    $
    27,495
    
    
    $
    21,030
    
    
    $
    2,423
    
    
    $
    
    
    
    $
    (16,326
    )
 F-32




---



##### Table of Contents



Consolidating Condensed Statements of Cash Flows
For the Year Ended December 31, 2004
(Unaudited) Guarantor
    
    
    GuarantorDomestic
    
    
    DomesticSubsidiaries
    
    
    Subsidiaries
    
    
    Non-Matria
    
    
    for 4.875%
    
    
    for 11%
    
    
    GuarantorHealthcare,
    
    
    Convertible
    
    
    Senior
    
    
    ForeignInc.
    
    
    Notesa
    
    
    Notesb
    
    
    Subsidiaries
    
    
    ConsolidatedCash Flows from Operating Activities:Net cash provided by (used in) continuing operations
    
    $
    (30,049
    )
    
    $
    14,488
    
    
    $
    38,773
    
    
    $
    (3,061
    )
    
    $
    5,663Net cash provided by discontinued operations
    
    
    
    
    
    
    
    
    
    
    3,640
    
    
    
    
    
    
    
    3,640Net cash provided by (used in) operating activities
    
    
    (30,049
    )
    
    
    14,488
    
    
    
    42,413
    
    
    
    (3,061
    )
    
    
    9,303Cash Flows from Investing Activities:Purchases of property and equipment
    
    
    (5,560
    )
    
    
    (3,249
    )
    
    
    (3,679
    )
    
    
    (470
    )
    
    
    (9,709
    )Purchases of property and equipment, discontinued operations
    
    
    
    
    
    
    
    
    
    
    (456
    )
    
    
    
    
    
    
    (456
    )Proceeds from disposition of business, net
    
    
    101,055
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    101,055Payment of acquisition obligation
    
    
    (20,480
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (20,480
    )Increase in restricted cash
    
    
    (368
    )
    
    
    (3,000
    )
    
    
    (3,000
    )
    
    
    
    
    
    
    (3,368
    )Net proceeds from investments
    
    
    927
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    927Acquisition of businesses, net of cash acquired
    
    
    
    
    
    
    
    
    
    
    (200
    )
    
    
    
    
    
    
    (200
    )Net cash provided by (used in) investing activities
    
    
    75,574
    
    
    
    (6,249
    )
    
    
    (7,335
    )
    
    
    (470
    )
    
    
    67,769Cash Flows from Financing Activities:Proceeds from issuance of convertible senior debt, net
    
    
    83,210
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    83,210Proceeds from issuance of debt
    
    
    2,446
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,446Net repayment for the retirement of 11% Senior Notes
    
    
    (136,518
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (136,518
    )Principal repayments of long-term debt
    
    
    (2,440
    )
    
    
    (35
    )
    
    
    (35
    )
    
    
    
    
    
    
    (2,475
    )Net repayments under credit agreements
    
    
    (2,418
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,418
    )Proceeds from issuance of common stock
    
    
    6,608
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,608Net cash used in financing activities
    
    
    (49,112
    )
    
    
    (35
    )
    
    
    (35
    )
    
    
    
    
    
    
    (49,147
    )Effect of exchange rate changes on cash and cash equivalents
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    907
    
    
    
    907Net change in intercompany balances
    
    
    35,713
    
    
    
    (8,115
    )
    
    
    (37,507
    )
    
    
    1,794
    
    
    
    Net increase (decrease) in cash and cash equivalents
    
    
    32,126
    
    
    
    89
    
    
    
    (2,464
    )
    
    
    (830
    )
    
    
    28,832Cash and cash equivalents at beginning of year
    
    
    2,450
    
    
    
    510
    
    
    
    3,202
    
    
    
    2,901
    
    
    
    8,553Cash and cash equivalents at end of year
    
    $
    34,576
    
    
    $
    599
    
    
    $
    738
    
    
    $
    2,071
    
    
    $
    37,385
 F-33




---



##### Table of Contents



Consolidating Condensed Statements of Cash Flows
For the Year Ended December 31, 2003
(Unaudited) Guarantor
    
    
    GuarantorDomestic
    
    
    DomesticSubsidiaries
    
    
    Subsidiaries
    
    
    Non-Matria
    
    
    for 4.875%
    
    
    for 11%
    
    
    GuarantorHealthcare,
    
    
    Convertible
    
    
    Senior
    
    
    ForeignInc.
    
    
    Notesa
    
    
    Notesb
    
    
    Subsidiaries
    
    
    ConsolidatedCash Flows from Operating Activities:Net cash provided by (used in) continuing operations
    
    $
    (15,217
    )
    
    $
    35,495
    
    
    $
    28,134
    
    
    $
    2,620
    
    
    $
    15,537Net cash used in discontinued operations
    
    
    
    
    
    
    
    
    
    
    (3,394
    )
    
    
    
    
    
    
    (3,394
    )Net cash provided by (used in) operating activities
    
    
    (15,217
    )
    
    
    35,495
    
    
    
    24,740
    
    
    
    2,620
    
    
    
    12,143Cash Flows from Investing Activities:Purchases of property and equipment
    
    
    (3,706
    )
    
    
    (3,895
    )
    
    
    (3,955
    )
    
    
    (429
    )
    
    
    (8,090
    )Purchases of property and equipment, discontinued operations
    
    
    
    
    
    
    
    
    
    
    (3,422
    )
    
    
    
    
    
    
    (3,422
    )Increase in restricted cash
    
    
    (455
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (455
    )Net purchases of investments
    
    
    (927
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (927
    )Acquisition of businesses, net of cash acquired
    
    
    
    
    
    
    
    
    
    
    (603
    )
    
    
    
    
    
    
    (603
    )Proceed from sales of short-term investments
    
    
    
    
    
    
    
    
    
    
    154
    
    
    
    
    
    
    
    154Net cash used in investing activities
    
    
    (5,088
    )
    
    
    (3,895
    )
    
    
    (7,826
    )
    
    
    (429
    )
    
    
    (13,343
    )Cash Flows from Financing Activities:Proceeds from issuance of debt
    
    
    1,919
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,919Principal repayments of long-term debt
    
    
    32
    
    
    
    (12
    )
    
    
    (40
    )
    
    
    (1,965
    )
    
    
    (1,973
    )Net proceeds under credit agreements
    
    
    2,418
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,418Proceeds from issuance of common stock
    
    
    816
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    816Net cash provided by (used in) financing activities
    
    
    5,185
    
    
    
    (12
    )
    
    
    (40
    )
    
    
    (1,965
    )
    
    
    3,180Effect of exchange rate changes on cash and cash equivalents
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,073
    
    
    
    1,073Net change in intercompany balances
    
    
    15,920
    
    
    
    (31,444
    )
    
    
    (16,021
    )
    
    
    101
    
    
    
    Net increase in cash and cash equivalents
    
    
    800
    
    
    
    144
    
    
    
    853
    
    
    
    1,400
    
    
    
    3,053Cash and cash equivalents at beginning of year
    
    
    1,650
    
    
    
    366
    
    
    
    2,349
    
    
    
    1,501
    
    
    
    5,500Cash and cash equivalents at end of year
    
    $
    2,450
    
    
    $
    510
    
    
    $
    3,202
    
    
    $
    2,901
    
    
    $
    8,553
 F-34




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##### Table of Contents



Consolidating Condensed Statements of Cash Flows
For the Year Ended December 31, 2002
(Unaudited) Guarantor
    
    
    GuarantorDomestic
    
    
    DomesticSubsidiaries
    
    
    Subsidiaries
    
    
    Non-Matria
    
    
    for 4.875%
    
    
    for 11%
    
    
    GuarantorHealthcare,
    
    
    Convertible
    
    
    Senior
    
    
    ForeignInc.
    
    
    Notesa
    
    
    Notesb
    
    
    Subsidiaries
    
    
    ConsolidatedCash Flows from Operating Activities:Net cash provided by (used in) continuing operations
    
    $
    (5,864
    )
    
    $
    41,363
    
    
    $
    21,963
    
    
    $
    7,124
    
    
    $
    23,223Net cash used in discontinued operations
    
    
    
    
    
    
    
    
    
    
    (2,701
    )
    
    
    
    
    
    
    (2,701
    )Net cash provided by (used in) operating activities
    
    
    (5,864
    )
    
    
    41,363
    
    
    
    19,262
    
    
    
    7,124
    
    
    
    20,522Cash Flows from Investing Activities:Purchases of property and equipment
    
    
    (5,211
    )
    
    
    (3,944
    )
    
    
    (4,368
    )
    
    
    (364
    )
    
    
    (9,943
    )Purchases of property and equipment, discontinued operations
    
    
    
    
    
    
    
    
    
    
    (6,157
    )
    
    
    
    
    
    
    (6,157
    )Acquisition of businesses, net of cash acquired
    
    
    
    
    
    
    
    
    
    
    (3,526
    )
    
    
    
    
    
    
    (3,526
    )Net cash used in investing activities
    
    
    (5,211
    )
    
    
    (3,944
    )
    
    
    (14,051
    )
    
    
    (364
    )
    
    
    (19,626
    )Cash Flows from Financing Activities:Proceeds from issuance of debt
    
    
    1,462
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,462Principal repayments of long-term debt
    
    
    572
    
    
    
    (12
    )
    
    
    (16
    )
    
    
    (2,573
    )
    
    
    (2,017
    )Proceeds from issuance of common stock
    
    
    1,858
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,858Net cash provided by (used in) financing activities
    
    
    3,892
    
    
    
    (12
    )
    
    
    (16
    )
    
    
    (2,573
    )
    
    
    1,303Effect of exchange rate changes on cash and cash equivalents
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,318
    
    
    
    1,318Net change in intercompany balances
    
    
    7,967
    
    
    
    (37,554
    )
    
    
    (3,834
    )
    
    
    (4,133
    )
    
    
    Net increase (decrease) in cash and cash equivalents
    
    
    784
    
    
    
    (147
    )
    
    
    1,361
    
    
    
    1,372
    
    
    
    3,517Cash and cash equivalents at beginning of year
    
    
    866
    
    
    
    513
    
    
    
    988
    
    
    
    129
    
    
    
    1,983Cash and cash equivalents at end of year
    
    $
    1,650
    
    
    $
    366
    
    
    $
    2,349
    
    
    $
    1,501
    
    
    $
    5,500
  (13)
    Subsequent EventsIn December 2004, the Companys Board of Directors approved a three-for-two stock split (in
the form of a stock dividend) of the Companys common stock. The additional shares were
distributed on February 4, 2005 to shareholders of record as of the close of business on
January 19, 2005. Accordingly, all amounts for common stock,
additional paid-in capital, number of shares, except shares authorized,
and per share information in the consolidated financial statements have been adjusted to
reflect the stock split on a retroactive basis.On March 9, 2005, the Company announced the signing of a definitive agreement to acquire the
business of Miavita LLC, a leading provider of on-line health and wellness solutions, for
approximately $5,000 in cash with potential additional amounts to be paid under earnout
arrangements. The acquisition is expected to be completed on April 1, 2005. F-35