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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X]
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934
 For the Quarterly Period Ended: September 30, 2004
OR [  ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from __________ to __________.
 American HomePatient, Inc. 
 (exact name of registrant as specified in its charter)
 Delaware
    
    0-19532
    
    62-1474680(State or other jurisdiction of
    
    (Commission
    
    (IRS Employer Identification No.)incorporation or organization)
    
    File Number)
 5200 Maryland Way, Suite 400, Brentwood, Tennessee 37027  (Address of principal executive offices) (Zip Code)
 (615) 221-8884  (Registrants telephone number, including area code)
 None  (Former name, former address and former fiscal year, if changes since last report)
 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 [X]  No    [  ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [   ]  No [X]   16,461,689
(Outstanding shares of the issuers common stock as of November 1, 2004) 1




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AMERICAN HOMEPATIENT, INC. AND SUBSIDIARIES INDEX Page No.PART I Financial InformationItem 1. Financial Statements (Unaudited)
    
    
    3Interim Condensed Consolidated Balance Sheets
    
    
    3Interim Condensed Consolidated Statements of Income  Three and Nine months ended September 30, 2004 and 2003
    
    
    5Interim Condensed Consolidated Statements of Cash Flows  Nine months ended September 30, 2004 and 2003
    
    
    6Notes to Interim Condensed Consolidated Financial Statements
    
    
    8Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    16Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    44Item 4. Controls and Procedures
    
    
    44Report of Independent Registered Public Accounting Firm
    
    
    45PART II Other Information and SignaturesItem 1. Legal Proceedings
    
    
    46Item 6. Exhibits and Reports on Form 8-K
    
    
    47Signatures
    
    
    48Index to Exhibits
    
    
    49Ex-3.5  Certificate of Amendment to the Certificate of Incorporation of the Company dated July 8, 1996Ex-15.1  Awareness Letter of KPMG LLPEx-31.1  Section 302 Certification of the CEOEx-31.2  Section 302 Certification of the CFOEx-32.1  Section 906 Certification of the CEOEx-32.2  Section 906 Certification of the CFO
  2




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PART I. FINANCIAL INFORMATION 
 ITEM 1 - FINANCIAL STATEMENTS AMERICAN HOMEPATIENT, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION FROM JULY 31, 2002 TO JULY 1, 2003) 
 INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
 September 30,
    
    December 31,ASSETS
    
    2004
    
    2003CURRENT ASSETS:Cash and cash equivalents
    
    $
    9,147,000
    
    
    $
    2,571,000Restricted cash
    
    
    650,000
    
    
    
    400,000Accounts receivable, less allowance for
doubtful accounts of $17,831,000 and
$17,486,000, respectively
    
    
    53,483,000
    
    
    
    58,875,000Inventories, net of inventory valuation
allowances of $407,000 and $558,000,
respectively
    
    
    14,863,000
    
    
    
    16,475,000Prepaid expenses and other current assets
    
    
    3,161,000
    
    
    
    4,131,000Total current assets
    
    
    81,304,000
    
    
    
    82,452,000Property and equipment
    
    
    175,165,000
    
    
    
    170,901,000Less accumulated depreciation and amortization
    
    
    (116,968,000
    )
    
    
    (114,070,000
    )Property and equipment, net
    
    
    58,197,000
    
    
    
    56,831,000Goodwill
    
    
    121,834,000
    
    
    
    121,834,000Investment in joint ventures
    
    
    6,381,000
    
    
    
    9,206,000Other assets
    
    
    13,455,000
    
    
    
    13,717,000Total other assets
    
    
    141,670,000
    
    
    
    144,757,000TOTAL ASSETS
    
    $
    281,171,000
    
    
    $
    284,040,000
 (Continued) 3




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AMERICAN HOMEPATIENT, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION FROM JULY 31, 2002 TO JULY 1, 2003) INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
 September 30,
    
    December 31,LIABILITIES AND SHAREHOLDERS DEFICIT
    
    2004
    
    2003CURRENT LIABILITIES:Current portion of long-term debt and capital leases
    
    $
    6,931,000
    
    
    $
    11,720,000Accounts payable
    
    
    16,961,000
    
    
    
    17,518,000Other payables
    
    
    2,269,000
    
    
    
    2,485,000Current portion of pre-petition accounts payable
    
    
    3,338,000
    
    
    
    5,624,000Accrued expenses:Payroll and related benefits
    
    
    10,962,000
    
    
    
    10,155,000Insurance, including self-insurance accruals
    
    
    7,202,000
    
    
    
    6,378,000Other
    
    
    10,075,000
    
    
    
    8,455,000Total current liabilities
    
    
    57,738,000
    
    
    
    62,335,000NONCURRENT LIABILITIES:Long-term debt and capital leases, less current portion
    
    
    250,009,000
    
    
    
    251,194,000Pre-petition accounts payable
    
    
    
    
    
    
    661,000Other noncurrent liabilities
    
    
    2,079,000
    
    
    
    3,601,000Total noncurrent liabilities
    
    
    252,088,000
    
    
    
    255,456,000Total liabilities
    
    
    309,826,000
    
    
    
    317,791,000MINORITY INTEREST
    
    
    534,000
    
    
    
    498,000SHAREHOLDERS DEFICITPreferred stock, $.01 par value; authorized 5,000,000
shares; none issued and outstanding
    
    
    
    
    
    
    Common stock, $.01 par value; authorized 35,000,000
shares; issued and outstanding, 16,462,000 and
16,377,000 shares, respectively
    
    
    164,000
    
    
    
    164,000Additional paid-in capital
    
    
    173,360,000
    
    
    
    173,305,000Accumulated deficit
    
    
    (202,713,000
    )
    
    
    (207,718,000
    )Total shareholders deficit
    
    
    (29,189,000
    )
    
    
    (34,249,000
    )TOTAL LIABILITIES AND SHAREHOLDERS DEFICIT
    
    $
    281,171,000
    
    
    $
    284,040,000
 4




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The accompanying notes to interim condensed consolidated financial statements
are an integral part of these consolidated financial statements. 5




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AMERICAN HOMEPATIENT, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION FROM JULY 31, 2002 TO JULY 1, 2003) 
 INTERIM CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited)
 Three Months Ended September30,
    
    Nine Months Ended September 30,2004
    
    2003
    
    2004
    
    2003REVENUES:Sales and related service revenues, net
    
    $
    36,009,000
    
    
    $
    36,638,000
    
    
    $
    108,588,000
    
    
    $
    109,238,000Rentals and other revenues, net
    
    
    47,493,000
    
    
    
    47,255,000
    
    
    
    142,999,000
    
    
    
    140,026,000Total revenues, net
    
    
    83,502,000
    
    
    
    83,893,000
    
    
    
    251,587,000
    
    
    
    249,264,000EXPENSES:Cost of sales and related services
    
    
    17,463,000
    
    
    
    17,342,000
    
    
    
    53,919,000
    
    
    
    52,084,000Cost of rentals and other revenues, including rental equipment
depreciation of $6,071,000, $5,513,000, $17,600,000 and
15,342,000, respectively
    
    
    9,937,000
    
    
    
    9,562,000
    
    
    
    29,084,000
    
    
    
    26,958,000Operating expenses
    
    
    41,316,000
    
    
    
    44,380,000
    
    
    
    127,913,000
    
    
    
    132,311,000Bad debt expense
    
    
    2,708,000
    
    
    
    2,955,000
    
    
    
    9,187,000
    
    
    
    8,278,000General and administrative
    
    
    4,201,000
    
    
    
    4,337,000
    
    
    
    12,710,000
    
    
    
    13,009,000Earnings from unconsolidated joint ventures
    
    
    (1,026,000
    )
    
    
    (964,000
    )
    
    
    (3,257,000
    )
    
    
    (3,385,000
    )Depreciation, excluding rental equipment, and amortization
    
    
    797,000
    
    
    
    942,000
    
    
    
    2,434,000
    
    
    
    2,713,000Interest expense, net (excluding post-petition contractual interest
of $0, $0, $0 and $12,510,000, respectively)
    
    
    4,587,000
    
    
    
    4,269,000
    
    
    
    13,894,000
    
    
    
    4,219,000Other income, net
    
    
    (40,000
    )
    
    
    (376,000
    )
    
    
    (122,000
    )
    
    
    (282,000
    )Total expenses
    
    
    79,943,000
    
    
    
    82,447,000
    
    
    
    245,762,000
    
    
    
    235,905,000INCOME FROM OPERATIONS BEFORE REORGANIZATION ITEMS AND INCOME TAXES
    
    
    3,559,000
    
    
    
    1,446,000
    
    
    
    5,825,000
    
    
    
    13,359,000Reorganization items
    
    
    449,000
    
    
    
    920,000
    
    
    
    520,000
    
    
    
    3,776,000INCOME FROM OPERATIONS BEFORE INCOME TAXES
    
    
    3,110,000
    
    
    
    526,000
    
    
    
    5,305,000
    
    
    
    9,583,000Provision for income taxes
    
    
    100,000
    
    
    
    100,000
    
    
    
    300,000
    
    
    
    300,000NET INCOME
    
    $
    3,010,000
    
    
    $
    426,000
    
    
    $
    5,005,000
    
    
    $
    9,283,000NET INCOME PER COMMON SHARE:- Basic
    
    $
    0.18
    
    
    $
    0.03
    
    
    $
    0.30
    
    
    $
    0.57- Diluted
    
    $
    0.18
    
    
    $
    0.02
    
    
    $
    0.29
    
    
    $
    0.49WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:- Basic
    
    
    16,462,000
    
    
    
    16,367,000
    
    
    
    16,462,000
    
    
    
    16,367,000- Diluted
    
    
    16,918,000
    
    
    
    19,111,000
    
    
    
    17,029,000
    
    
    
    18,942,000
  The accompanying notes to interim condensed consolidated financial statements
are an integral part of these consolidated financial statements. 6




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AMERICAN HOMEPATIENT, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION FROM JULY 31, 2002 TO JULY 1, 2003) 
 INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
 Nine Months Ended Sept. 30,2004
    
    2003CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    5,005,000
    
    
    $
    9,283,000Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation and amortization
    
    
    20,034,000
    
    
    
    18,055,000Non-cash interest income on adequate protection
payments
    
    
    
    
    
    
    (787,000
    )Equity in earnings of unconsolidated joint ventures
    
    
    (1,772,000
    )
    
    
    (1,771,000
    )Minority interest
    
    
    226,000
    
    
    
    245,000Reorganization items
    
    
    520,000
    
    
    
    3,776,000Reorganization items paid
    
    
    (1,153,000
    )
    
    
    (3,572,000
    )Change in assets and liabilities:Accounts receivable, net
    
    
    5,392,000
    
    
    
    (1,120,000
    )Inventories
    
    
    1,612,000
    
    
    
    1,391,000Prepaid expenses and other current assets
    
    
    970,000
    
    
    
    (278,000
    )Accounts payable, other payables and accrued
expenses
    
    
    164,000
    
    
    
    (9,690,000
    )Other assets and liabilities
    
    
    (93,000
    )
    
    
    4,667,000Other noncurrent liabilities
    
    
    (1,522,000
    )
    
    
    (490,000
    )Net cash provided by operating activities
    
    
    29,383,000
    
    
    
    19,709,000CASH FLOWS FROM INVESTING ACTIVITIES:Additions to property and equipment, net
    
    
    (21,045,000
    )
    
    
    (21,446,000
    )Distributions and loan payments from unconsolidated
joint ventures, net
    
    
    4,597,000
    
    
    
    2,517,000Net cash used in investing activities
    
    $
    (16,448,000
    )
    
    $
    (18,929,000
    )
 (Continued) 7




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AMERICAN HOMEPATIENT, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION FROM JULY 31, 2002 TO JULY 1, 2003) INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
 Nine Months Ended Sept. 30,2004
    
    2003CASH FLOWS FROM FINANCING ACTIVITIES:Distributions to minority interest owners
    
    $
    (190,000
    )
    
    $
    (254,000
    )Principal payments on long-term debt and capital leases
    
    
    (5,974,000
    )
    
    
    (303,000
    )Exercising of employee stock options
    
    
    55,000
    
    
    
    Adequate protection payments
    
    
    
    
    
    
    (7,794,000
    )Restricted cash
    
    
    (250,000
    )
    
    
    (400,000
    )Net cash used in financing activities
    
    
    (6,359,000
    )
    
    
    (8,751,000
    )INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    
    
    6,576,000
    
    
    
    (7,971,000
    )CASH AND CASH EQUIVALENTS, beginning of period
    
    
    2,571,000
    
    
    
    22,827,000CASH AND CASH EQUIVALENTS, end of period
    
    $
    9,147,000
    
    
    $
    14,856,000SUPPLEMENTAL INFORMATION:Cash payments of interest
    
    $
    14,144,000
    
    
    $
    2,970,000Cash payments of income taxes
    
    $
    404,000
    
    
    $
    338,000
 The accompanying notes to interim condensed consolidated financial statements
are an integral part of these consolidated financial statements. 8




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AMERICAN HOMEPATIENT, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION FROM JULY 31, 2002 TO JULY 1, 2003) 
 NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
 1. BASIS OF PRESENTATION American HomePatient, Inc. was incorporated in Delaware in September 1991.
American HomePatient Inc.s principal executive offices are located at 5200
Maryland Way, Suite 400, Brentwood, Tennessee 37027-5018, and its telephone
number at that address is (615) 221-8884. American HomePatient, Inc. and
subsidiaries (the Company) provides home health care services and products
consisting primarily of respiratory therapies, infusion therapies and the
rental and sale of home medical equipment and home health care supplies. For
the nine months ended September 30, 2004, these services represented 71%, 12%
and 17% of revenues, respectively. These services and products are paid for
primarily by Medicare, Medicaid and other third-party payors. As of September
30, 2004, the Company provided these services to patients primarily in the home
through 280 centers in 35 states: Alabama, Arizona, Arkansas, Colorado,
Connecticut, Delaware, Florida, Georgia, Illinois, Iowa, Kansas, Kentucky,
Maine, Maryland, Michigan, Minnesota, Mississippi, Missouri, Nebraska, Nevada,
New Jersey, New Mexico, New York, North Carolina, Ohio, Oklahoma, Pennsylvania,
South Carolina, South Dakota, Tennessee, Texas, Virginia, Washington, West
Virginia and Wisconsin. The interim condensed consolidated financial statements of the Company for the
three and nine months ended September 30, 2004 and 2003 herein are unaudited
and have been prepared by the Company pursuant to the rules and regulations of
the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with U.S. generally accepted accounting principles have been condensed or
omitted pursuant to such rules and regulations. In the opinion of management
of the Company, the accompanying unaudited interim condensed consolidated
financial statements reflect all adjustments (consisting of only normally
recurring accruals) necessary to present fairly the financial position at
September 30, 2004 and the results of operations and the cash flows for the
three and nine months ended September 30, 2004 and 2003. The results of operations for the three and nine months ended September 30,
2004 and 2003 are not necessarily indicative of the operating results for the
entire respective years. These unaudited interim condensed consolidated
financial statements should be read in conjunction with the audited financial
statements and notes thereto included in the Companys 2003 Annual Report on
Form 10-K. Certain reclassifications have been made to the 2003 interim condensed
consolidated financial statements to conform to the 2004 presentation. 2. PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE On July 1, 2003, American HomePatient, Inc. emerged from bankruptcy pursuant to
a 100% pay plan whereby the Companys shareholders retained their equity
interest and all of the Companys creditors and vendors will be paid 100% of
all amounts they are owed, either
immediately or over time with interest. American HomePatient, Inc. and 24 of
its subsidiaries (collectively, the Debtors) 9




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originally filed voluntary
petitions for relief on July 31, 2002 to reorganize under Chapter 11 of the
U.S. Bankruptcy Code (the Bankruptcy Filing) in the United States Bankruptcy
Court for the Middle District of Tennessee (the Bankruptcy Court). These cases (the Chapter 11 Cases) were consolidated for the purpose of joint
administration under Case Number 02-08915-GP3-11. On January 2, 2003, the
Debtors filed their Second Amended Joint Plan of Reorganization (the Proposed
Plan), proposed by the Debtors and the Official Committee of Unsecured
Creditors appointed by the Office of the United States Trustee in the Chapter
11 Cases. The holders of the Companys senior debt (the Lenders) objected to
the Proposed Plan. On May 15, 2003, the Bankruptcy Court entered a memorandum
opinion overruling the Lenders objections to the Proposed Plan. On May 27,
2003, the Bankruptcy Court entered an Order confirming the Proposed Plan
(Confirmation Order) (hereafter referred to as the Approved Plan). On June
30, 2003, the United States District Court for the Middle District of Tennessee
(the District Court) rejected the Lenders request to stay the effective date
of the Approved Plan. On July 1, 2003, the Companys Approved Plan became effective and the Company
successfully emerged from bankruptcy protection. The Lenders filed an appeal
to the District Court of the order confirming the Approved Plan. On September
12, 2003, the District Court issued an opinion affirming in all respects the
Confirmation Order. The Lenders have filed an appeal to the order confirming
the Approved Plan with the United States Court of Appeals for the Sixth Circuit
under Case Number 03-6500, which appeal is still pending. The Company intends
to vigorously defend the Confirmation Order entered by the Bankruptcy Court and
upheld by the District Court, but no assurances can be given as to the outcome
of that appeal. The Approved Plan allows the Company to continue its business operations
uninterrupted, led by its current management team, and accomplishes the
Companys primary goal of restructuring its long-term debt obligations to its
Lenders. In addition, the Approved Plan provides that the Companys
shareholders retain their equity interest in the Company and that all of the
Companys creditors and vendors will be paid 100% of all amounts they are owed,
either immediately or over time with interest. The Approved Plan provides for the treatment of all of the claims subject to
compromise in the Bankruptcy Filing. The Approved Plan provides for the
extension of the maturity on the debt to the Lenders, a reduction of the
related interest cost on such debt, and the payment of all of the Companys
reported liabilities. The Lenders retained their liens on substantially all of
the assets of the Company. Pursuant to the Approved Plan, the Companys secured debt to the Lenders is
quantified at $250.0 million and is evidenced by a promissory note in that
amount and is secured by various security agreements. To the Companys
knowledge, the Lenders have not executed the agreements as of the date of this
filing. The Company is no longer a party to a credit agreement. The remainder
of the amounts due to the Lenders at July 1, 2003 over and above the $250.0
million is treated as unsecured. The Approved Plan provides that principal is payable annually on the $250.0
million secured debt on March 31 of each year, beginning March 31, 2005, in the
amount of one-third of the
Companys Excess Cash Flow (defined in the Approved Plan as cash in excess of
$7.0 million at the end of each 10




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fiscal year) for the previous fiscal year with
a prepayment that became due on September 30 of each year in an amount equal to
one-half of the anticipated March payment. After the unsecured debt of the
Lenders and the general unsecured debt is paid in full, 100% of the Companys
Excess Cash Flow is paid as a principal payment on the $250.0 million secured
debt on March 31 of each year. Other than the Excess Cash Flow payments, there
are no scheduled principal payments on the $250.0 million secured debt until it
matures on July 1, 2009. The Approved Plan provides that interest is payable
monthly on the $250.0 million secured debt at a rate of 6.785% per annum.
Because the Company does not anticipate Excess Cash Flow for 2004, no estimated
prepayment was made on September 30, 2004 and the Company does not anticipate
making an Excess Cash Flow Payment on March 31, 2005. The Approved Plan treats the general unsecured debt and the Lenders unsecured
debt in the same manner. Principal and accrued interest is payable
semi-annually (on June 30 and December 31 of each year) in six equal
installments beginning December 31, 2003. Interest accrues on this unsecured
debt at an annual rate of 8.3675%. The holders of the unsecured debt also
received an estimated prepayment of the Pro Rata Payment (as defined in the
Approved Plan) on September 30, 2003. Because the Company did not have Excess
Cash Flow for fiscal year 2003 (as defined by the Approved Plan), there was no
Pro Rata Payment due on March 31, 2004 and no estimated prepayment of the Pro
Rata Payment due on September 30, 2004. The Pro Rata Payment due on March 31,
2005 is in the amount of two-thirds of the Companys Excess Cash Flow, if any,
for the 2004 fiscal year. Additionally, an estimated prepayment was due on
September 30, 2004 in an amount equal to one-half of the anticipated March 2005
Pro Rata Payment. Because the Company does not anticipate Excess Cash Flow for
2004, no estimated prepayment was made on September 30, 2004 and the Company
does not anticipate making a Pro Rata Payment on March 31, 2005. The Approved Plan allows the Company to make prepayments to holders of
unsecured debt, either in whole or in part, at any time without penalty, which
prepayments reduce and are a credit against any subsequent mandatory payments. Prior to emergence from bankruptcy protection, the Company made adequate
protection payments to the Lenders totaling approximately $15.8 million.
Pursuant to the Approved Plan all of the adequate protection payments have been
applied to the Lenders unsecured debt during 2003 as part of the 2003
scheduled payments and certain prepayments also have been made. The Company has made all payments due as of September 30, 2004 under the
Approved Plan, and has also prepaid some of its obligations thereunder. As of
September 30, 2004, the Lenders were owed approximately $256.0 million,
comprised of $250.0 million of secured debt and $6.0 million of unsecured debt.
The remaining general unsecured claims (excluding the Government Settlement)
as of September 30, 2004 were approximately $3.3 million. The Company paid an
additional $291,000 to the holders of general unsecured claims subsequent on
August 18, 2004 to correct an error in the allocation of a prior payment. On July 1, 2003, the Company paid, in full, unsecured claims that individually
totaled $10,000 or less, according to the provisions of the Approved Plan. The
total of these payments was $3.3 million. The Bankruptcy Court issued an opinion ruling in favor of the Companys request
to reject the warrants 11




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originally issued to the Lenders to purchase 3,265,315
shares of the Companys common stock for $.01 per share. As a result of the
ruling, the warrants, which represented approximately 20% of the Companys
outstanding common stock, were rejected by the Company. The Bankruptcy Court
determined the damages stemming from rejection of the warrants were $846,000,
which is payable by the Company to the warrant holders as an unsecured claim.
The warrant holders have appealed the damages calculation determined in this
ruling. If the Lenders are unsuccessful in their appeal, they will be entitled
to receive payment from the Company for damages in the amount of $846,000,
which will be treated as a general unsecured claim. If the Lenders appeal is
successful, the amount owed to the warrant holders could substantially
increase, which could materially adversely affect the Companys cash flow and
results from operations. The Company intends to vigorously defend the damages
calculation determined by the Bankruptcy Court, but no assurances can be given
as to the outcome of the Lenders appeal. 3. STOCK BASED COMPENSATION The Company applies the intrinsic-value-based method of accounting prescribed
by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock
Issued to Employees (APB No. 25) and related interpretations including FIN
44, Accounting for Certain Transactions Involving Stock Compensation, an
interpretation of APB Opinion No. 25, to account for its fixed-plan stock
options. Under this method, compensation expense is recorded only if the
current market price of the underlying stock exceeds the exercise price on the
date of grant. SFAS No. 123, Accounting for Stock-Based Compensation (SFAS
No. 123), and SFAS No. 148, Accounting for Stock-Based Compensation 
Transition and Disclosure, an amendment to FASB Statement No. 123 (SFAS No.
148), established accounting and disclosure requirements using a
fair-value-based method of accounting for stock-based employee compensation
plans. As permitted by existing accounting standards, the Company has elected
to continue to apply the intrinsic-value-based method of accounting described
above, and has adopted only the disclosure requirements of SFAS No. 123, as
amended. The following table illustrates the effect on net income if the
fair-value-based method had been applied to all outstanding and unvested awards
in each period. Three Months Ended September 30,
    
    

    Nine Months Ended September 30,2004
    
    2003
    
    
    2004
    
    2003Net income  as reported
    
    $
    3,010,000
    
    
    $
    426,000
    
    
    
    $
    5,005,000
    
    
    $
    9,283,000Additional compensation expense
    
    
    (121,000
    )
    
    
    (4,000
    )
    
    
    
    (422,000
    )
    
    
    (12,000
    )Net income  pro forma
    
    $
    2,889,000
    
    
    $
    422,000
    
    
    
    $
    4,583,000
    
    
    $
    9,271,000Net income per common share
- as reportedBasic
    
    $
    0.18
    
    
    $
    0.03
    
    
    
    $
    0.30
    
    
    $
    0.57Diluted
    
    $
    0.18
    
    
    $
    0.02
    
    
    
    $
    0.29
    
    
    $
    0.49Net income per common share
- pro formaBasic
    
    $
    0.18
    
    
    $
    0.03
    
    
    
    $
    0.28
    
    
    $
    0.57Diluted
    
    $
    0.17
    
    
    $
    0.02
    
    
    
    $
    0.27
    
    
    $
    0.49
 12




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4. REORGANIZATION ITEMS Reorganization items represent expenses that are incurred by the Company as a
result of reorganization under Chapter 11 of the Federal Bankruptcy Code.
Reorganization items for the three and nine months ended September 30, 2004 and
September 30, 2003 were $449,000, $520,000, $920,000, and $3,776,000,
respectively, and are comprised primarily of professional fees. 5. LIQUIDITY As discussed in Note 2, on July 1, 2003, the Companys Approved Plan became
effective and the Company emerged from bankruptcy protection. In connection
with the Approved Plan, the Amended Credit Agreement was terminated. Pursuant
to the Approved Plan, as of the effective date of the Approved Plan the Company
had secured debt to the Lenders of $250,000,000 and unsecured debt of
$30,100,000. The secured debt is evidenced by a promissory note in that amount
and is secured by various security agreements. The accompanying interim condensed consolidated financial statements were
prepared on a going concern basis, which contemplates the realization of assets
and the satisfaction of liabilities in the normal course of business. During the year ended December 31, 2003, the Company emerged from bankruptcy,
achieved net income of $14,025,000, and improved operating results compared to
the prior years. The 2003 results were favorably impacted by the exclusion of
$12,510,000 in post-petition interest expense while the Company was in
bankruptcy in 2003. For the year ended December 31, 2003, net cash provided by
operating activities was $17,238,000. For the nine months ended September 30,
2004, the Company achieved net income of $5,005,000 and had $29,383,000 of cash
provided by operating activities. Total long-term debt and capital leases have decreased by $5,974,000 from
$262,914,000 at December 31, 2003 to $256,940,000 at September 30, 2004. All
of the Companys debt has fixed interest rates, which on a weighted average was
6.8% at September 30, 2004. The Company has scheduled current debt principal payments of $6,931,000,
pre-petition accounts payable payments of $3,338,000, and minimum rental
obligations of $9,113,000 under long-term operating leases due during the
twelve months ending September 30, 2005. The Company is also obligated to pay
any Excess Cash Flow for application on the Lenders secured and unsecured debt
as well as to holders of other unsecured debt. During 2003, the Company made
payments, including some pre-payments, on the Lenders unsecured debt, as well
as on other unsecured debt totaling $29.5 million. The Company has the option
to apply the pre-payments against future required payments, including the
required 2004 payments; however, the Company intends to continue making
payments to the Lenders and general unsecured creditors (as defined in the
Approved Plan) if it has sufficient cash. Because the Company does not
anticipate Excess Cash Flow for 2004, no estimated prepayment was made on
September 30, 2004. 13




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As of September 30, 2004, the Company had approximately $9,147,000 in
unrestricted cash and cash equivalents and $23,566,000 of working capital. The
Companys consolidated cash flows from operations for the year ended December
31, 2003 and through September 30, 2004 were sufficient to meet 2003 and year
to date 2004 debt and lease obligations. Management believes that the Company
can operate on its existing cash and cash flow and make all payments provided
for in the Approved Plan through September 30, 2005. The Companys future
liquidity and capital resources will also be materially adversely impacted by
the Medicare reimbursement reductions contained in the Medicare Prescription
Drug, Improvement and Modernization Act of 2003. The Medicare reimbursement
reductions that became effective January 2004 impacted the Companys
profitability and ability to improve its liquidity and capital resources as
compared to 2003. The adverse impact that the scheduled 2005 reimbursement
reductions will have on the Companys future operating results and financial
condition will be material in 2005 and beyond. The magnitude of this impact
will depend upon the success of the Companys efforts to grow revenues, improve
productivity, and reduce costs. It also will depend upon final resolution of
lobbying efforts to modify the pricing changes. See Managements Discussion
and Analysis of Financial Condition and Results of Operations  Trends, Events,
and Uncertainties  Reimbursement Changes and the Companys Response and Risk
Factors  Medicare Reimbursement Reductions. In order to meet its future payment obligations, the Company must continue to
improve its cash flow from operations. There can be no assurance that the
Companys operations will improve as rapidly as anticipated. The failure to
make its periodic debt, lease and other financial obligations, or the failure
to extend, refinance or repay any of its debt obligations as they become due
would have a material adverse effect upon the Company. The Companys future liquidity will continue to be dependent upon the relative
amounts of current assets (principally cash, accounts receivable and
inventories) and current liabilities (principally accounts payable and accrued
expenses). In that regard, the level and quality of accounts receivable can
have a significant impact on the Companys liquidity. The Company has various
types of accounts receivable, the majority of which are patient receivables.
Accounts receivable are generally outstanding for longer periods of time in the
health care industry than many other industries because of requirements to
provide third-party payors with additional information subsequent to billing
and the time required by such payors to process claims. Certain accounts
receivable frequently are outstanding for more than 90 days, particularly where
the account receivable relates to services for a patient receiving a new
medical therapy or covered by private insurance or Medicaid. Net patient
accounts receivable were $52,202,000 and $56,940,000 at September 30, 2004 and
December 31, 2003, respectively. Average days sales in accounts receivable
(DSO) was approximately 58 and 60 days at September 30, 2004 and December 31,
2003, respectively. The Company calculates DSO by dividing the previous 90
days of revenue (excluding dispositions and acquisitions), net of bad debt
expense into net patient accounts receivable and multiplying the ratio by 90
days. The Companys level of DSO and net patient receivables is affected by
the extended time required to obtain necessary billing documentation. The
Companys DSO at September 30, 2004 was impacted negatively by delays in
billing and collection caused by HIPAA implementation which began in the last
quarter of 2003 and by a slow down in Medicaid payments by some states. 14




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In accordance with the Approved Plan, none of the Companys current debt and
lease agreements contain financial and other restrictive covenants. However,
any non-payment, or other default with respect to the Companys debt
obligations could cause the Companys Lenders to attempt to declare defaults,
accelerate payment obligations or foreclose upon the assets securing such
indebtedness or exercise their remedies with respect to such assets. Any of
such events, if appropriately taken by the Lenders, would have a material
adverse impact on the Company. 6. GOVERNMENT INVESTIGATION AND LITIGATION On June 11, 2001, a settlement agreement (the Government Settlement) was
entered among the Company, the United States of America, acting through the
United States Department of Justice (DOJ) and on behalf of the Office of
Inspector General of the Department of Health and Human Services (OIG) and
the TRICARE Management Activity, and a former Company employee, as relator.
The Government Settlement was approved by the United States District Court for
the Western District of Kentucky, the court in which the relators false claim
action was filed. The Government Settlement covers alleged improprieties by
the Company during the period from January 1, 1995 through December 31, 1998,
including allegedly improper billing activities and allegedly improper
remuneration to and contracts with physicians, hospitals and other healthcare
providers. Pursuant to the Government Settlement, the Company made an initial
payment of $3,000,000 in the second quarter of 2001 and agreed to make
additional payments in the principal amount of $4,000,000, together with
interest on this amount, in installments due at various times until March 2006.
The Company also paid the relators attorneys fees and expenses. Pursuant to
the Approved Plan, amounts owed pursuant to the Government Settlement will be
paid in full in accordance with the Government Settlement, and the Company has
made all payments due to date under the Government Settlement. During the nine
month period ended September 30, 2004, the Company paid $880,000 including
interest of $380,000, pursuant to the Government Settlement. At September 30,
2004, the Company had an accrual of $3,520,000 for its remaining obligations
pursuant to the Government Settlement. Of the total accrual related to the
Government Settlement, $1,520,000 is included in other accrued expenses and
$2,000,000 is included in other noncurrent liabilities on the accompanying
interim condensed consolidated balance sheets at September 30, 2004. 7. INCOME PER COMMON SHARE Income per share is measured at two levels: basic income per share and diluted
income per share. Basic income per share is computed by dividing net income by
the weighted average number of common shares outstanding during the year.
Diluted income per share is computed by dividing net income by the weighted
average number of common shares after considering the additional dilution
related to stock options and warrants. In computing diluted income per share,
the outstanding stock warrants and stock options are considered dilutive using
the treasury stock method. 15




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The following information is necessary to calculate income per share for the
periods presented: Three Months Ended September 30,
    
    Nine Months Ended September 30,2004
    
    2003
    
    2004
    
    2003Net income
    
    $
    3,010,000
    
    
    $
    426,000
    
    
    $
    5,005,000
    
    
    $
    9,283,000Weighted average common shares outstanding
    
    
    16,462,000
    
    
    
    16,367,000
    
    
    
    16,462,000
    
    
    
    16,367,000Effect of dilutive options and warrants
    
    
    456,000
    
    
    
    2,744,000
    
    
    
    567,000
    
    
    
    2,575,000Adjusted diluted common shares outstanding
    
    
    16,918,000
    
    
    
    19,111,000
    
    
    
    17,029,000
    
    
    
    18,942,000Net income per common share- Basic
    
    $
    0.18
    
    
    $
    0.03
    
    
    $
    0.30
    
    
    $
    0.57- Diluted
    
    $
    0.18
    
    
    $
    0.02
    
    
    $
    0.29
    
    
    $
    0.49Employee stock options excluded from
computation of diluted per share amounts
because the exercise price exceeds
average
market price of common stock
    
    
    1,918,000
    
    
    
    713,000
    
    
    
    1,927,000
    
    
    
    1,344,000
 8. RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS In December 2003, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 46, revised December 2003, (FIN 46R), Consolidation of
Variable Interest Entities, which addresses how a business enterprise should
evaluate whether it has a controlling financial interest in an entity through
means other than voting rights and accordingly should consolidate the entity.
FIN 46R replaced FASB Interpretation No. 46, Consolidations of Variable
Interest Entities, which was issued in January 2003. Beginning in 2004, the
Company was required to apply FIN 46R to variable interests in variable
interest entities (VIEs). The adoption of FIN 46R did not have an impact on the Companys consolidated
balance sheet as none of the existing VIEs need to be consolidated by the
Company. FASB Statement No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity, was issued in May 2003. This
Statement established standards for the classification and measurement of
certain financial instruments with characteristics of both liabilities and
equity. The Statement also includes required disclosures for financial
instruments within its scope. For the Company, the Statement was effective for
instruments entered into or modified after May 31, 2003 and otherwise was
effective as of January 1, 2004, except for mandatorily redeemable financial
instruments. For certain manditorily redeemable financial instruments, the
Statement will be effective for the Company on January 1, 2005. The effective
date has been deferred indefinitely for certain other types of manditorily
redeemable financial instruments. Adoption of FASB Statement No. 150 did not 16




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have an impact on the Companys consolidated financial statements as the
Company currently does not have any financial instruments that are within the
scope of this Statement. 17




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ITEM 2   MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Quarterly Report on Form 10-Q includes forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995 including,
without limitation, statements containing the words believes, anticipates,
intends, expects, estimates, projects, may, plan, will, likely,
could and words of similar import. Such statements include statements
concerning the Companys Approved Plan (as defined in Note 2 to the interim
condensed consolidated financial statements), other effects and consequences of
the Bankruptcy Filing (as defined in Note 2 to the interim condensed
consolidated financial statements), forecasts upon which the Approved Plan is
based, business strategy, the ability to satisfy interest expense and principal
repayment obligations, operations, cost savings initiatives, industry, economic
performance, financial condition, liquidity and capital resources, adoption of,
or changes in, accounting policies and practices, existing government
regulations and changes in, or the failure to comply with, governmental
regulations, legislative proposals for healthcare reform, the ability to enter
into strategic alliances and arrangements with managed care providers on an
acceptable basis, and changes in reimbursement policies. Such statements are
not guarantees of future performance and are subject to various risks and
uncertainties. The Companys actual results may differ materially from the
results discussed in such forward-looking statements because of a number of
factors, including those identified in the Risk Factors section and elsewhere
in this Quarterly Report on Form 10-Q. The forward-looking statements are made
as of the date of this Quarterly Report on Form 10-Q and the Company does not
undertake to update the forward-looking statements or to update the reasons
that actual results could differ from those projected in the forward-looking
statements. General The Company provides home health care services and products to patients through
its 280 centers in 35 states. These services and products are primarily paid
for by Medicare, Medicaid and other third-party payors. As a result, prices
for the Companys products and services are set by the payors and not by the
Company. Since the Company cannot affect pricing, it can improve operating
results primarily by increasing the number of units sold and rented and
controlling expenses. It can improve cash flow by limiting the amount of time
that it takes to collect payment after delivering products and services. Key
indicators of performance include: Sales and Rentals. Operating in an industry with pre-set prices makes it
crucial to increase revenues by increasing the volume of sales and rentals.
Over the past three years, the Company has increased its focus on sales and
marketing efforts in an effort to improve revenues. Continuing these efforts
will be critical to the Companys success. Management closely tracks overall
increases and decreases in sales and rentals as well as increases and decreases
by product line and branch location and region. Managements goal is to
identify geographic or product line weaknesses and take corrective actions.
Shareholders should realize that reductions in reimbursement levels can more
than offset 18




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increased sales and rental volumes. See Trends, Events, and
Uncertainties  Reimbursement Changes and the Companys Response. Bad Debt Expense. Billing and collecting in the healthcare industry is
extremely complex. Rigorous substantive and procedural standards are set by
each third party payor, and failure to adhere to these standards can lead to
non-payment, which can have a significant impact on the Companys net income
and cash flow. The Company measures bad debt as a percent of net sales and
rentals, and management considers this percentage a key indicator in monitoring
its billing and collection function. Bad debt expense as a percentage of net
revenue has decreased in the past three years from 4.6% in 2001 to 3.6% in 2002
to 3.1% in 2003, but has increased to 3.7% for the nine months ended September
30, 2004. The increase in the current year is the result of the processing
changes in state Medicaid programs; however, the backlog of unprocessed claims
improved in the three months ended September 30, 2004. Managements goal is to
lower this percentage in the remainder of 2004. Cash Flow. The Companys funding of day-to-day operations going forward
and all payments required under the Approved Plan will rely on cash flow and
cash on hand as it has since the Lenders terminated the Companys ability to
access a revolving line of credit in 2000. The Approved Plan also obligates
the Company to pay Excess Cash Flow (as defined in the Approved Plan) to
creditors to reduce the Companys debt. The nature of the Companys business
also requires substantial capital expenditures in order to buy the equipment
used to generate revenues. As a result, management views cash flow as
particularly critical to the Companys operations. The Companys future
liquidity will continue to be dependent upon the relative amounts of current
assets (principally cash, accounts receivable and inventories) and current
liabilities (principally accounts payable and accrued expenses). Management
attempts to monitor and improve cash flow in a number of ways, including
inventory utilization analysis, cash flow forecasting, and accounts receivable
collection. In that regard, the length of time that it takes to collect
receivables can have a significant impact on the Companys liquidity as
described below in Days Sales Outstanding. Days Sales Outstanding. DSO is a measure used by management to assess
collections and the consequent impact on cash flow. The Company calculates DSO
by dividing the previous 90 days of revenue (excluding dispositions and
acquisitions), net of bad debt expense into net patient accounts receivable and
multiplying the ratio by 90 days. The Company attempts to minimize DSO by
screening new patient cases for adequate sources of reimbursement and by
providing complete and accurate claims data to relevant payor sources. The
Company monitors DSO trends for each of its branches and billing centers, and
for the Company in total, as part of the management of the billing and
collections process. An increase in DSO usually indicates a breakdown in
processes at the billing centers. A decline in DSO usually results from
process improvements and improved cash collections. Management uses DSO trends
to monitor, evaluate and improve the performance of the billing centers. The
decrease in DSO in the past three years from 68 in 2001 to 61 in 2002 to 60 in
2003 is due to improved collection results on current billings and improved
timeliness in obtaining necessary billing documentation. Managements goal is
to continue to lower DSO in 2004. The Companys DSO of 58 at September 30,
2004 was impacted negatively by delays in billing and collection caused by
HIPAA implementation which began in the last quarter of 2003 and a slow down in
Medicaid payments by some states. See Managements Discussion and Analysis of
Financial Condition and Results of Operations  Trends, Events, and
Uncertainties  HIPAA and -Medicaid. 19




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Unbilled Revenue.Another key indicator of the Companys receivable
collection efforts is the amount of unbilled revenue, which reports the amount
of sales and rental revenues that have not
yet been billed to the payors due to incomplete documentation or the receipt of
the Certificate of Medical Necessity (CMN). At September 30, 2004 and
December 31, 2003, the amount of unbilled revenue net of allowances was $10.9
million and $10.2 million, respectively. Productivity and Profitability. As discussed above, the fixed priced
reimbursement in our industry makes it particularly important to control
expenses. Management considers many of the Companys expenses to be either
fixed costs or cost of goods sold, which are difficult to reduce or eliminate.
As a result, managements primary areas of focus for expense reduction and
containment are productivity analysis and profitability analysis. For
instance, management analyzes billing center productivity using measures such
as monthly revenue processed per full time equivalent (FTE) and monthly claims
processed per FTE, with the goal of increasing productivity and eliminating the
resulting excess capacity. This analysis has enabled the Company to
consolidate billing centers and reduce expenses. Moreover, it helps identify
and standardize best practices and identify and correct deficiencies.
Similarly, the Company monitors its business on a branch, geographic area, and
product-line basis to identify opportunities for gains in productivity and to
target growth or contraction. This analysis has led to the past closure or
sale of businesses and to the expansion of product lines and new sales
initiatives. Management anticipates that further closures and consolidation
will occur in light of the Medicare reimbursement reductions recently
implemented. See Trends, Events, and Uncertainties  Reimbursement Changes
and the Companys Response. Trends, Events, and Uncertainties From time to time changes occur in our industry or our business such that it is
reasonably likely that aspects of our future operating results will be
materially different than our historical operating results. Sometimes these
matters have not occurred but probability of their occurrence is sufficient as
to raise doubt regarding the likelihood that historical operating results are
an accurate gauge of future performance. The Company attempts to identify and
describe these trends, events, and uncertainties to assist investors in
assessing the likely future performance of the Company. Investors should
understand that these matters typically are new, sometimes are unforeseen, and
often are fluid in nature. Moreover, the matters described below are not the
only issues that can result in variances between past and future performance
nor are they necessarily the only material trends, events, and uncertainties
that will effect the Company. As a result, investors are encouraged to use
this and other information to ascertain for themselves the likelihood that past
performance is indicative of future performance. The following trends, events, and uncertainties have been identified by the
Company as reasonably likely to materially affect the comparison of historical
operating results reported herein to either other past period results or to
future operating results: Reimbursement Changes and the Companys Response. The reimbursement
reductions contained in the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the MMA) will negatively impact the Companys
future operating results, liquidity and capital resources. A provision in the
MMA required that the reimbursement rate for inhalation drugs used with a
nebulizer 20




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##### Table of Contents



be reduced from 95% of the average wholesale price (AWP) to 80% of
AWP effective January 1, 2004. Beginning January 1, 2005, the MMA specifies
that the reimbursement for inhalation drugs will be further reduced to the
average manufacturers sales price plus six percent (ASP + 6%). Revenue in the
first nine months of 2004 was reduced by
approximately $5.6 million as result of an approximate 15.8% reduction in the
Medicare reimbursement rates for inhalation drugs effective January 1, 2004.
Management believes that the reimbursement reductions scheduled to take effect
January 1, 2005 with respect to the Companys inhalation drug business, which
constitutes approximately 12% of the Companys year to date 2004 revenues, will
have the greatest impact on the Companys operating results. Management is
working to reduce the expected impact of the 2005 reimbursement reductions
contained in the MMA, including initiatives to grow revenues, improve
productivity, and reduce costs. The Company also has undertaken a number of
efforts, including lobbying lawmakers and regulators, aimed at addressing the
Medicare patient drug availability issues created by the inhalation drug
reimbursement reductions scheduled for January 1, 2005, with the hope of
modifying the pricing changes for inhalation drugs to avoid patient drug
availability issues. In July 2004, the Centers for Medicare & Medicaid Services (CMS) announced
possible rulemaking that could impact fees paid for dispensing of inhalation
drugs and asked for comments on such a fee in light of other Medicare
regulations that affect inhalation drug reimbursement. The Company responded
to CMS request for comments. Additionally, as directed by the MMA, the United
States Government Accountability Office (GAO) examined suppliers acquisition
costs of inhalation therapy drugs and identified costs to suppliers of
dispensing inhalation therapy drugs to Medicare beneficiaries. Suppliers of
inhalation drugs, including the Company, have raised concerns that the
reimbursement rate for inhalation drugs scheduled to go into effect on January
1, 2005 (ASP+6%) will not cover the costs of dispensing the drugs. In October
2004, the GAO issued its findings in a report entitled MEDICARE: Appropriate
Dispensing Fee Needed for Suppliers of Inhalation Therapy Drugs. In this
report, the GAO recommends that CMS evaluate the costs of dispensing inhalation
therapy drugs and modify the dispensing fee, if warranted, to ensure that the
fee appropriately accounts for the costs necessary to dispense the drugs. CMS
has agreed with the GAOs recommendation and has stated that a reasonable range
for a monthly dispensing fee is $55.00 to $64.00. The final Medicare fee
schedule for inhalation drugs has not yet been issued. If the final dispensing
fee is in the range as stated by CMS, the Company expects to continue in the
inhalation drug business. However, a dispensing fee in this range combined
with ASP+6% will represent a significant reduction in reimbursement compared to
the current level and will have a material adverse impact on the Companys
operating results and financial condition. Included in the MMA is a freeze in the reimbursement rates for certain durable
medical equipment at those rates in effect on October 1, 2003. These
reimbursement rates will remain in effect until the start of a competitive
bidding process, which is scheduled to begin in 2007. The Company does not
know which of its locations will be included in the competitive bidding
process. In addition, the reimbursement for 16 durable medical equipment items
and home oxygen equipment will be reduced to the median Federal Employee Health
Benefit Plan (FEHBP) rate beginning January 1, 2005. As mandated by the MMA,
the OIG conducted a study to determine the median FEHBP prices for home oxygen.
CMS has stated that they agree with the findings of the OIG. A final fee
schedule for oxygen for 2005 has not yet been issued. 21




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The magnitude of the adverse impact that the MMAs reimbursement reductions
will have on the Companys future operating results and financial condition
will depend upon the success of the Companys revenue growth and cost reduction
initiatives as well as the final inhalation drug and oxygen reimbursement
rates, but the adverse impact will be material in 2005 and beyond. The
Company has been able to offset much of the 2004 impact through revenue growth
and cost reductions through the first nine months of the year. In February 2004 the executive branch of the federal government released the
fiscal year 2005 budget for the Department of Health and Human Services and
made reference to eliminating the Medicare capped rental program. Under the
current provisions of Medicare regulations, the Company receives rental
payments for certain durable medical equipment for fifteen months and then
receives a semi-annual maintenance payment which is equal to one months rent.
If the capped rental program were to be eliminated, durable medical equipment
repair costs would be reimbursed at actual cost, eliminating the semi-annual
payment. The items that are included in the capped rental program are durable
medical equipment items traditionally rented to Medicare patients, such as
hospital beds, wheelchairs, nebulizers, etc. At this time, no legislation has
been enacted that would eliminate the capped rental program. The elimination
of the capped rental program would materially adversely impact the Companys
financial results and financial condition. HIPAA. HIPAA has mandated an extensive set of regulations to protect the
privacy of individually identifiable health information. The regulations
consist of three sets of standards, each with a different date for required
compliance: (1) Privacy Standards had a compliance date of April 14, 2003; (2)
Transactions and Code Sets Standards required compliance by October 16, 2002,
except as extended by one year to October 16, 2003 for providers, such as the
Company, that filed a compliance extension form by October 15, 2002; and (3)
Security Standards which were published in final form on February 2, 2003 and
have a compliance date of April 20, 2005. The Company has filed its compliance
extension form and is actively pursuing its strategies toward compliance with
the final Privacy Standards and Transaction and Code Sets Standards. The
Companys HIPAA compliance plan will require modifications to existing
information management systems and physical security mechanisms, and may
require additional personnel as well as extensive training of existing
personnel, the full cost of which has not yet been determined. The Company
cannot predict the impact that final regulations, when fully implemented, will
have on its operations. The Companys implementation of mandated HIPAA
Transaction and Code Sets has resulted in disruptions to cash collections, and
additional disruptions may occur in the future. Further, the Company cannot
predict when all payors and clearinghouses will be fully HIPAA Transaction
compliant and able to process electronic claims. Alternative methods of claims
submission may be required, possibly resulting in delay in payment, which could
have a material adverse effect on the Companys result of operations, cash
flow, and financial condition. Medicaid.The Company has experienced delays in reimbursement from
several state Medicaid programs. These delays are primarily the result of the
state budgetary concerns and state programs becoming compliant with the new HIPAA Transaction and Code Sets
and/or changing the intermediary contracted by the state to process claims
submitted by the providers. The Company cannot predict when these
states will resume processing claims at a
rate consistent with past performance, if at all. 22




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Approved Plan. On July 1, 2003, American HomePatient, Inc. and 24 of its
subsidiaries (collectively, the Debtors) emerged from bankruptcy pursuant to
a 100% pay plan (the Approved Plan) whereby shareholders retained their
equity interest and the Companys creditors and vendors will be paid 100% of
amounts they are owed, either immediately or over
time with interest. The Approved Plan fixed the interest on the Companys debt
at 6.785% for the secured debt and 8.3675% for the unsecured debt, thus
eliminating all material interest rate risk for the Company. The Approved Plan
set terms for repayment of the Companys outstanding debt and other terms, all
as described in more detail in Managements Discussion and Analysis of
Financial Condition and Results of Operations  Liquidity and Capital
Resources. The Lenders have filed an appeal of the order confirming the Approved Plan with
the United States Court of Appeals for the Sixth Circuit appealing both the
Bankruptcy Courts determination of the amount of their secured claim and the
interest rates on both the secured and unsecured portions of their claims. The
Case Number for this appeal, which is still pending, is 03-6500. The Company
intends to vigorously defend the Confirmation Order entered by the Bankruptcy
Court and upheld by the District Court, and the Company anticipates additional
professional and other fees will be incurred in 2004 and 2005 in connection
with the appeal process. The outcome of the appeal cannot be predicted, and an
adverse ruling could have a material adverse effect on the Company. See Note 2
to the interim condensed consolidated financial statements Proceedings under
Chapter 11 of the Bankruptcy Code and Managements Discussion and Analysis of
Financial Condition and Results of Operations  Liquidity and Capital
Resources. Pursuant to a motion filed by the Company, the Bankruptcy Court issued an
opinion ruling in favor of the Companys request to reject warrants held by the
Lenders that represented approximately 20% of the Companys outstanding common
stock. The Lenders now are entitled to an additional unsecured claim of
approximately $846,000, which is the judicially determined damages stemming
from rejection of the warrants as of July 30, 2002, the date immediately prior
to the Companys bankruptcy filing. The warrant holders have appealed the
damages determination in this ruling. If the appeal is successful, the amount
owed to the warrant holders could substantially increase, which could
materially adversely affect the Companys cash flow and results from
operations. Product Mix. The Companys strategy for 2003 was to maintain a
diversified offering of home health care services reflective of its current
business mix. For 2004, respiratory services will remain a primary focus along
with home medical equipment rental and enteral nutrition products and services. Financial Presentation. The accompanying interim condensed consolidated
financial statements for 2003 have been prepared on a going concern basis and
in accordance with American Institute of Certified Public Accountants Statement
of Position (SOP) 90-7. Accordingly, these consolidated financial statements
do not reflect any adjustments that might result if the Company was unable to
continue as a going concern. Revenues, expenses, realized gains and losses,
and provisions for losses and expenses resulting from the reorganization are
reported separately as reorganization items. Cash used for reorganization
items is disclosed separately in the consolidated statements of cash flows.
Since the Company emerged from bankruptcy, the accompanying interim condensed 23




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consolidated financial statements have not been presented, as during the
bankruptcy proceedings, to reflect liabilities subject to compromise. Services and Products The Company provides a diversified range of home health care services and
products. The following table sets forth the percentage of revenues
represented by each line of business for the periods presented: Nine Months Ended September 30,2004
    
    2003Home respiratory therapy services
    
    
    71
    %
    
    
    69
    %Home infusion therapy services
    
    
    12
    
    
    
    13Home medical equipment and medical supplies
    
    
    17
    
    
    
    18Total
    
    
    100
    %
    
    
    100
    %
 Home Respiratory Therapy Services. The Company provides a wide variety of
home respiratory services primarily to patients with severe and chronic
pulmonary diseases. Patients are referred to a Company center most often by
primary care and pulmonary physicians as well as by hospital discharge planners
and case managers. After reviewing pertinent medical records on the patient
and confirming insurance coverage information, a Company respiratory therapist
or technician visits the patients home to deliver and to prepare the
prescribed therapy or equipment. Company representatives coordinate the
prescribed therapy with the patients physician and train the patient and
caregiver in the correct use of the equipment. For rental patients, Company
representatives also make periodic follow-up visits to the home to provide
additional instructions, perform required equipment maintenance and deliver
oxygen and other supplies. The respiratory services that the Company provides include the following:  
    
    Oxygen systemsto assist patients with breathing. There are
three types of oxygen systems: (i) oxygen concentrators, which are
stationary units that filter ordinary room air to provide a
continuous flow of oxygen; (ii) liquid oxygen systems, which are
portable, thermally-insulated containers of liquid oxygen which can
be used as stationary units and/or as portable options for patients;
and (iii) high pressure oxygen cylinders, which are used primarily
for portability as an adjunct to oxygen concentrators. Oxygen
systems are prescribed by physicians for patients with chronic
obstructive pulmonary disease, cystic fibrosis and
neurologically-related respiratory problems.  
    
    Nebulizersto deliver inhalation drugsto patients.
Nebulizer compressors are used to administer aerosolized medications
(such as albuterol) to patients with asthma, bronchitis, chronic
obstructive pulmonary disease, and cystic fibrosis. AerMeds is
the Companys registered marketing name for its aerosol medications
program.  
    
    Home ventilatorsto sustain a patients respiratory function
mechanically in cases of severe respiratory failure when a patient
can no longer breathe independently. 24




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
    
    Non-invasive positive pressure ventilation (NPPV)to
provide ventilation support via a face mask for patients with
chronic respiratory failure and neuromuscular diseases. This therapy
enables patients to receive positive pressure ventilation without
the invasive procedure of intubation.
    
    Continuous positive airway pressure (CPAP) and bi-level
positive airway pressure therapiesto force air through respiratory
passage-ways during sleep. These treatments are used on adults with
obstructive sleep apnea (OSA), a condition in which a patients
normal breathing patterns are disturbed during sleep.  
    
    Apnea monitorsto monitor and to warn parents of apnea
episodes in newborn infants as a preventive measure against sudden
infant death syndrome.  
    
    Home respiratory evaluations and related diagnostic equipment
to assist physicians in identifying, monitoring and managing their
respiratory patients. Oxygen systems comprised approximately 36% of the Companys year-to-date 2004
revenues. Inhalation drugs and nebulizers comprised approximately 12% and 2%,
respectively, of the Companys total 2004 revenues. All other respiratory
products and services comprised approximately 21% of the Companys total 2004
revenues. The Company provides respiratory therapy services at all but six of
its 280 centers. Home Infusion Therapy Services. The Company provides a wide range of home
infusion therapy services. Patients are referred to a Company center most
often by primary care and specialist physicians (such as infectious disease
physicians and oncologists) as well as by hospital discharge planners and case
managers. After confirming the patients treatment plan with the physician,
the pharmacist mixes the medications and coordinates with the nurse the
delivery of necessary equipment, medication and supplies to the patients home.
The Company provides the patient and caregiver with detailed instructions on
the patients prescribed medication, therapy, pump and supplies. For rental
patients, the Company also schedules follow-up visits and deliveries in
accordance with physicians orders. Home infusion therapy involves the administration of nutrients, antibiotics and
other medications intravenously (into the vein), subcutaneously (under the
skin), intramuscularly (into the muscle), intrathecally (via spinal routes),
epidurally (also via spinal routes) or through feeding tubes into the digestive
tract. The primary infusion therapy services that the Company provides include
the following:  
    
    Enteral nutritionis the infusion of nutrients through a
feeding tube inserted directly into the functioning portion of a
patients digestive tract. This long-term therapy is often
prescribed for patients who are unable to eat or to drink normally
as a result of a neurological impairment such as a stroke or a
neoplasm (tumor). 25




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
    
    Anti-infective therapyis the infusion of anti-infective
medications into a patients bloodstream typically for 5 to 14 days
to treat a variety of serious bacterial and viral infections and
diseases.  
    
    Total parenteral nutrition(TPN) is the long-term provision
of nutrients through central vein catheters that are surgically
implanted into patients who cannot absorb adequate nutrients
enterally due to a chronic gastrointestinal condition.
    
    Pain managementinvolves the infusion of certain drugs into
the bloodstream of patients, primarily terminally or chronically ill
patients, suffering from acute or chronic pain.  
    
    Other infusion therapiesinclude chemotherapy, hydration,
growth hormone and immune globulin therapies. Enteral nutrition services account for approximately 6% of the Companys total
revenues in 2004. Antibiotic therapy, TPN, and pain management and other
infusion revenues accounted for approximately 6% of the Companys year-to-date
revenues in 2004. Enteral nutrition services are provided at most of the
Companys centers, and the Company currently provides other infusion therapies
in 45 of its 280 centers. Home Medical Equipment and Medical Supplies. The Company provides a
comprehensive line of equipment and supplies to serve the needs of home care
patients. Revenues from home equipment and supplies are derived principally
from the rental and sale of wheelchairs, hospital beds, ambulatory aids,
bathroom aids and safety equipment, and rehabilitation equipment. Sales and
rentals of home medical equipment and sales of medical supplies account for 17%
of the Companys year-to-date revenues in 2004. Government Regulation General.The Company, as a participant in the health care industry, is
subject to extensive federal, state and local regulation. In addition to the
Federal False Claims Act (False Claims Act) and other federal and state
anti-kickback and self-referral laws applicable to all of the Companys
operations (discussed more fully below), the operations of the Companys home
health care centers are subject to federal laws covering the repackaging and
dispensing of drugs (including oxygen) and regulating interstate motor-carrier
transportation. Such centers also are subject to state laws (most notably
licensing and controlled substances registration) governing pharmacies, nursing
services and certain types of home health agency activities. The Companys operations are also subject to a series of laws and regulations
dating back to 1987 that apply to the Companys operations. Changes have
occurred from time to time since 1987, including reimbursement reductions and
changes to payment rules. The Federal False Claims Act imposes civil liability on individuals or entities
that submit false or fraudulent claims to the government for payment. False
Claims Act penalties for violations can include sanctions, including civil
monetary penalties. 26




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As a provider of services under the federal reimbursement programs such as
Medicare, Medicaid and TRICARE, the Company is subject to the federal statute
known as the anti-kickback statute, also known as the fraud and abuse law.
This law prohibits any bribe, kickback, rebate or remuneration of any kind in
return for, or as an inducement for, the referral of patients for
government-reimbursed health care services. The Company may also be affected by the federal physician self-referral
prohibition, known as the Stark Law, which, with certain exceptions,
prohibits physicians from referring patients to entities with which they have a
financial relationship. Many states in which the Company operates have
adopted similar fraud and abuse and self-referral laws, as well as laws that
prohibit certain direct or indirect payments or fee-splitting arrangements
between health care providers, under the theory that such arrangements are
designed to induce or to encourage the referral of patients to a particular
provider. In many states, these laws apply to services reimbursed by all payor
sources. In 1996, the Health Insurance Portability and Accountability Act (HIPAA)
introduced a new category of federal criminal health care fraud offenses. If a
violation of a federal criminal law relates to a health care benefit, then an
individual is guilty of committing a Federal Health Care Offense. The specific
offenses are: health care fraud, theft or embezzlement, false statements,
obstruction of an investigation, and money laundering. These crimes can apply
to claims submitted not only to government reimbursement programs such as
Medicare, Medicaid and TRICARE, but to any third-party payor, and carry
penalties including fines and imprisonment. HIPAA has mandated an extensive
set of regulations to protect the privacy of individually identifiable health
information. See Managements Discussion and Analysis of Financial Condition
and Results of Operations  Trends, Events, and Uncertainties  HIPAA. The Company must follow strict requirements with paperwork and billing. As
required by law, it is Company policy that certain service charges (as defined
by Medicare) falling under Medicare Part B are confirmed with a CMN signed by a
physician. In January 1999, the OIG published a draft Model Compliance Plan
for the Durable Medical Equipment, Prosthetics, Orthotics and Supply Industry.
The OIG has stressed the importance for all health care providers to have an
effective compliance plan. The Company has created and implemented a
compliance program, which it believes meets the elements of the OIGs Model
Plan for the industry. As part of its compliance program, the Company performs
internal audits of the adequacy of billing documentation. The Companys policy
is to voluntarily refund to the government any reimbursements previously
received for claims with insufficient documentation that are identified in this
process and that cannot be corrected. The Company periodically reviews and
updates its policies and procedures in an effort to comply with applicable laws
and regulations; however, certain proceedings have been and may in the future
be commenced against the Company alleging violations of applicable laws
governing the operation of the Companys business and its billing practices. The Company is also subject to state laws governing Medicaid, professional
training, licensure, financial relationships with physicians and the dispensing
and storage of pharmaceuticals. The facilities operated by the Company must
comply with all applicable laws, regulations and licensing standards and many
of the Companys employees must maintain licenses to provide some of the
services offered by the 27




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Company. Additionally, certain of the Companys
employees are subject to state laws and regulations governing the professional
practice of respiratory therapy, pharmacy and nursing. Information about individuals and other health care providers who have been
sanctioned or excluded from participation in government reimbursement programs
is readily available on the Internet, and all health care providers, including
the Company, are held responsible for carefully screening entities and
individuals they employ or do business with, to avoid contracting with an
excluded provider. The entity cannot bill government programs for services or
supplies provided by an excluded provider, and the federal government may also
impose sanctions, including financial penalties, on companies that contract
with excluded providers. Health care law is an area of extensive and dynamic regulatory oversight.
Changes in laws or regulations or new interpretations of existing laws or
regulations can have a dramatic effect on permissible activities, the relative
costs associated with doing business, and the amount and availability of
reimbursement from government and other third-party payors. There can be no
assurance that federal, state, or local governments will not impose additional
standards or change existing standards or interpretations. Enforcement Activities.In recent years, various state and federal
regulatory agencies have stepped up investigative and enforcement activities
with respect to the health care industry, and many health care providers,
including the Company and other durable medical equipment suppliers, have
received subpoenas and other requests for information in connection with their
business operations and practices. From time to time, the Company also
receives notices and subpoenas from various government agencies concerning
plans to audit the Company, or requesting information regarding certain aspects
of the Companys business. The Company cooperates with the various agencies in
responding to such subpoenas and requests. The Company expects to incur
additional legal expenses in the future in connection with existing and future
investigations. The government has broad authority and discretion in enforcing applicable laws
and regulations; therefore, the scope and outcome of any such investigations,
inquiries, or legal actions cannot be predicted. There can be no assurance
that federal, state or local governments will not impose additional regulations
upon the Companys activities nor that the Companys past activities will not
be found to have violated some of the governing laws and regulations. Any such
regulatory changes or findings of violations of laws could adversely affect the
Companys business and financial position, and could even result in the
exclusion of the Company from participating in Medicare, Medicaid, and other
contracts for goods or services reimbursed by the government. Legal Proceedings.The following is a summary of the Companys material
legal proceedings: On June 11, 2001, a settlement agreement (the OIG Settlement or Government
Settlement) was entered among the Company, the United States of America,
acting through the United States Department of Justice (DOJ) and on behalf of
the OIG and the TRICARE Management Activity, and a former Company employee, as
relator. The Government Settlement was approved by the United States District
Court for the Western District of Kentucky, the court in which the relators
false claim action was filed. The Government Settlement covers alleged
improprieties by the Company during the 28




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period from January 1, 1995 through
December 31, 1998, including allegedly improper billing activities and
allegedly improper remuneration to and contracts with physicians, hospitals and
other healthcare providers. Pursuant to the Government Settlement, the Company
made an initial payment of $3,000,000 in the second quarter of 2001 and agreed
to make additional payments in the principal amount of $4,000,000, together
with interest on this amount, in installments due at various times until March
2006. An installment of $880,000, including interest of $380,000, was due and
paid on March 11, 2004. The Company also paid the relators attorneys fees and
expenses. Pursuant to the Approved Plan, the amounts owed pursuant to the
Government Settlement will be paid in full in accordance with the Government
Settlement. As of September 30, 2004, the Company has an accrual of $3,520,000
for its obligations pursuant to the Government Settlement, of which $1,520,000
is classified as a current liability and $2,000,000 included in other
noncurrent liabilities. See also Managements Discussion and Analysis of
Financial Condition and Results of Operations  Trends, Events, and
Uncertainties  Approved Plan. Critical Accounting Policies Managements Discussion and Analysis of Financial Condition and Results of
Operations are based upon the Companys consolidated financial statements. The
preparation of these consolidated financial statements in accordance with U.S.
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
the disclosure of contingent assets and liabilities at the dates of the
financial statements, and the reported amounts of revenues and expenses during
the reporting periods. On an on-going basis, management evaluates its critical
accounting policies and estimates. A critical accounting policy is one which is both important to the
understanding of the financial condition and results of operations of the
Company and requires managements most difficult, subjective or complex
judgments, often as a result of the need to make estimates about the effect of
matters that are inherently uncertain. Management believes the following
accounting policies fit this definition: Revenue Recognition and Allowance for Doubtful Accounts.The Company
provides credit for a substantial part of its non third-party reimbursed
revenues and continually monitors the credit-worthiness and collectibility of
amounts due from its patients. Approximately 62% of the Companys 2004
revenues are derived from participation in Medicare and state Medicaid
programs. Amounts paid under these programs are generally based upon a fixed
rate. Revenues are recorded at the expected reimbursement rates when the
services are provided or when merchandise or equipment is delivered to
patients. Revenues are recorded net of estimated adjustments for billing
errors or other reimbursement adjustments. Although amounts earned under the
Medicare and Medicaid programs are subject to review by such third-party
payors, subsequent adjustments to reimbursements as a result of such reviews
are historically insignificant as these reimbursements are based on fixed fee
schedules. In the opinion of management, adequate provision has been made for
any adjustment that may result from such reviews. Any differences between
estimated settlements and final determinations are reflected as an adjustment
to revenue in the year finalized. Sales and related services revenues include all product sales to patients and
are derived from the provision of infusion therapies, the sale of home health
care equipment and supplies, the sale of aerosol 29




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medications and respiratory
therapy equipment and supplies, and services related to the delivery of these
products. Sales revenues are recognized at the time of delivery using fixed
fee schedules based upon the type of product and the payor, and are billed when
the Company has obtained the properly completed CMN from the healthcare
provider, where applicable. Rentals and other patient revenues are derived
from the rental of home health care equipment, enteral pumps and equipment
related to the provision of respiratory therapy. All rentals of equipment are
provided by the Company on a month-to-month basis and are billed using fixed
monthly fee schedules based upon the type of rental and the payor, when the
Company has obtained the properly completed CMN from the healthcare provider,
where applicable. The fixed monthly fee encompasses the rental of the product
as well as the delivery and the set-up and instruction by the product
technician. The Company recognizes revenues at the time services are performed or products
are delivered and all necessary medical documentation is obtained. As such, a
portion of patient receivables consists of unbilled revenue for which the
Company has not obtained all of the necessary medical documentation, but has
provided the service or equipment. The Company calculates its allowance for
doubtful accounts based upon the type of receivable (billed or unbilled) as
well as the age of the receivable. As a receivable balance ages, an
increasingly larger allowance is recorded for the receivable. All billed
receivables over one year old and all unbilled receivables over 180 days old
are fully reserved. Management believes that the recorded allowance for
doubtful accounts is adequate and that historical collections substantiate the
percentages used in the allowance valuation process. However, the Company is
subject to further loss to the extent uncollectible receivables exceed its
allowance for doubtful accounts. If the Company were to experience a
deterioration in the aging of its accounts receivable due to disruptions or a
slow down in cash collections, the Companys allowance for doubtful accounts
and bad debt expense would likely increase from current levels. Conversely, an
improvement in the Companys cash collection trends and in its receivable aging
would likely result in a decrease in both the allowance for doubtful accounts
and bad debt expense. The Companys allowance for doubtful accounts totaled approximately $17.8
million and $17.5 million as of September 30, 2004 and December 31, 2003,
respectively. Inventory Valuation and Cost of Sales Recognition. Inventories represent
goods and supplies and are priced at the lower of cost (on a first-in,
first-out basis) or market value. The Company recognizes cost of sales and
relieves inventory on an interim basis at a standard rate, based upon the type
of product sold and payor mix, and performs physical counts of inventory at
each center on an annual basis. The Company records a valuation allowance for
its estimated count adjustments and the difference between inventory actual
costs and standard costs. The Company is subject to loss for inventory
adjustments in excess of the recorded inventory valuation allowance. The
inventory valuation allowance was $0.4 and $0.6 million at September 30, 2004
and December 31, 2003, respectively. Rental Equipment Valuation. Rental equipment is rented to patients for
use in their homes and is depreciated over the equipments estimated useful
life. On an annual basis, the Company performs physical counts of rental
equipment at each center and reconciles all recorded rental assets to internal
billing reports. Any resulting adjustment for unlocated, damaged, or obsolete
equipment is charged to rental equipment depreciation expense. Since rental
equipment is maintained in the patients 30




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home, the Company is subject to loss
resulting from lost equipment as well as losses for damaged, outdated, or
obsolete equipment. Management records a valuation allowance for its estimated
lost, damaged, outdated, or obsolete rental equipment based upon historical
adjustment amounts and believes the recorded rental allowance is adequate. The
Company is subject to loss for unrecorded adjustments in excess of its recorded
rental equipment valuation allowance. The Companys rental equipment valuation
allowance totaled $1.2 million and $0.9 million at September 30, 2004 and
December 31, 2003, respectively. Valuation of Long-lived Assets. Management evaluates the Companys
long-lived assets for impairment whenever events or changes in circumstances
indicate that the carrying value of an asset may not be recoverable.
Management utilizes estimated undiscounted future cash flows to determine if an
impairment exists. When this analysis indicates an impairment exists, the
amount of loss is determined based upon a comparison of estimated fair value
with the carrying value of the asset. While management believes that the estimates of
future cash flows are reasonable, different assumptions regarding such cash
flows could materially affect the evaluations. Valuation of Goodwill and Other Intangible Assets.Goodwill represents
the excess of cost over the fair value of net assets acquired. Goodwill and
intangible assets with indefinite lives are required to be tested for
impairment on an annual basis and when an event occurs or circumstances change
such that it is reasonably possible that an impairment may exist. The Company
selected September 30 as its annual testing date. Goodwill is tested for
impairment by comparing the fair value of goodwill to the carrying value of
goodwill. The fair value is determined using a combination of analyses which
included discounted cash flow calculations, market multiples and other market
information. Key assumptions used in these estimates include projected
operating results, discount rates and peer market multiples. There was no impairment recognized as a result of the Companys annual
impairment testing in September 2004. As a result of the potential impact of
the Medicare Prescription Drug Improvement and Modernization Act of 2003, which
was enacted in December 2003, the Company performed an impairment test of
goodwill at December 31, 2003 and concluded that the carrying value of goodwill
did not exceed its fair value. Self Insurance.Self-insurance accruals primarily represent managements
loss estimate for self-insurance or large deductible risks associated with
workers compensation insurance. The Company is insured for workers
compensation, but retains the first $250,000 of risk exposure for each claim.
The Company is not maintaining annual aggregate stop loss coverage for claims
made in 2004 and did not maintain annual aggregate stop loss coverage for
claims made in 2003 or 2002, as such coverage was not available. Judgments
used in determining the accruals related to workers compensation include loss
development factors, frequency of claims and severity of claims. The Companys
liability includes known claims and an estimate of claims incurred but not yet
reported. The liability for estimated workers compensation claims totaled
approximately $3.3 million and $2.9 million as of September 30, 2004 and
December 31, 2003, respectively. The Company utilizes analyses prepared by its
third-party administrator based on historical claims information to support the
required reserve and related expense associated with workers compensation.
The Company records claims 31




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expense by plan year based on the lesser of the
aggregate stop loss (if applicable) or the developed losses as calculated by
its third-party administrator. The Company is also self-insured for health insurance for substantially all
employees for the first $150,000 on a per person, per year basis and maintained
annual aggregate stop loss coverage of $13.3 million for 2004. The health
insurance policies are limited to maximum lifetime reimbursements of $2.0
million per person for 2004, 2003 and 2002 and had unlimited lifetime
reimbursements for 2001. The estimated liability for health insurance claims
totaled approximately $1.9 million and $2.0 million as of September 30, 2004
and December 31, 2003, respectively. The Company reviews health insurance
trends and payment history and maintains an accrual for incurred unpaid
reported claims and for incurred but not reported claims based upon its
assessment of lag time in reporting and paying claims. Judgments include
assessing historical paid claims, average lags between the claims incurred
dates, reported dates and paid dates, the frequency of claims and the severity
of claims. The Company is required to maintain cash collateral accounts with the insurance
companies related to its self-insurance obligations. The Company currently
maintains cash collateral balances of $4.6 million related to its self-insured
obligations, which is included in other assets. Management continually analyzes its accrued liabilities for incurred but not
reported claims, and for reported but not paid claims related to its
self-insurance programs and believes these accruals to be adequate. However,
significant judgment is involved in assessing these accruals, and the Company
is at risk for differences between actual settlement amounts and recorded
accruals, and any resulting adjustments are included in expense once a probable
amount is known. Results of Operations The Company reports its revenues as follows: (i) sales and related services
and (ii) rentals and other revenues. Sales and related services revenues are
derived from the provision of infusion therapies; the sale of home health care
equipment and supplies; the sale of aerosol and respiratory therapy medications
and equipment; and supplies and services related to the delivery of these
products. Rentals and other revenues are derived from the rental of home
health care equipment, enteral pumps and equipment related to the provision of
respiratory therapies. Cost of sales and related services includes the cost of
equipment, drugs and related supplies sold to patients. Cost of rentals and
other revenues includes the costs of oxygen and rental supplies, demurrage for
leased oxygen tanks, rent expense for leased equipment, and rental equipment
depreciation expense, and excludes delivery expenses and salaries associated
with the rental set-up. Operating expenses include operating center labor
costs, delivery expenses, division and area management expenses, selling costs,
occupancy costs, billing center costs, bad debt expense, and other operating
costs. General and administrative expenses include corporate and senior
management expenses. Some of the Companys operations are conducted through joint ventures with
hospitals. The majority of the Companys hospital joint ventures are not
consolidated for financial statement reporting purposes. Earnings from
hospital joint ventures represent the Companys equity in earnings from
unconsolidated hospital joint ventures and management and administrative fees
from unconsolidated hospital joint ventures. 32




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Reorganization Items.The Company has incurred reorganization expenses as
a result of reorganization under Chapter 11 of the Federal Bankruptcy Code. In
accordance with the American Institute of Certified Public Accountants
Statement of Position 90-7, Financial Reporting by Entities in Reorganization
Under the Bankruptcy Code (SOP 90-7), all revenues, expenses, realized gains
and losses, and provisions for losses and expenses resulting from the
reorganization are reported separately as Reorganization Items. These items
include, but are not limited to, professional fees and other expenses incurred
related to the Chapter 11 proceedings, write-off of deferred financing costs,
and provision for damages from future lease rejections. 33




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The following table and discussion sets forth items from the Companys interim
condensed consolidated statements of income as a percentage of revenues for the
periods indicated: Percentage of Revenues Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Revenues
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales and related services
    
    
    20.9
    
    
    
    20.7
    
    
    
    21.4
    
    
    
    20.9Cost of rentals and other
revenues, including rental
equipment depreciation expense
    
    
    11.9
    
    
    
    11.4
    
    
    
    11.6
    
    
    
    10.8Operating expenses
    
    
    49.5
    
    
    
    52.9
    
    
    
    50.8
    
    
    
    53.1Bad debt expense
    
    
    3.2
    
    
    
    3.5
    
    
    
    3.7
    
    
    
    3.3General and administrative expense
    
    
    5.0
    
    
    
    5.2
    
    
    
    5.1
    
    
    
    5.2Earnings from unconsolidated
joint ventures
    
    
    (1.2
    )
    
    
    (1.2
    )
    
    
    (1.3
    )
    
    
    (1.4
    )Depreciation, excluding rental
equipment, and amortization
    
    
    1.0
    
    
    
    1.1
    
    
    
    1.0
    
    
    
    1.1Interest expense, net
    
    
    5.5
    
    
    
    5.1
    
    
    
    5.5
    
    
    
    1.7Other income, net
    
    
    (0.1
    )
    
    
    (0.4
    )
    
    
    (0.1
    )
    
    
    (0.1
    )Total expenses
    
    
    95.7
    
    
    
    98.3
    
    
    
    97.7
    
    
    
    94.6Income from operations before
reorganization items and income
taxes
    
    
    4.3
    
    
    
    1.7
    
    
    
    2.3
    
    
    
    5.4Reorganization items
    
    
    0.5
    
    
    
    1.1
    
    
    
    0.2
    
    
    
    1.5Provision for income taxes
    
    
    0.1
    
    
    
    0.1
    
    
    
    0.1
    
    
    
    0.1Net income
    
    
    3.7
    %
    
    
    0.5
    %
    
    
    2.0
    %
    
    
    3.8
    %
 34




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##### Table of Contents



Three Months Ended September 30, 2004 Compared to Three Months Ended September 30, 2003 Revenues.Revenues decreased from $83.9 million for the quarter ended
September 30, 2003 to $83.5 million for the same period in 2004, a decrease of
$0.4 million, or 0.5%. Effective January 1, 2004, Medicare reduced the
reimbursement rate for inhalation drugs by approximately 15.8%, which reduced
revenues in the third quarter of 2004 by approximately $1.8 million. Without
the inhalation drug reimbursement reduction, revenues would have increased $1.4
million, or 1.7%. Following is a discussion of the components of revenues:  Sales and Related Services Revenues.Sales and related services revenues
decreased from $36.6 million for the quarter ended September 30, 2003 to
$36.0 million for the same period of 2004, a decrease of $0.6 million, or
1.6%. Without the inhalation drug reimbursement reduction, sales and
related services revenues would have increased $1.7 million, or 4.7%,
compared to prior year.Rentals and Other Revenues. Rentals and other revenues increased from
$47.3 million for the quarter ended September 30, 2003 to $47.5 million
for the same period in 2004, an increase of $0.2 million, or 0.4%. Cost of Sales and Related Services. Cost of sales and related services
increased from $17.3 million for the quarter ended September 30, 2003 to $17.5
million for the same period in 2004, an increase of $0.2 million, or 1.2%. As
a percentage of sales and related services revenues, cost of sales and related
services increased from 47.3% for the quarter ended September 30, 2003 to 48.5%
for the same period in 2004. This increase is primarily attributable to lower
gross margins on the Companys inhalation drug sales in the current quarter,
due to lower reimbursements as a result of the Medicare Prescription Drug,
Improvement and Modernization Act of 2003. Cost of Rentals and Other Revenues. Cost of rentals and other revenues
increased from $9.6 million for the quarter ended September 30, 2003 to $9.9
million for the same period in 2004, an increase of $0.3 million, or 3.1%.
This increase is primarily the result of a higher level of rental equipment
depreciation associated with the Companys growth in rentals of oxygen
equipment and respiratory assist devices. As a percentage of rentals and other
revenue, cost of rentals and other revenues increased from 20.2% for the
quarter ended September 30, 2003 to 20.8% for the same period in 2004. Operating Expenses. Operating expenses decreased from $44.4 million for the
quarter ended September 30, 2003 to $41.3 million for the same period in 2004,
a decrease of $3.1 million or 7.0%. As a percentage of revenues, operating
expenses decreased from 52.9% to 49.5% for the quarters ended September 30,
2003 and 2004, respectively. This decrease is the result of the Companys
initiatives to reduce staffing levels in its billing centers and branches. Bad Debt Expense.Bad debt expense decreased from $3.0 million for the quarter
ended September 30, 2003 to $2.7 million for the same period in 2004, a
decrease of $0.3 million, or 10.0%. As a percentage of revenues, bad debt
expense was 3.5% and 3.2% for the three months ended September 35




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30, 2003 and 2004, respectively. Cash collections for the three months ended September 30,
2004 were improved compared to the same period in 2003, which resulted in lower
bad debt expense in the third quarter of 2004. General and Administrative Expenses. General and administrative expenses
decreased from $4.3 million for the quarter ended September 30, 2003 to $4.2
million for the same period in 2004, a decrease of $0.1 million, or 2.3%. This
decrease is primarily the result of decreased salary and professional services
expenses. As a percentage of revenues, general and administrative expenses
were 5.2% and 5.0% for the quarters ended September 30, 2003 and 2004,
respectively. Earnings from Unconsolidated Joint Ventures. Earnings from unconsolidated
joint ventures remained unchanged at $1.0 million for the quarters ended
September 30, 2003 and 2004. Depreciation and Amortization. Depreciation (excluding rental equipment) and
amortization expenses decreased from $0.9 million for the quarter ended
September 30, 2003 to $0.8 million for the same period in 2004, a decrease of
$0.1 million, or 11.1%. Interest Expense, Net. Interest expense, net increased from $4.3 million for
the quarter ended September 30, 2003 to $4.6 million for the same period in
2004, an increase of $0.3 million, or 7.0%. The increase in interest expense,
net is the result of a decrease in interest income earned in the three months
ended September 30, 2004. Other Income, Net. Other income, net decreased from $0.4 million for the
quarter ended September 30, 2003 to less than $0.1 million for the quarter
ended September 30, 2004, a decrease of more than $0.3 million, or 75.0%.
Other income, net primarily relates to investment losses or gains associated
with collateral interest in split dollar life insurance policies. Provision for Income Taxes. The provision for income taxes was $0.1 million
for the quarters ended September 30, 2003 and 2004. Nine Months Ended September 30, 2004 Compared to Nine Months Ended September 30, 2003 Revenues.Revenues increased from $249.3 million for the nine months ended
September 30, 2003 to $251.6 million for the same period in 2004, an increase
of $2.3 million, or 0.9%. Effective January 1, 2004, Medicare reduced the
reimbursement rate for inhalation drugs by approximately 15.8%, which reduced
revenues in the first nine months of 2004 by approximately $5.6 million.
Without the inhalation drug reimbursement reductions, revenues would have
increased $7.9 million, or 3.2%. The increase in revenues is a result of the
Companys sales and marketing efforts. Following is a discussion of the
components of revenues:  Sales and Related Services Revenues.Sales and related services revenues
decreased from $109.2 million for the nine months ended September 30,
2003 to $108.6 million for the same period in 2004, a decrease of $0.6
million, or 0.6%. Without the inhalation drug reimbursement 36




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reduction,
sales and related services revenues would have increased $4.9 million, or
4.5%, compared to prior year.Rentals and Other Revenues. Rentals and other revenues increased from
$140.0 million for the nine months ended September 30, 2003 to $143.0
million for the same period in 2004, an increase of $3.0 million, or
2.1%. Cost of Sales and Related Services. Cost of sales and related services
increased from $52.1 million for the nine months ended September 30, 2003 to
$53.9 million for the same period in 2004, an increase of $1.8 million, or
3.5%. As a percentage of sales and related services revenues, cost of sales
and related services increased from 47.7% for the nine months ended September
30, 2003 to 49.7% for the same period in 2004. This increase is primarily
attributable to lower gross margins on the Companys inhalation drug sales in
the current year, due to lower reimbursements as a result of the Medicare
Prescription Drug, Improvement and Modernization Act of 2003. Cost of Rentals and Other Revenues. Cost of rentals and other revenues
increased from $27.0 million for the nine months ended September 30, 2003 to
$29.1 million for the same period in 2004, an increase of $2.1 million, or
7.8%. This increase is primarily the result of a higher level of rental
equipment depreciation associated with the Companys growth in rentals of
oxygen equipment and respiratory assist devices. As a percentage of rentals
and other revenue, cost of rentals and other revenues were 19.3% and 20.4% for
the nine months ended September 30, 2003 and 2004, respectively. Operating Expenses. Operating expenses decreased from $132.3 million for the
nine months ended September 30, 2003 to $127.9 million for the same period in
2004, a decrease of $4.4 million, or 3.3%. As a percentage of revenues,
operating expenses were 53.1% and 50.8% for the nine months ended September 30,
2003 and 2004, respectively. This decrease is the result of the Companys
initiatives to reduce staffing levels in its billing centers and branches. Bad Debt Expense.Bad debt expense increased from $8.3 million for the nine
months ended September 30, 2003 to $9.2 million for the same period in 2004, an
increase of $0.9 million, or 10.8%. As a percentage of revenues, bad debt
expense was 3.3% and 3.7% for the nine months ended September 30, 2003 and
2004, respectively. Bad debt expense in the current year has been impacted by
disruptions in cash collections resulting from the inability of certain
third-party payors to effectively process electronic claims due to the
implementation of the new HIPAA Transaction and Code Sets. Also impacting bad
debt expense has been payment delays associated with certain state Medicaid
programs changing the intermediary contracted by the state to process claims
submitted by the providers. Certain intermediaries have begun processing
claims in a more timely manner, which has improved collections in the third
quarter of 2004; however, backlogs in unprocessed claims remain and likely will
remain for some time. The resulting delay has increased accounts receivable
reserves as the related receivables balances age. General and Administrative Expenses. General and administrative expenses
decreased from $13.0 million for the nine months ended September 30, 2003 to
$12.7 million for the same period in 2004, a decrease of $0.3 million, or 2.3%.
This decrease is primarily the result of a lower level of professional 37




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services fees related to the Companys annual financial statement audits. As a
percentage of revenues, general and administrative expenses were 5.2% and 5.1%
for the nine months ended September 30, 2003 and 2004, respectively. Earnings from Unconsolidated Joint Ventures. Earnings from unconsolidated
joint ventures decreased slightly from $3.4 million for the nine months ended
September 30, 2003 to $3.3 million for the nine months ended September 30,
2004. Depreciation and Amortization. Depreciation (excluding rental equipment) and
amortization expenses decreased from $2.7 million for the nine months ended
September 30, 2003 to $2.4
million for the same period in 2004, a decrease of $0.3 million, or 11.1%.
This decrease primarily is attributable to certain property and equipment
becoming fully depreciated. Interest Expense, Net. Interest expense, net increased from $4.2 million for
the nine months ended September 30, 2003 to $13.9 million for the same period
in 2004. This change is attributable to the Company resuming its obligation to
record interest expense as a result of its emergence from bankruptcy protection
on July 1, 2003. Post-petition interest excluded from the statements of
operations for the nine months ended September 30, 2003, of $12.5 million,
represents the default rate of interest pursuant to the terms described in the
Amended Credit Agreement. Other Income, Net. Other income, net primarily relates to investment losses or
gains associated with collateral interest in split dollar life insurance
policies. Other income of $0.3 million was recorded in the nine months ended
September 30, 2003 compared to other expense of $0.1 million for the same
period in 2004. Provision for Income Taxes. The provision for income taxes remained unchanged
at $0.3 million for the nine months ended September 30, 2003 and 2004. Liquidity and Capital Resources At September 30, 2004, the Company had current assets of $81.3 million and
current liabilities of $57.7 million, resulting in working capital of $23.6
million and a current ratio of 1.4x as compared to a working capital of $20.1
million and a current ratio of 1.3x at December 31, 2003. On July 31, 2002, the Company filed for bankruptcy protection due to its
inability to pay significant debt maturities due in December 2002. On July 1,
2003, American HomePatient, Inc. and 24 of its subsidiaries (collectively, the
Debtors) emerged from bankruptcy pursuant to a 100% pay plan (the Approved
Plan) whereby shareholders retained their equity interest and creditors and
vendors will be paid 100% of all amounts they are owed, either immediately or
over time with interest. The Approved Plan provides for the treatment of all of the claims subject to
compromise in the bankruptcy filing. The Approved Plan provides for the
extension of the maturity on the debt to the Lenders, a reduction of the
related interest cost on such debt, and the payment of all of the Companys
reported liabilities. The Lenders retained their liens on substantially all of
the assets of the Company. 38




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##### Table of Contents



Pursuant to the Approved Plan, the Companys secured debt to the Lenders is
$250.0 million and is evidenced by a promissory note in that amount and is
secured by various security agreements. To the Companys knowledge, the
Lenders have not executed the agreements as of the date of this filing. The
Company is no longer a party to a credit agreement. The remainder of the
amounts due to the Lenders at July 1, 2003 over and above the $250.0 million is
treated as unsecured debt. The Approved Plan provides that principal is payable annually on the $250.0
million secured debt on March 31 of each year, beginning March 31, 2005, in the
amount of one-third of the Companys Excess Cash Flow (defined in the Approved
Plan as cash in excess of $7.0 million at the end of each fiscal year) for the
previous fiscal year. After the unsecured debt of the Lenders and the general
unsecured debt is paid in full, 100% of the Companys Excess Cash Flow is paid
as a principal payment on the $250.0 million secured debt on March 31 of each
year. A prepayment due on each previous September 30 in an amount equal to
one-half of the anticipated March payment. No prepayment was made on September
30, 2004 because the Company anticipates it will not have Excess Cash Flows for
2004. The maturity date of the $250.0 million secured debt is July 1, 2009.
The Approved Plan provides that interest is payable monthly on the $250.0
million secured debt at a rate of 6.785% per annum. The Approved Plan treats the general unsecured debt and the Lenders unsecured
debt in the same manner. Principal and accrued interest is payable
semi-annually (on June 30 and December 31 of each year) in six equal
installments beginning December 31, 2003. Interest accrues on this unsecured
debt at an annual rate of 8.3675%. In addition to the six scheduled payments,
the holders of the unsecured debt also received an estimated prepayment of the
Pro Rata Payment (as defined in the Approved Plan) on September 30, 2003. The
Company did not have Excess Cash Flow (as defined in the Approve Plan) for
fiscal year 2003 and does not anticipate having Excess Cash Flow for fiscal
year 2004. There was no Pro Rata Payment due on March 31, 2004 and no
estimated prepayment of the Pro Rata Payment was due on September 30, 2004.
The Pro Rata Payment due on March 31, 2005 is in the amount of two-thirds of
the Companys Excess Cash Flow, if any, for the 2004 fiscal year. The Company has made all payments due as of September 30, 2004 under the
Approved Plan, and has also prepaid some of its obligations thereunder. As of
September 30, 2004, the Lenders were owed approximately $256.0 million,
comprised of $250.0 million of secured debt and $6.0 million of unsecured debt.
The remaining general unsecured claims (excluding the Government Settlement)
as of September 30, 2004 were approximately $3.3 million. The Company paid an
additional $0.3 million to the holders of general unsecured claims on August
18, 2004 to correct an error in the allocation of a prior payment. The Companys funding of day-to-day operations going forward and all payments
required under the Approved Plan will rely on cash flow and cash on hand as it
has since the Lenders terminated the Companys ability to access a revolving
line of credit in 2000. At September 30, 2004 the Company had cash and cash
equivalents of approximately $9.1 million. The Companys principal cash requirements are for working capital, capital
expenditures and debt service. The Company has met and intends to continue to
meet these requirements with existing cash balances, net cash provided by
operations and other available capital expenditure financing vehicles. 39




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##### Table of Contents



Managements goal is to generate cash sufficient to meet these requirements by
increasing profitable revenues, decreasing and controlling expenses, increasing
productivity, and improving accounts receivable collections. Management believes that the Company can operate on its existing cash and cash
flow and make all payments provided for in the Approved Plan through September
30, 2005. The Medicare reimbursement reductions that became effective January
2004 impacted the Companys profitability and ability to improve its liquidity
and capital resources as compared to 2003. The adverse impact that the
scheduled 2005 reimbursement reductions will have on the Companys future
operating results and financial condition will be material in 2005 and beyond.
The magnitude of this impact will depend upon the success of the Companys
efforts to grow revenues, improve productivity, and reduce costs. It also will
depend upon final resolution of lobbying efforts to modify the pricing changes.
See Trends, Events, and Uncertainties -
Reimbursement Changes and the Companys Response and Risk Factors  Medicare
Reimbursement Reductions. There can be no guarantee that existing cash and
cash flow will be sufficient and there can be no assurance that in such event
the Company will be able to obtain additional funds from other sources on terms
acceptable to the Company or at all. The Companys future liquidity will continue to be dependent upon the relative
amounts of current assets (principally cash, accounts receivable and
inventories) and current liabilities (principally accounts payable and accrued
expenses). In that regard, accounts receivable can have a significant impact
on the Companys liquidity. The Company has various types of accounts
receivable, such as receivables from patients, contracts, and former owners of
acquisitions. The majority of the Companys accounts receivable are patient
receivables. Accounts receivable are generally outstanding for longer periods
of time in the health care industry than many other industries because of
requirements to provide third-party payors with additional information
subsequent to billing and the time required by such payors to process claims.
Certain accounts receivable frequently are outstanding for more than 90 days,
particularly where the account receivable relates to services for a patient
receiving a new medical therapy or covered by private insurance or Medicaid.
Net patient accounts receivable were $52.2 million and $56.9 million at
September 30, 2004 and December 31, 2003, respectively. Average days sales in
accounts receivable (DSO) was approximately 58 and 60 days at September 30,
2004 and December 31, 2003, respectively. The Company calculates DSO by
dividing the previous 90 days of revenue (excluding dispositions and
acquisitions), net of bad debt expense into net patient accounts receivable and
multiplying the ratio by 90 days. The Companys level of DSO and net patient
receivables is affected by the extended time required to obtain necessary
billing documentation. The Companys future liquidity and capital resources will be materially
adversely impacted by the Medicare reimbursement reductions contained in the
Medicare Prescription Drug, Improvement and Modernization Act of 2003. See
Trends, Events, and Uncertainties  Reimbursement changes and the Companys
response. Net cash provided by operating activities was $29.4 million and $19.7 million
for the nine months ended September 30, 2004 and 2003. Net income decreased
from $9.3 million for the nine months ended September 30, 2003 to $5.0 million
for the nine months ended September 30, 2004. This decrease of $4.3 million is
primarily the result of increased interest expense. Net cash used by
reorganization items totaled $0.6 million for the nine months ended September
30, 2004. Reorganization items consist 40




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##### Table of Contents



primarily of professional fees. Net
cash used in investing activities was $16.4 million and $18.9 million for the
nine months ended September 30, 2004 and 2003, respectively. Additions to
property and equipment, net were $21.0 million for the nine months ended
September 30, 2004 compared to $21.5 million for the same period in 2003. Net
cash used in financing activities was $6.4 million and $8.8 million for the
nine months ended September 30, 2004 and 2003, respectively. The cash used in
financing activities for the nine months ended September 30, 2004 primarily
relates to principal payments to the Lenders of $6.4 million. At September 30,
2004 the Company had cash and cash equivalents of approximately $9.1 million. 41




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##### Table of Contents



Contractual Obligations and Commercial Commitments The following is a tabular disclosure of all contractual obligations and
commitments, including all off-balance sheet arrangements of the Company as of
September 30, 2004: Year 5 &Total
    
    Year 1
    
    Year 2
    
    Year 3
    
    Year 4
    
    thereafterLong-term debt and
capital leases
    
    $
    256,940,000
    
    
    $
    6,931,000
    
    
    $
    9,000
    
    
    $
    
    
    
    $
    
    
    
    $
    250,000,000Accrued interest on
long-term debt
    
    
    1,414,000
    
    
    
    1,414,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Pre-petition
accounts payable
    
    
    3,338,000
    
    
    
    3,338,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    OIG settlement
    
    
    3,500,000
    
    
    
    1,500,000
    
    
    
    1,000,000
    
    
    
    1,000,000
    
    
    
    
    
    
    
    Accrued interest on
OIG settlement
    
    
    20,000
    
    
    
    20,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating lease
obligations
    
    
    24,369,000
    
    
    
    9,113,000
    
    
    
    6,604,000
    
    
    
    4,747,000
    
    
    
    3,199,000
    
    
    
    706,000Total contractual
cash obligations
    
    $
    289,581,000
    
    
    $
    22,316,000
    
    
    $
    7,613,000
    
    
    $
    5,747,000
    
    
    $
    3,199,000
    
    
    $
    250,706,000
 In addition to the scheduled cash payments above, the Company is obligated to
make Excess Cash Flow payments on the Lenders secured and unsecured debt as
well as the pre-petition accounts payable as defined by the Approved Plan.
Excess Cash Flow is defined in the Approved Plan as cash in excess of $7.0
million at the end of each fiscal year. As these payments will be based on
Excess Cash Flow at future dates, the Company is not able to project the
amounts of these payments. As such, the $250.0 million secured debt, which is
all classified in the Year 5 and thereafter column in the table above, will
require principal payments in Years 2, 3, and 4 if the Companys cash balance
exceeds $7.0 million at each year end. In addition, the Approved Plan allows
the Company to make prepayments, which would reduce and be a credit against any
subsequent mandatory payments. The operating lease obligations presented is
based on information available as of September 30, 2004. Long-term debt is comprised primarily of amounts owed to the Lenders. See
Managements Discussion and Analysis of Financial Condition and Results of
Operations  Liquidity and Capital Resources. Capital leases consist primarily of leases of office equipment. 42




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##### Table of Contents



Operating leases are noncancelable leases on certain vehicles, buildings and
equipment. The OIG Settlement represents the settlement regarding the alleged billing
improprieties by the Company during the period from January 1, 1995 through
December 31, 1998. See Managements Discussion and Analysis of Financial
Condition and Results of Operations  Government Regulation  Enforcement
Activities. At September 30, 2004, the Company has no commitments or guarantees
outstanding. At September 30, 2004, the Company has letters of credit in place totaling
$650,000 securing obligations with respect to the Companys professional
liability insurance. The letters of credit expire in January 2005. Risk Factors This section summarizes certain risks, among others, that should be considered
by stockholders and prospective investors in the Company. Many of these risks
are also discussed in other sections of this report. Medicare Reimbursement Reductions.In the last quarter of 2003, Congress
enacted the Medicare Prescription Drug, Improvement and Modernization Act of
2003 (the MMA). The MMA reduces Medicare reimbursement levels for a variety
of the Companys products and services, with some reductions beginning in
January 2004 and others beginning in January 2005. These reductions will have a
material adverse effect on the Companys revenues, net income, cash flows and
capital resources. See Managements Discussion and Analysis of Financial
Condition and Results of Operations  Reimbursement Changes and the Companys
Response. Dependence on Reimbursement by Third-Party Payors.For the nine months
ended September 30, 2004, the percentage of the Companys revenues derived from
Medicare, Medicaid and private pay was 53%, 9% and 38%, respectively. The
revenues and profitability of the Company may be impacted by the efforts of
payors to contain or reduce the costs of health care by lowering reimbursement
rates, narrowing the scope of covered services, increasing case management
review of services and negotiating reduced contract pricing. Reductions in
reimbursement levels under Medicare, Medicaid or private pay programs and any
changes in applicable government regulations could have a material adverse
effect on the Companys revenues and net income. Changes in the mix of the
Companys patients among Medicare, Medicaid and private pay categories and
among different types of private pay sources may also affect the Companys
revenues and profitability. There can be no assurance that the Company will
continue to maintain its current payor or revenue mix. See Managements
Discussion and Analysis of Financial Condition and Results of Operations. Substantial Leverage.The Company maintains a significant amount of debt.
The secured claim of the Lenders as of September 30, 2004 was $250.0 million.
The unsecured claim of the Lenders as of September 30, 2004 was approximately
$6.0 million. The amount of general unsecured debt (excluding the Government
Settlement) due to other creditors at September 30, 2004 was $3.3 million.
Required payments to the Lenders and general unsecured creditors are detailed in 43




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Managements Discussion and Analysis of Financial Condition and Results of
Operations  Liquidity and Capital Resources. Due to the amount of debt, a
substantial portion of our cash flow from operations will be dedicated to
servicing debt. The substantial leverage could adversely affect the Companys
ability to grow its business or to withstand adverse economic conditions,
reimbursement changes, or competitive pressures and the inability to pay debt
would have a material adverse effect on the Company. See Managements
Discussion and Analysis of Financial Condition and Results of Operations 
Liquidity and Capital Resources. Bankruptcy Appeal. On July 1, 2003, the Approved Plan became effective
and the Company successfully emerged from bankruptcy protection. The Lenders
filed an appeal of the order confirming the Approved Plan to the United States
District Court. That court affirmed the order confirming the Approved Plan on
September 12, 2003. On October 14, 2003, the Lenders filed a notice of appeal
to the United States Court of Appeals for the Sixth Circuit, Case Number
03-6500. That appeal is pending. If the Lenders appeal is successful, it
could have a material adverse effect on the Company. See Note 2 to the interim
condensed consolidated financial statements Proceedings under Chapter 11 of
the Bankruptcy Code and Managements Discussion and Analysis of Financial
Condition and Results of Operations  Liquidity and Capital Resources. Warrant Rejection Appeal.The Bankruptcy Court issued an opinion ruling
in favor of the Companys request to reject the warrants originally issued to
the Companys Lenders to purchase 3,265,315 shares of the Companys common
stock for $.01 per share. As a result of the ruling, the warrants, which
represented approximately 20% of the Companys outstanding common stock, were
rejected by the Company. The Bankruptcy Court determined the damages stemming
from rejection of the warrants were $846,000, which is payable by the Company
to the warrant holders as an unsecured debt. The warrant holders have appealed
the damages calculation determined in this ruling. If the warrant holders
appeal is successful, the amount owed to the warrant holders could
substantially increase, which could materially adversely affect the Companys
cash flow and results from operations. See Note 2 to the interim condensed
consolidated financial statements Proceedings under Chapter 11 of the
Bankruptcy Code and Managements Discussion and Analysis of Financial
Condition and Results of Operations  Liquidity and Capital Resources. Government Regulation.The Company is subject to extensive and frequently
changing federal, state and local regulation. In addition, new laws and
regulations are adopted periodically to regulate products and services in the
health care industry. 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 other third-party
payors. There can be no assurance that the Company is in compliance with all
applicable existing laws and regulations or that the Company will be able to
comply with any new laws or regulations that may be enacted in the future.
Changes in applicable laws, any failure by the Company to comply with existing
or future laws, regulations or standards, or discovery of past regulatory
noncompliance by the Company could have a material adverse effect on the
Companys results of operations, financial condition, business or prospects.
See Managements Discussion and Analysis of Financial Condition and Results of
Operations  Government Regulation. 44




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Collectibility of Accounts Receivable.The Company has substantial
accounts receivable, representing DSO of 58 and 60 days as of September 30,
2004 and December 31, 2003, respectively. No assurances can be given that
future bad debt expense will not increase above current operating levels as a
result of difficulties associated with the Companys billing activities and
meeting payor documentation requirements and claim submission deadlines.
Increased bad debt expense or delays in collecting accounts receivable could
have a material adverse effect on cash flows and results of operations. See
Managements Discussion and Analysis of Financial Condition and Results of
Operations  Critical Accounting Policies  Revenue Recognition and Allowance
for Doubtful Accounts. Health Care Initiatives.The health care industry continues to undergo
dramatic changes influenced in large part by federal legislative initiatives.
New federal health care initiatives likely will continue to arise. There can
be no assurance that these or other federal legislative and regulatory
initiatives will not be adopted in the future. One or more of these
initiatives could limit patient access to, or the Companys reimbursement for,
products and services provided by the Company. Some states are adopting health
care programs and initiatives as a replacement for Medicaid. There can be no
assurance that the adoption of such legislation or other changes in the
administration or interpretation of government health care programs or
initiatives will not have a material adverse effect on the Company. Role of Managed Care.As managed care plays an increasingly significant
role in markets in which the Company operates, the Companys success will, in
part, depend on retaining and obtaining profitable managed care contracts.
There can be no assurance that the Company will retain or obtain such managed
care contracts. In addition, reimbursement rates under managed care contracts
are likely to continue to experience downward pressure as a result of payors
efforts to contain or reduce the costs of health care by increasing case
management review of services, retrospective payment audits, and negotiating
reduced contract pricing. Therefore, even if the Company is successful in
retaining and obtaining managed care contracts, it will experience declining
profitability, unless the Company also decreases its cost for providing
services and increases higher margin services. Liquidity.Trading of the Companys common stock under its current
trading symbol, AHOM or AHOM.OB, is conducted on the over-the-counter bulletin
board which may limit the Companys ability to raise additional capital and the
ability of shareholders to sell their shares. HIPAA Compliance.HIPAA has mandated an extensive set of regulations to
protect the privacy of individually identifiable health information. The
regulations consist of three sets of standards, each with a different date for
required compliance: (1) Privacy Standards had a compliance date of April 14,
2003; (2) Transactions and Code Sets Standards required compliance by October
16, 2002, except as extended by one year to October 16, 2003 for providers,
such as the Company, that filed a compliance extension form by October 15,
2002; and (3) Security Standards which were published in final form on February
2, 2003 and have a compliance date of April 20, 2005. The Company has filed
its compliance extension form and is actively pursuing its strategies toward
compliance with the final Privacy Standards and Transaction and Code Sets
Standards. The Companys HIPAA compliance plan will require modifications to
existing information management systems and physical security mechanisms, and
may require additional personnel as well as extensive training of existing
personnel, the full cost of which has not yet been determined. The Company
cannot predict the impact that final 45




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regulations, when fully implemented, will
have on its operations. The Companys implementation of mandated HIPAA
Transaction and Code Sets has resulted in disruptions to cash collections, and
additional disruptions may occur in the future. Further, the Company cannot
predict whether all payors and clearinghouses will be fully HIPAA Transaction
compliant and able to process electronic claims by the final implementation
deadline. Alternative methods of claims submission may be required, possibly
resulting in delay in payment, which could have a material adverse effect on
the Companys result of operations, cash flow, and financial condition. 46




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Ability to Attract and Retain Management.The Company is highly dependent
upon its senior management, and competition for qualified management personnel
is intense. The Companys chief financial officer retired, effective September
30, 2004, and the Company is engaged in a search for a new CFO. The Companys
historical financial results and reimbursement environment, among other
factors, may limit the Companys ability to attract and retain qualified
personnel, which in turn could adversely affect profitability. Competition.The home health care market is highly fragmented and
competition varies significantly from market to market. In the small and
mid-size markets in which the Company primarily operates, the majority of its
competition comes from local independent operators or hospital-based
facilities, whose primary competitive advantage is market familiarity. There
are relatively few barriers to entry in the local markets served by the
Company, and it encounters substantial competition from new market entrants.
In the larger markets, regional and national providers account for a
significant portion of competition. Some of the Companys present and
potential competitors are significantly larger than the Company and have, or
may obtain, greater financial and marketing resources than the Company. Liability and Adequacy of Insurance.The provision of healthcare services
entails an inherent risk of liability. Certain participants in the home
healthcare industry may be subject to lawsuits that may involve large claims
and significant defense costs. It is expected that the Company periodically
will be subject to such suits as a result of the nature of its business. The
Company currently maintains product and professional liability insurance
intended to cover such claims in amounts which management believes are in
keeping with industry standards. There can be no assurance that the Company
will be able to obtain liability insurance coverage in the future on acceptable
terms, if at all. There can be no assurance that claims in excess of the
Companys insurance coverage will not arise. A successful claim against the
Company in excess of the Companys insurance coverage could have a material
adverse effect upon the results of operations, financial condition or prospects
of the Company. Claims against the Company, regardless of their merit or
eventual outcome, may also have a material adverse effect upon the Companys
ability to attract patients or to expand its business. In addition, the
Company is self-insured for its workers compensation insurance and employee
health insurance and is at risk for claims up to individual stop loss and
aggregate stop loss amounts. Recent Accounting Pronouncements In December 2003, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 46, revised December 2003, (FIN 46R), Consolidation of
Variable Interest Entities, which addresses how a business enterprise should
evaluate whether it has a controlling financial interest in an entity through
means other than voting rights and accordingly should consolidate the entity.
FIN 46R replaced FASB Interpretation No. 46, Consolidations of Variable
Interest Entities, which was issued in January 2003. The Company was required
to apply FIN 46R to variable interests in variable interest entities (VIEs). The adoption of FIN 46R did not have an impact on the Companys consolidated
balance sheet as none of the existing VIEs needed to be consolidated by the
Company. 47




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FASB Statement No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity, was issued in May 2003. This
Statement established standards for the classification and measurement of
certain financial instruments with characteristics of both liabilities and
equity. The Statement also includes required disclosures for financial
instruments within its scope. For the Company, the Statement was effective for
instruments entered into or modified after May 31, 2003 and otherwise was
effective as of January 1, 2004, except for mandatorily redeemable financial
instruments. For certain manditorily redeemable financial instruments, the
Statement will be effective for the Company on January 1, 2005. The effective
date has been deferred indefinitely for certain other types of manditorily
redeemable financial instruments. Adoption of FASB Statement No. 150 did not
have an impact on the Companys consolidated financial statements as the
Company currently does not have any financial instruments that are within the
scope of this Statement. 48




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ITEM 3  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is not subject to material interest rate sensitivity since the
Approved Plan provides for a fixed interest rate for both the $250 million
secured debt and the Companys unsecured debt. Interest expense associated
with other debts would not materially impact the Company as most interest rates
are fixed. The Company does not own and is not a party to any material market
risk sensitive instruments. We have not experienced large increases in either the cost of supplies or
operating expenses due to inflation. With reductions in reimbursement by
government and private medical insurance programs and pressure to contain the
costs of such programs, we bear the risk that reimbursement rates set by such
programs will not keep pace with inflation. 
 ITEM 4  CONTROLS AND PROCEDURES In an effort to ensure that the information the Company must disclose in its
filings with the Securities and Exchange Commission is recorded, processed,
summarized, and reported on a timely basis, the Companys chief executive
officer and principal financial officer have evaluated the effectiveness of the
Companys disclosure controls and procedures, as defined in Exchange Act Rules
13a-15(e) and 15d-15(e), as of September 30, 2004. Based on such evaluation,
such officers have concluded that, as of September 30, 2004, the Companys
disclosure controls and procedures were effective in timely alerting them to
information relating to the Company required to be disclosed in the Companys
periodic reports filed with the SEC. There has been no change in the Companys
internal control over financial reporting during the nine months ended
September 30, 2004 that has materially affected, or is reasonably likely to
materially affect, the Companys internal control over financial reporting. 49




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Report of Independent Registered Public Accounting Firm The Board of Directors and Shareholders
American HomePatient, Inc.: We have reviewed the accompanying interim condensed consolidated balance sheet
of American HomePatient, Inc. and subsidiaries as of September 30, 2004, the
related interim condensed consolidated statements of income for the three-month
and nine-month periods ended September 30, 2004 and 2003, and the related
interim condensed consolidated statements of cash flows for the nine month
periods ended September 30, 2004 and 2003. These interim condensed
consolidated financial statements are the responsibility of the Companys
management. We conducted our review in accordance with standards established by the Public
Company Accounting Oversight Board (United States). A review of interim
financial information consists principally of applying analytical procedures
and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in
accordance with the standards of the Public Company Accounting Oversight Board
(United States), the objective of which is the expression of an opinion
regarding the financial statements taken as a whole. Accordingly, we do not
express such an opinion. Based on our review, we are not aware of any material modifications that should
be made to the interim condensed consolidated financial statements referred to
above for them to be in conformity with U.S. generally accepted accounting
principles. KPMG LLP Nashville, Tennessee
November 2, 2004 50




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PART II. OTHER INFORMATION 
 ITEM 1  LEGAL PROCEEDINGS A description of the Chapter 11 Cases is set forth in Note 2 to the Companys
interim condensed consolidated financial statements contained in this Report
and is incorporated herein by reference. All of the civil legal proceedings
against the Company were stayed by the Bankruptcy Filing. A summary of the
Companys material legal proceedings that existed as of the Bankruptcy Filing
is set forth in Managements Discussion and Analysis of Financial Condition
and Results of Operations  Government Regulation  Legal Proceedings. 51




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ITEM 6  EXHIBITS AND REPORTS ON FORM 8-K  (A)
    
    Exhibits. The exhibits filed as part of this Report are listed on the
Index to Exhibits immediately following the signature page.(B)
    
    Reports on Form 8-K. The Company filed the following reports on Form 8-K
during the quarterly period ended September 30, 2004:  1)
    
    A current report on Form 8-K was filed on July 29, 2004 to disclose,
under Item 5, the Companys press release containing American
HomePatients response to the Notice of Proposed Rule Making by the
Centers for Medicare & Medicaid Services relating to revisions to the
physician fee schedule to be published in the Federal Register August 5,
2004.2)
    
    A current report on Form 8-K was filed on August 6, 2004 to disclose,
under Item 12, the Companys press release reporting financial results
for the second quarter and six months ended June 30, 2004. 52




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SIGNATURES Pursuant to the requirements 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. AMERICAN HOMEPATIENT, INC.November 2, 2004
    
    By:
    
    /s/ Joseph F. FurlongJoseph F. FurlongChief Executive Officer and An Officer DulyAuthorized to Sign on Behalf of the RegistrantBy:
    
    /s/ Robert L. FringerRobert L. FringerPrincipal Financial Officer and An Officer DulyAuthorized to Sign on Behalf of the Registrant
 53




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INDEX TO EXHIBITS EXHIBITNUMBER
    
    DESCRIPTION OF EXHIBITS2.1
    
    Second Amended Joint Plan of Reorganization Proposed by the Debtors and
the Official Unsecured Creditors Committee dated January 2, 2003
(incorporated by reference to Exhibit 99.3 to the Companys Current Report
on Form 8-K filed on March 27, 2003).3.1
    
    Certificate of Incorporation of the Company (incorporated by reference to
Exhibit 3.1 to the Companys Registration Statement No. 33-42777 on Form
S-1).3.2
    
    Certificate of Amendment to the Certificate of Incorporation of the
Company dated October 31, 1991 (incorporated by reference to Exhibit 3.2
to Amendment No. 2 to the Companys Registration Statement No. 33-42777 on
Form S-1).3.3
    
    Certificate of Amendment to the Certificate of Incorporation of the
Company Dated May 14, 1992 (incorporated by reference to the Companys
Registration Statement on Form S-8 dated February 16, 1993).3.4
    
    Certificate of Ownership and Merger merging American HomePatient, Inc.
into Diversicare Inc. dated May 11, 1994 (incorporated by reference to
Exhibit 4.4 to the Companys Registration Statement No.33-89568 on Form
S-2).3.5
    
    Certificate of Amendment to the Certificate of Incorporation of the
Company dated July 8, 1996.3.6
    
    Bylaws of the Company, as amended (incorporated by reference to Exhibit
3.3 to the Companys Registration Statement No. 33-42777 on Form S-1).15.1
    
    Awareness Letter of KPMG LLP.31.1
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 
Chief Executive Officer.31.2
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 
Principal Financial Officer.32.1
    
    Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002  Chief Executive Officer.32.2
    
    Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002  Principal Financial
Officer.
 54