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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: June 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
incorporation or organization)
    
    (Commission
File Number)
    
    (IRS Employer Identification No.)
 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 July 21, 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 Six months ended June 30, 2004 and 2003
    
    
    5Interim Condensed Consolidated Statements of Cash Flows  Six months ended June 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 4. Submission of Matters to a Vote of Security Holders
    
    
    46Item 6. Exhibits and Reports on Form 8-K
    
    
    47Signatures
    
    
    48Index to Exhibits
    
    
    49EX-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)
 June 30,
    
    December 31,2004
    
    2003ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    3,590,000
    
    
    $
    2,571,000Restricted cash
    
    
    650,000
    
    
    
    400,000Accounts receivable, less allowance for
doubtful accounts of $18,364,000 and
$17,486,000, respectively
    
    
    56,837,000
    
    
    
    58,875,000Inventories, net of inventory valuation
allowances of $420,000 and $558,000,
respectively
    
    
    15,498,000
    
    
    
    16,475,000Prepaid expenses and other current assets
    
    
    2,498,000
    
    
    
    4,131,000Total current assets
    
    
    79,073,000
    
    
    
    82,452,000Property and equipment
    
    
    176,063,000
    
    
    
    170,901,000Less accumulated depreciation and amortization
    
    
    (117,703,000
    )
    
    
    (114,070,000
    )Property and equipment, net
    
    
    58,360,000
    
    
    
    56,831,000Goodwill
    
    
    121,834,000
    
    
    
    121,834,000Investment in joint ventures
    
    
    6,904,000
    
    
    
    9,206,000Other assets
    
    
    13,111,000
    
    
    
    13,717,000Total other assets
    
    
    141,849,000
    
    
    
    144,757,000TOTAL ASSETS
    
    $
    279,282,000
    
    
    $
    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) June 30,
    
    December 31,2004
    
    2003LIABILITIES AND SHAREHOLDERS DEFICITCURRENT LIABILITIES:Current portion of long-term debt and capital leases
    
    $
    6,950,000
    
    
    $
    11,720,000Accounts payable
    
    
    21,874,000
    
    
    
    17,518,000Other payables
    
    
    2,332,000
    
    
    
    2,485,000Current portion of pre-petition accounts payable
    
    
    3,629,000
    
    
    
    5,624,000Accrued expenses:Payroll and related benefits
    
    
    8,247,000
    
    
    
    10,155,000Insurance, including self-insurance accruals
    
    
    6,757,000
    
    
    
    6,378,000Other
    
    
    8,070,000
    
    
    
    8,455,000Total current liabilities
    
    
    57,859,000
    
    
    
    62,335,000NONCURRENT LIABILITIES:Long-term debt and capital leases, less current portion
    
    
    250,012,000
    
    
    
    251,194,000Pre-petition accounts payable
    
    
    
    
    
    
    661,000Other noncurrent liabilities
    
    
    3,085,000
    
    
    
    3,601,000Total noncurrent liabilities
    
    
    253,097,000
    
    
    
    255,456,000Total liabilities
    
    
    310,956,000
    
    
    
    317,791,000MINORITY INTEREST
    
    
    535,000
    
    
    
    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
    
    
    173,350,000
    
    
    
    173,305,000Accumulated deficit
    
    
    (205,723,000
    )
    
    
    (207,718,000
    )Total shareholders deficit
    
    
    (32,209,000
    )
    
    
    (34,249,000
    )TOTAL LIABILITIES AND SHAREHOLDERS DEFICIT
    
    $
    279,282,000
    
    
    $
    284,040,000
 The accompanying notes to interim condensed consolidated financial statements
are an integral part of these consolidated financial statements. 4




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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 June 30,
    
    Six Months Ended June 30,2004
    
    2003
    
    2004
    
    2003REVENUES:Sales and related service revenues, net
    
    $
    35,712,000
    
    
    $
    36,199,000
    
    
    $
    72,579,000
    
    
    $
    72,600,000Rentals and other revenues, net
    
    
    47,600,000
    
    
    
    46,665,000
    
    
    
    95,506,000
    
    
    
    92,771,000Total revenues, net
    
    
    83,312,000
    
    
    
    82,864,000
    
    
    
    168,085,000
    
    
    
    165,371,000EXPENSES:Cost of sales and related services
    
    
    17,839,000
    
    
    
    17,449,000
    
    
    
    36,456,000
    
    
    
    34,742,000Cost of rentals and other revenues, including rental
equipment depreciation of $6,018,000, $5,088,000,
$11,529,000 and $9,829,000, respectively
    
    
    9,804,000
    
    
    
    8,970,000
    
    
    
    19,147,000
    
    
    
    17,396,000Operating expenses, including bad debt expense of
$3,660,000, $2,206,000, $6,479,000 and $5,323,000,
respectively
    
    
    46,017,000
    
    
    
    46,018,000
    
    
    
    93,076,000
    
    
    
    93,254,000General and administrative
    
    
    4,220,000
    
    
    
    4,126,000
    
    
    
    8,509,000
    
    
    
    8,672,000Earnings from unconsolidated joint ventures
    
    
    (1,179,000
    )
    
    
    (1,191,000
    )
    
    
    (2,231,000
    )
    
    
    (2,421,000
    )Depreciation, excluding rental equipment, and amortization
    
    
    804,000
    
    
    
    846,000
    
    
    
    1,637,000
    
    
    
    1,771,000Interest expense (income), net (excluding post-petition
contractual interest
of $0, 6,210,000, $0 and $12,510,000, respectively)
    
    
    4,657,000
    
    
    
    22,000
    
    
    
    9,307,000
    
    
    
    (50,000
    )Other (income) expense, net
    
    
    (57,000
    )
    
    
    
    
    
    
    (82,000
    )
    
    
    94,000Total expenses
    
    
    82,105,000
    
    
    
    76,240,000
    
    
    
    165,819,000
    
    
    
    153,458,000INCOME FROM OPERATIONS BEFORE REORGANIZATION ITEMS AND INCOME TAXES
    
    
    1,207,000
    
    
    
    6,624,000
    
    
    
    2,266,000
    
    
    
    11,913,000Reorganization items
    
    
    71,000
    
    
    
    2,004,000
    
    
    
    71,000
    
    
    
    2,856,000INCOME FROM OPERATIONS BEFORE INCOME TAXES
    
    
    1,136,000
    
    
    
    4,620,000
    
    
    
    2,195,000
    
    
    
    9,057,000Provision for income taxes
    
    
    100,000
    
    
    
    100,000
    
    
    
    200,000
    
    
    
    200,000NET INCOME
    
    $
    1,036,000
    
    
    $
    4,520,000
    
    
    $
    1,995,000
    
    
    $
    8,857,000NET INCOME PER COMMON SHARE:- Basic
    
    $
    0.06
    
    
    $
    0.28
    
    
    $
    0.12
    
    
    $
    0.54- Diluted
    
    $
    0.06
    
    
    $
    0.24
    
    
    $
    0.12
    
    
    $
    0.47WEIGHTED AVERAGE COMMON SHARES OUTSTANDING- Basic
    
    
    16,437,000
    
    
    
    16,367,000
    
    
    
    16,407,000
    
    
    
    16,367,000- Diluted
    
    
    17,017,000
    
    
    
    18,835,000
    
    
    
    17,007,000
    
    
    
    18,663,000
 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 CASH FLOWS (unaudited)
 Six Months Ended June 30,2004
    
    2003CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    1,995,000
    
    
    $
    8,857,000Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation and amortization
    
    
    13,166,000
    
    
    
    11,600,000Provision for doubtful accounts
    
    
    (4,627,000
    )
    
    
    (3,306,000
    )Provision for inventory
    
    
    (138,000
    )
    
    
    (21,000
    )Equity in earnings of unconsolidated joint ventures
    
    
    (1,228,000
    )
    
    
    (1,338,000
    )Minority interest
    
    
    140,000
    
    
    
    179,000Reorganization items
    
    
    71,000
    
    
    
    2,856,000Reorganization items paid
    
    
    (747,000
    )
    
    
    (2,660,000
    )Change in assets and liabilities:Accounts receivable, net
    
    
    6,665,000
    
    
    
    2,759,000Inventories
    
    
    1,115,000
    
    
    
    1,538,000Prepaid expenses and other current assets
    
    
    1,633,000
    
    
    
    (419,000
    )Accounts payable, other payables and accrued
expenses
    
    
    309,000
    
    
    
    (1,071,000
    )Other assets and liabilities
    
    

    377,000
    
    
    
    (93,000
    )Other noncurrent liabilities
    
    
    (516,000
    )
    
    
    (15,000
    )Net cash provided by operating activities
    
    
    18,215,000
    
    
    
    18,866,000CASH FLOWS FROM INVESTING ACTIVITIES:Additions to property and equipment, net
    
    
    (14,466,000
    )
    
    
    (13,782,000
    )Distributions and loan payments from unconsolidated
joint ventures, net
    
    
    3,530,000
    
    
    
    2,203,000Net cash used in investing activities
    
    $
    (10,936,000
    )
    
    $
    (11,579,000
    )
 (Continued) 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) Six Months Ended June 30,2004
    
    2003CASH FLOWS FROM FINANCING ACTIVITIES:Distributions to minority interest owners
    
    $
    (103,000
    )
    
    $
    (163,000
    )Principal payments on long-term debt and capital leases
    
    
    (5,952,000
    )
    
    
    (226,000
    )Exercising of employee stock options
    
    
    45,000
    
    
    
    Adequate protection payments
    
    
    
    
    
    
    (7,794,000
    )Restricted cash
    
    
    (250,000
    )
    
    
    (400,000
    )Net cash used in financing activities
    
    
    (6,260,000
    )
    
    
    (8,583,000
    )INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    
    
    1,019,000
    
    
    
    (1,296,000
    )CASH AND CASH EQUIVALENTS, beginning of period
    
    
    2,571,000
    
    
    
    22,827,000CASH AND CASH EQUIVALENTS, end of period
    
    $
    3,590,000

    
    
    $
    21,531,000SUPPLEMENTAL INFORMATION:Cash payments of interest
    
    $
    9,809,000
    
    
    $
    49,000Cash payments of income taxes
    
    $
    274,000
    
    
    $
    105,000
 The accompanying notes to interim condensed consolidated financial statements
are an integral part of these consolidated financial statements. 7




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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 six months ended June 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 June 30, 2004, the
Company provided these services to patients primarily in the home through 283
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 six months ended June 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 June
30, 2004 and the results of operations and the cash flows for the three and six
months ended June 30, 2004 and 2003. The results of operations for the three and six months ended June 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 8




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immediately or over time with interest. American HomePatient, Inc. and 24 of
its subsidiaries (collectively, the Debtors) 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 9




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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 with
an estimated prepayment due on September 30, 2004 in an amount equal to
one-half of the anticipated payment due on March 31, 2005. 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. An estimated prepayment is due on each
previous September 30 in an amount equal to one-half of the anticipated March
payment. 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. 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. 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 is due on
September 30, 2004 in an amount equal to one-half of the anticipated March 2005
Pro Rata Payment. 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 June 30, 2004 under the Approved
Plan, and has also prepaid some of its obligations thereunder. As of June 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 June 30,
2004 were approximately $3.6 million. The Company plans to pay an additional
$291,000 to the holders of general unsecured claims subsequent to June 30, 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 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 10




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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 June 30,
    
    Six Months Ended June 30,2004
    
    2003
    
    2004
    
    2003Net income  as reported
    
    $
    1,036,000
    
    
    $
    4,520,000
    
    
    $
    1,995,000
    
    
    $
    8,857,000Additional compensation expense
    
    
    (83,000
    )
    
    
    (4,000
    )
    
    
    (301,000
    )
    
    
    (8,000
    )Net income  pro forma
    
    $
    953,000
    
    
    $
    4,516,000
    
    
    $
    1,694,000
    
    
    $
    8,849,000Net income per common share 
as reportedBasic
    
    $
    0.06
    
    
    $
    0.28
    
    
    $
    0.12
    
    
    $
    0.54Diluted
    
    $
    0.06
    
    
    $
    0.24
    
    
    $
    0.12
    
    
    $
    0.47Net income per common share 
pro formaBasic
    
    $
    0.06
    
    
    $
    0.28
    
    
    $
    0.10
    
    
    $
    0.54Diluted
    
    $
    0.06
    
    
    $
    0.24
    
    
    $
    0.10
    
    
    $
    0.47
 11




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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 six months ended June 30, 2004 and June
30, 2003 were $71,000, $2,004,000, $71,000, and $2,856,000, 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. The Company is focused on generating positive cash flow
from operating activities, primarily through improvements in its operating
results. For the year ended December 31, 2003, net cash provided by operating
activities was $17,238,000. Notwithstanding this net cash provided by
operating activities, the Company did not have Excess Cash Flow (as defined in
the Approved Plan), primarily because the Company made prepayments authorized
under the Approved Plan. For the six months ended June 30, 2004, the Company
achieved net income of $1,995,000 and had $18,768,000 of cash provided by
operating activities. Total long-term debt and capital leases have decreased by $5,952,000 from
$262,914,000 at December 31, 2003 to $256,962,000 at June 30, 2004. All of the
Companys debt has fixed interest rates, which on a weighted average was 6.83%
at June 30, 2004. The Company has scheduled current debt principal payments of $6,950,000,
pre-petition accounts payable payments of $3,629,000, and minimum rental
obligations of $9,886,000 under long-term operating leases due during the
twelve months ending June 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. 12




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As of June 30, 2004, the Company had approximately $3,590,000 in unrestricted
cash and cash equivalents and $21,214,000 of working capital. The Companys
consolidated cash flows from operations for the year ended December 31, 2003
and through June 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 June 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. 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 $55,610,000 and $56,940,000 at June 30, 2004 and
December 31, 2003, respectively. Average days sales in accounts receivable
(DSO) was approximately 63 and 60 days at June 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 for
the quarter ended June 30, 2004 was impacted negatively by delays in billing
and collection caused by HIPAA implementation in the last quarter of 2003 and
by a slow down in Medicaid payments by some states. 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. See
Managements Discussion and Analysis of Financial Condition and Results of
Operations  Trends, Events, and Uncertainties  Reimbursement Changes and the
Companys Response. 13




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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 six month period ended June 30, 2004, the Company paid
$880,000, including interest of $380,000, pursuant to the Government
Settlement. At June 30, 2004, the Company had an accrual of $3,511,000 for its
remaining obligations pursuant to the Government Settlement. Of the total
accrual related to the Government Settlement, $511,000 is included in other
accrued expenses and $3,000,000 is included in other noncurrent liabilities on
the accompanying interim condensed consolidated balance sheets at June 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. 14




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The following information is necessary to calculate income per share for the
periods presented: Three Months Ended June 30,
    
    Six Months Ended June 30,2004
    
    2003
    
    2004
    
    2003Net income
    
    $
    1,036,000
    
    
    $
    4,520,000
    
    
    $
    1,995,000
    
    
    $
    8,857,000Weighted average common shares outstanding
    
    
    16,437,000
    
    
    
    16,367,000
    
    
    
    16,407,000
    
    
    
    16,367,000Effect of dilutive options and warrants
    
    
    580,000
    
    
    
    2,468,000
    
    
    
    600,000
    
    
    
    2,296,000Adjusted diluted common shares outstanding
    
    
    17,017,000
    
    
    
    18,835,000
    
    
    
    17,007,000
    
    
    
    18,663,000Net income per common share- Basic
    
    $
    0.06
    
    
    $
    0.28
    
    
    $
    0.12
    
    
    $
    0.54- Diluted
    
    $
    0.06
    
    
    $
    0.24
    
    
    $
    0.12
    
    
    $
    0.47Employee stock options excluded from
computation of diluted per share amounts
because the exercise price exceeds
average
market price of common stock
    
    
    1,945,000
    
    
    
    1,379,000
    
    
    
    1,838,000
    
    
    
    1,817,000
 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
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. 15




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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 283 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 increased sales and rental volumes. See Trends, Events, and
Uncertainties  Reimbursement Changes and the Companys Response. 16




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##### Table of Contents



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 to 3.9% for the six months ended June 30, 2004. Managements
goal is to further lower this percentage in 2004, but management anticipates
that the rate of decrease may be less 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 lower DSO in 2004. The Companys DSO for the six months ended June 30, 2004
was 63, having been impacted negatively by delays in billing and collection
caused by HIPAA implementation 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. 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 which have not yet been billed to the payors due
to incomplete documentation or the receipt of the Certificate of 17




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##### Table of Contents



Medical Necessity (CMN). At June 30, 2004 and December 31, 2003, the amount
of unbilled revenue net of allowances was $10.6 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 (Act) will negatively impact the Companys future
operating results, liquidity and capital resources. A provision in the
Medicare Prescription Drug, Improvement and Modernization Act of 2003 required
that the reimbursement rate for inhalation drugs used with a nebulizer be
reduced from 95% of the average wholesale price (AWP) to 80% of AWP effective
January 1, 2004. Beginning January 1, 2005, 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 six months of 2004 was reduced by
approximately $3.7 million as result of an approximate 15.8% 18




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##### Table of Contents



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 believes that the scheduled reductions could
force providers to exit the inhalation drug business, which in turn could
create difficulties for Medicare beneficiaries needing inhalation drugs to
obtain these drugs under current Medicare regulations. Management is taking a
number of steps in an effort to reduce the expected impact of the reimbursement
reductions contained in the Act, including initiatives to grow revenues,
improve productivity, and reduce costs. The Company also is undertaking 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. CMS is seeking comments on adding a separate dispensing fee for
inhalation drugs that would be in addition to the difference between the amount
the supplier paid for the drug and the Medicare payment for the drugs. CMS has
asked for comments on such a fee in light of other Medicare regulations that
effect inhalation drug reimbursement. The Company intends to respond to the
request for comments, and it is too early to know what impact, if any, the new
rules may have on inhalation drug reimbursement, particularly given CMS
apparent view that any such dispensing fee adjustments will only need to be a
short-term adjustment for 2005 as a new Medicare Part D provision that takes
effect in 2006 will work to shift patients away from nebulizers and towards
metered dose inhalers. The magnitude of the adverse impact that the Act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 its lobbying efforts, but the adverse impact will likely
be material in 2005 and beyond. The Company hopes to offset much of the 2004
impact through revenue growth and cost reductions. However, as with all
projections, there can be no guarantee that managements projections will be
achieved. Included in the Act 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 and respiratory
items will be reduced to the median Federal Employee Health Benefit Plan rate
which some analysts estimate to be a cut of approximately 10% on average. In February 2004 the executive branch of the federal government released the
fiscal year 2005 budget for the Department of Health and Human Services that
contained a provision to eliminate 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.
The proposed budget would eliminate the rental payments for the fourteenth and
fifteenth months and 19




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##### Table of Contents



reimburse durable medical equipment repair costs at actual cost, eliminating
the semi-annual payment. The items affected by this proposed budget are
durable medical equipment items traditionally rented to Medicare and Medicaid
patients, such as hospital beds, wheelchairs, nebulizers, etc. As the budget
has not yet been approved, the magnitude of the adverse impact that the budget
could have on the Companys future operating results is not yet known. 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 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 21, 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 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 can not predict when these states will
be fully HIPAA Transaction compliant and will resume processing claims at a
rate consistent with past performance, if at all. 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 20




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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 professional and other fees will be incurred in 2004 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 as of July
30, 2002, the date immediately prior to the Companys bankruptcy filing
stemming from rejection of the warrants. 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
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: Six Months Ended June 30,2004
    
    2003Home respiratory therapy services
    
    
    71
    %
    
    
    68
    %Home infusion therapy services
    
    
    12
    
    
    
    13Home medical equipment and medical supplies
    
    
    17
    
    
    
    19Total
    
    
    100
    %
    
    
    100
    %
 21




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##### Table of Contents



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.
    
    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 3%,
respectively, of the 22




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##### Table of Contents



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 283 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).
    
    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 283 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 23




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##### Table of Contents



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. 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. 24




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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 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. 25




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##### Table of Contents



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 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 June 30, 2004, the Company has an accrual of $3,511,000 for
its obligations pursuant to the Government Settlement, of which $511,000 is
classified as a current liability and $3,000,000 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 26




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##### Table of Contents



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 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. 27




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##### Table of Contents



The Companys allowance for doubtful accounts totaled approximately $18.4
million and $17.5 million as of June 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 June 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 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 $1.1 million and $0.9 million at June 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 2003. As a result of the potential impact of
the Medicare Prescription Drug 28




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##### Table of Contents



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.
During the six months ended June 30, 2004, no events occurred that would
require goodwill to be tested for impairment. 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 $3.2 million and $2.9 million as of June 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 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 and 2003 and had unlimited lifetime reimbursements
for 2001. The estimated liability for health insurance claims totaled
approximately $1.7 million and $2.0 million as of June 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. 29




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##### Table of Contents



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. 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. 30




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##### Table of Contents



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
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Revenues
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales and related services
    
    
    21.4
    
    
    
    21.1
    
    
    
    21.7
    
    
    
    21.0Cost of rentals and other
revenues, including rental
equipment depreciation
    
    
    11.8
    
    
    
    10.8
    
    
    
    11.4
    
    
    
    10.5Operating expenses
    
    
    55.2
    
    
    
    55.5
    
    
    
    55.4
    
    
    
    56.4General and administrative expense
    
    
    5.1
    
    
    
    5.0
    
    
    
    5.1
    
    
    
    5.2Earnings from unconsolidated
joint ventures
    
    
    (1.4
    )
    
    
    (1.4
    )
    
    
    (1.3
    )
    
    
    (1.5
    )Depreciation, excluding rental
equipment, and amortization
    
    
    1.0
    
    
    
    1.0
    
    
    
    1.0
    
    
    
    1.1Interest expense (income), net
    
    
    5.6
    
    
    
    
    
    
    
    5.6
    
    
    
    Other expense, net
    
    
    (0.1
    )
    
    
    
    
    
    
    (0.1
    )
    
    
    0.1Total expenses
    
    
    98.6
    
    
    
    92.0
    
    
    
    98.8
    
    
    
    92.8Income from operations before
reorganization items and income
taxes
    
    
    1.4
    
    
    
    8.0
    
    
    
    1.2
    
    
    
    7.2Reorganization items
    
    
    0.1
    
    
    
    2.4
    
    
    
    
    
    
    
    1.7Provision for income taxes
    
    
    0.1
    
    
    
    0.1
    
    
    
    0.1
    
    
    
    0.1Net income
    
    
    1.2
    %
    
    
    5.5
    %
    
    
    1.1
    %
    
    
    5.4
    %
 31




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##### Table of Contents



Three Months Ended June 30, 2004 Compared to Three Months Ended June 30, 2003 Revenues.Revenues increased from $82.9 million for the quarter ended June 30,
2003 to $83.3 million for the same period in 2004, an increase of $0.4 million,
or 0.5%. Effective January 1, 2004, Medicare reduced the reimbursement rate
for inhalation drugs by approximately $1.8 million. 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 $36.2 million for the quarter ended June 30, 2003 to $35.7
million for the same period of 2004, a decrease of $0.5 million, or 1.4%.
Without the inhalation drug reimbursement reduction, sales and related
services revenues would have increased $1.3 million, or 3.6%, compared to
prior year. Rentals and Other Revenues. Rentals and other revenues increased from
$46.7 million for the quarter ended June 30, 2003 to $47.6 million for
the same period in 2004, an increase of $0.9 million, or 1.9%. Cost of Sales and Related Services. Cost of sales and related services
increased from $17.4 million for the quarter ended June 30, 2003 to $17.8
million for the same period in 2004, an increase of $0.4 million, or 2.3%. As
a percentage of sales and related services revenues, cost of sales and related
services increased from 48.2% for the quarter ended June 30, 2003 to 50.0% 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 $9.0 million for the quarter ended June 30, 2003 to $9.8 million
for the same period in 2004, an increase of $0.8 million, or 8.9%. This
increase is primarily attributable to a higher level of purchases of oxygen and
rental supplies associated with the Companys growth in rental revenue. As a
percentage of rentals and other revenue, cost of rentals and other revenues
increased from 19.2% for the quarter ended June 30, 2003 to 20.6% for the same
period in 2004. Operating Expenses. Operating expenses remained unchanged at $46.0 million for
the quarters ended June 30, 2003 and 2004. As a percentage of revenues,
operating expenses decreased from 55.5% to 55.2% for the quarters ended June
30, 2003 and 2004, respectively. Bad debt expense increased from $2.2 million,
or 2.7% of revenues, for the quarter ended June 30, 2003 to $3.7 million, or
4.4% of revenues, for the same period in 2004. Bad debt expense in the current
quarter 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. The resulting delay has increased
accounts receivable reserves as the related receivables balances age. 32




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##### Table of Contents



General and Administrative Expenses. General and administrative expenses
increased from $4.1 million for the quarter ended June 30, 2003 to $4.2 million
for the same period in 2004, an increase of $0.1 million, or 2.4%. This
increase is primarily the result of costs of lobbying efforts aimed at
addressing the Medicare patient drug availability issues created by the
inhalation drug reimbursement reductions scheduled for January 1, 2005. As a
percentage of revenues, general and administrative expenses were 5.0% and 5.1%
for the quarters ended June 30, 2003 and 2004, respectively. Earnings from Unconsolidated Joint Ventures. Earnings from unconsolidated
joint ventures remained unchanged at $1.2 million for the quarters ended June
30, 2003 and 2004. Depreciation and Amortization. Depreciation (excluding rental equipment) and
amortization expenses remained unchanged at $0.8 million for the quarters ended
June 30, 2003 and 2004. Interest Expense (Income), Net. Interest expense (income), net increased from
$0.1 million for the quarter ended June 30, 2003 to $4.7 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 three months ended June 30, 2003, of $6.2
million, represents the default rate of interest pursuant to the terms
described in the Amended Credit Agreement. Other (Income) Expense, Net. Other (income) expense, net primarily relates to
investment losses or gains associated with collateral interest in split dollar
life insurance policies. Income of less than $0.1 million was recorded for the
quarter ended June 30, 2004. Provision for Income Taxes. The provision for income taxes was $0.1 million
for the quarters ended June 30, 2003 and 2004. Six Months Ended June 30, 2004 Compared to Six Months Ended June 30, 2003 Revenues.Revenues increased from $165.4 million for the six months ended June
30, 2003 to $168.1 million for the same period in 2004, an increase of $2.7
million, or 1.6%. Effective January 1, 2004, Medicare reduced the
reimbursement rate for inhalation drugs by approximately 15.8%, which reduced
revenues in the first six months of 2004 by approximately $3.7 million. 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
remained unchanged at $72.6 million for the six months ended June 30,
2003 and 2004. Without the inhalation drug reimbursement reduction,
sales and related services revenues would have increased $3.7 million, or
5.1%, compared to prior year. Rentals and Other Revenues. Rentals and other revenues increased from
$92.8 million for the six months ended June 30, 2003 to $95.5 million for
the same period in 2004, an increase of $2.7 million, or 2.9%. Cost of Sales and Related Services. Cost of sales and related services
increased from $34.7 million for the six months ended June 30, 2003 to $36.5
million for the same period in 2004, an 33




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##### Table of Contents



increase of $1.8 million, or 5.2%. As a percentage of sales and related
services revenues, cost of sales and related services increased from 47.9% for
the six months ended June 30, 2003 to 50.2% 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 $17.4 million for the six months ended June 30, 2003 to $19.1
million for the same period in 2004, an increase of $1.7 million, or 9.8%.
This increase is primarily attributable to a higher level of purchases of
oxygen and rental supplies associated with the Companys growth in rental
revenue. As a percentage of rentals and other revenue, cost of rentals and
other revenues were 18.8% and 20.0% for the six months ended June 30, 2003 and
2004, respectively. Operating Expenses. Operating expenses decreased from $93.3 million for the
six months ended June 30, 2003 to $93.1 million for the same period in 2004, a
decrease of $0.2 million, or 0.2%. As a percentage of revenues, operating
expenses were 56.4% and 55.4% for the six months ended June 30, 2003 and 2004,
respectively. Bad debt expense increased from $5.3 million, or 3.2% of
revenues, for the six months ended June 30, 2003 to $6.5 million, or 3.9% of
revenues, for the same period in 2004. 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. The resulting delay has increased
accounts receivable reserves as the related receivables balances age. General and Administrative Expenses. General and administrative expenses
decreased from $8.7 million for the six months ended June 30, 2003 to $8.5
million for the same period in 2004, a decrease of $0.2 million, or 2.3%. This
decrease is primarily the result of a lower level of professional 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 six
months ended June 30, 2003 and 2004, respectively. Earnings from Unconsolidated Joint Ventures. Earnings from unconsolidated
joint ventures decreased slightly from $2.4 million for the six months ended
June 30, 2003 to $2.2 million for the six months ended June 30, 2004. Depreciation and Amortization. Depreciation (excluding rental equipment) and
amortization expenses decreased from $1.8 million for the six months ended June
30, 2003 to $1.6 million for the same period in 2004, a decrease of $0.2
million, or 11.1%. This decrease primarily is attributable to certain property
and equipment becoming fully depreciated. Interest Expense (Income), Net. Interest expense (income), net increased from
$(0.1) million for the six months ended June 30, 2003 to $9.3 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 six months ended June 30, 2003, of $12.5
million, represents the default rate of interest pursuant to the terms
described in the Amended Credit Agreement. 34




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##### Table of Contents



Other (Income) Expense, Net. Other (income) expense, net primarily relates to
investment losses or gains associated with collateral interest in split dollar
life insurance policies. Expense of $0.1 million was recorded in the six
months ended June 30, 2003 compared to income of less than $0.1 million for the
same period in 2004. Provision for Income Taxes. The provision for income taxes remained unchanged
at $0.2 million for the six months ended June 30, 2003 and 2004. Liquidity and Capital Resources At June 30, 2004, the Company had current assets of $79.1 million and current
liabilities of $57.9 million, resulting in working capital of $21.2 million and
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 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. 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 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. In addition, an estimated prepayment is due on September
30, 2004 in an amount equal to one-half of the anticipated Excess Cash Flow
payment due on March 31, 2005. 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, with an estimated prepayment due on each previous September 30 in
an amount equal to one-half of the anticipated March payment. 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 35




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##### Table of Contents



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. 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. 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 is due on
September 30, 2004 in an amount equal to one-half of the anticipated March 2005
Pro Rata Payment. The Company has made all payments due as of June 30, 2004 under the Approved
Plan, and has also prepaid some of its obligations thereunder. As of June 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 June 30,
2004 were approximately $3.6 million. The Company plans to pay an additional
$0.3 million to the holders of general unsecured claims subsequent to June 30,
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 June 30, 2004 the Company had cash and cash
equivalents of approximately $3.6 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.
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 June 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 36




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##### Table of Contents



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 $55.6 million and $56.9 million at June 30, 2004 and
December 31, 2003, respectively. Average days sales in accounts receivable
(DSO) was approximately 63 and 60 days at June 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 $18.2 million and $18.9 million
for the six months ended June 30, 2004 and 2003. Net income decreased from
$8.9 million for the six months ended June 30, 2003 to $2.0 million for the six
months ended June 30, 2004. This decrease of $6.9 million is primarily the
result of increased interest expense. Net cash used by reorganization items
totaled $0.7 million for the six months ended June 30, 2004. Reorganization
items consist primarily of professional fees. Net cash used in investing
activities was $10.9 million and $11.6 million for the six months ended June
30, 2004 and 2003, respectively. Additions to property and equipment, net were
$14.5 million for the six months ended June 30, 2004 compared to $13.8 million
for the same period in 2003. Net cash used in financing activities was $6.3
million and $8.6 million for the six months ended June 30, 2004 and 2003,
respectively. The cash used in financing activities for the six months ended
June 30, 2004 primarily relates to principal payments to the Lenders of $5.2
million. At June 30, 2004 the Company had cash and cash equivalents of
approximately $3.6 million. 37




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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
June 30, 2004: Year 5 &Total
    
    Year 1
    
    Year 2
    
    Year 3
    
    Year 4
    
    thereafterLong-term debt and
capital leases
    
    $
    256,962,000
    
    
    $
    6,950,000
    
    
    $
    12,000
    
    
    $
    
    
    
    $
    
    
    
    $
    250,000,000Accrued interest on
long-term debt
    
    
    1,414,000
    
    
    
    1,414,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Pre-petition
accounts payable
    
    
    3,629,000
    
    
    
    3,629,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    OIG settlement
    
    
    3,500,000
    
    
    
    500,000
    
    
    
    1,000,000
    
    
    
    2,000,000
    
    
    
    
    
    
    
    Accrued interest on
OIG settlement
    
    
    11,000
    
    
    
    11,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating lease
obligations
    
    
    27,228,000
    
    
    
    9,886,000
    
    
    
    7,183,000
    
    
    
    5,173,000
    
    
    
    3,573,000
    
    
    
    1,413,000Total contractual
cash obligations
    
    $
    292,744,000
    
    
    $
    22,390,000
    
    
    $
    8,195,000
    
    
    $
    7,173,000
    
    
    $
    3,573,000
    
    
    $
    251,413,000
 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 per 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 June 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. 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. 38




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##### Table of Contents



At June 30, 2004, the Company has no commitments or guarantees outstanding. At June 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 Act). The Act 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 six months
ended June 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 June 30, 2004 was $250.0 million. The
unsecured claim of the Lenders as of June 30, 2004 was approximately $6.0
million. The amount of general unsecured debt (excluding the Government
Settlement) due to other creditors at June 30, 2004 was $3.6 million. Required
payments to the Lenders and general unsecured creditors are detailed in
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 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. 39




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##### Table of Contents



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. Collectibility of Accounts Receivable.The Company has substantial
accounts receivable, representing DSO of 63 and 60 days as of June 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. 40




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##### Table of Contents



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 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 21, 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 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. 41




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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 has announced her
retirement, 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. 42




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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. 43




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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 chief 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 June 30, 2004. Based on such evaluation, such
officers have concluded that, as of June 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 six months ended June 30, 2004 that
has materially affected, or is reasonably likely to materially affect, the
Companys internal control over financial reporting. 44




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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 June 30, 2004, the related
interim condensed consolidated statements of income for the three-month and
six-month periods ended June 30, 2004 and 2003, and the related interim
condensed consolidated statements of cash flows for the six month periods ended
June 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
August 4, 2004 45




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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. 
 ITEM 4  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The 2004 annual meeting of shareholders was held on June 2, 2004. At the
meeting, the re-election of the individuals nominated as Class 1 directors of
the Companys Board of Directors, Henry T. Blackstock and W. Wayne Woody, was
approved. Continuing directors consisted of: Class 2 director Joseph F.
Furlong, III, and Class 3 director Donald R. Millard. No other matters were
voted upon at the annual meeting. The following table sets forth the voting tabulation for the matter voted upon
at the meeting: Votes
    
    Votes
    
    Votes
    
    
    
    
    
    BrokerFor
    
    Against
    
    Withheld
    
    Abstentions
    
    Non-VotesReelection of Class 1director Henry T.Blackstock
    
    
    13,664,070
    
    
    
    N/A
    
    
    
    378,899
    
    
    
    N/A
    
    
    
    N/AReelection of Class 1director W. WayneWoody
    
    
    13,996,662
    
    
    
    N/A
    
    
    
    46,307
    
    
    
    N/A
    
    
    
    N/A
 46




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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 June 30, 2004:  1)
    
    A current report on Form 8-K was filed on May 5, 2004 to disclose,
under Item 12, the Companys press release describing the Companys
results of operations for the first quarter ended March 31, 2004.2)
    
    A current report on Form 8-K was filed on May 18, 2004 to disclose,
under Item 5, the Companys press release announcing that the Companys
chief financial officer is planning to retire.3)
    
    A current report on Form 8-K was filed on June 7, 2004 to disclose,
under Item 5, the Companys press release announcing that William C.
ONeil, Jr. has been appointed to the Companys board of directors. 47




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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.August 5, 2004
    
    By:
    
    /s/ Marilyn A. OHaraMarilyn A. OHaraChief Financial Officer and An Officer DulyAuthorized to Sign on Behalf of the registrant
 48




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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 (incorporated by reference to Exhibit 3.5 to
the Companys Quarterly Report on Form 10-Q for the quarter ended June 30,
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).10.1
    
    Amended and Restated American HomePatient, Inc. 1991 Nonqualified Stock
Option Plan (incorporated by reference to Exhibit 10 to the Companys
Registration Statement on Form S-8 filed on April 5, 2004).10.2
    
    1995 Nonqualified Stock Option Plan for Directors (incorporated by
reference to Exhibit B of Schedule 14A dated April 17, 1995).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 
Chief Financial Officer.
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EXHIBITNUMBER
    
    DESCRIPTION OF EXHIBITS32.1
    
    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  Chief Financial Officer.
 50