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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 Form 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2008
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 Commission File Number: 1-14316
 APRIA HEALTHCARE GROUP INC.
 (Exact name of registrant as specified in its charter)
 Delaware
    
    33-0488566(State or Other Jurisdiction of
    
    (I.R.S. EmployerIncorporation or Organization)
    
    Identification Number)26220 Enterprise Court, Lake Forest, CA
    
    92630(Address of Principal Executive Offices)
    
    (Zip Code)
 Registrants telephone number: (949) 639-2000
 þ o
  Large Accelerated Filer þ
    
    Accelerated Filer o
    
    Non-Accelerated Filer o
    
    Smaller Reporting Company o(Do not check if a smaller reporting company)
 o þ




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##### 



APRIA HEALTHCARE GROUP INC.
 FORM 10-Q
 For the period ended March 31, 2008
 PagePART I. FINANCIAL INFORMATIONItem 1. Financial Statements (unaudited)
    
    
    4 Condensed Consolidated Balance Sheets
    
    
    4 Condensed Consolidated Income Statements
    
    
    5 Condensed Consolidated Statements of Cash Flows
    
    
    6 Notes to Unaudited Condensed Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    20Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    36Item 4. Controls and Procedures
    
    
    37PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    38Item 1A. Risk Factors
    
    
    38Item 2. Unregistered Sale of Equity Securities and Use of Proceeds
    
    
    39Item 3. Defaults Upon Senior Securities
    
    
    39Item 4. Submission of Matters to a Vote of Security Holders
    
    
    39Item 5. Other Information
    
    
    39Item 6. Exhibits
    
    
    40SIGNATURES
    
    
    41EXHIBITS INDEX AND EXHIBITSExhibit 10.34Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2
   2




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Cautionary statement for purposes of the Safe Harbor provisions of the Private Securities
Litigation Reform Act of 1995:
 
    
    trends and developments affecting the collectibility of accounts receivable;
 
    
    government legislative and budget developments that could continue to affect
reimbursement levels;
 
    
    potential reductions in reimbursement rates by government and third-party payors;
 
    
    the effectiveness of our operating systems and controls;
 
    
    healthcare reform and the effect of federal and state healthcare regulations;
 
    
    economic and political events, international conflicts and natural disasters;
 
    
    acquisition-related risks; and
 
    
    other factors described in our filings with the Securities and Exchange Commission.
  3




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##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 ITEM 1. FINANCIAL STATEMENTS
 APRIA HEALTHCARE GROUP INC.
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (Unaudited)
 (Dollars in thousands, except share data)
 March 31,
    
    
    December 31,2008
    
    
    2007ASSETSCURRENT ASSETSCash and cash equivalents
    
    $
    21,046
    
    
    $
    28,451Accounts receivable, less allowance for doubtful accounts of $43,901 and
$47,823 at March 31, 2008 and December 31, 2007, respectively
    
    
    288,440
    
    
    
    284,141Inventories, net
    
    
    53,671
    
    
    
    52,079Deferred income taxes
    
    
    55,134
    
    
    
    66,198Deferred expenses
    
    
    3,118
    
    
    
    3,102Prepaid expenses and other current assets
    
    
    17,314
    
    
    
    23,364TOTAL CURRENT ASSETS
    
    
    438,723
    
    
    
    457,335PATIENT SERVICE EQUIPMENT, less accumulated depreciation of $453,327 and
$453,324 at March 31, 2008 and December 31, 2007, respectively
    
    
    202,388
    
    
    
    200,180PROPERTY, EQUIPMENT AND IMPROVEMENTS, net
    
    
    112,949
    
    
    
    102,827GOODWILL
    
    
    718,233
    
    
    
    715,235INTANGIBLE ASSETS, less accumulated amortization of $8,445 and $7,907 at
March 31, 2008 and December 31, 2007, respectively
    
    
    106,732
    
    
    
    107,757DEFERRED DEBT ISSUANCE COSTS, net
    
    
    2,390
    
    
    
    2,834OTHER ASSETS
    
    
    13,316
    
    
    
    11,6341,594,731
    
    
    $
    1,597,802LIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIESAccounts payable
    
    $
    134,834
    
    
    $
    120,360Accrued payroll and related taxes and benefits
    
    
    53,899
    
    
    
    66,625Income taxes payable
    
    
    8,839
    
    
    
    3,076Other accrued liabilities
    
    
    56,644
    
    
    
    73,835Deferred revenue
    
    
    30,085
    
    
    
    29,704Current portion of long-term debt
    
    
    253,631
    
    
    
    254,252TOTAL CURRENT LIABILITIES
    
    
    537,932
    
    
    
    547,852LONG-TERM DEBT, net of current portion
    
    
    417,405
    
    
    
    433,031DEFERRED INCOME TAXES
    
    
    68,643
    
    
    
    62,290INCOME TAXES PAYABLE AND OTHER NON-CURRENT LIABILITIES
    
    
    35,993
    
    
    
    42,604TOTAL LIABILITIES
    
    
    1,059,973
    
    
    
    1,085,777COMMITMENTS AND CONTINGENCIES (Note 10)STOCKHOLDERS EQUITYPreferred stock, $.001 par value: 10,000,000 shares authorized; none issued
    
    
    
    
    
    
    Common stock, $.001 par value: 150,000,000 shares authorized; 60,955,680
and 60,844,901 shares issued at March 31, 2008 and December 31, 2007,
respectively; 43,865,753 and 43,794,492 shares outstanding at March 31,
2008 and December 31, 2007, respectively
    
    
    61
    
    
    
    61Additional paid-in capital
    
    
    517,778
    
    
    
    514,848Treasury stock, at cost; 17,089,927 and 17,050,409 shares at March 31, 2008
and December 31, 2007, respectively
    
    
    (432,590
    )
    
    
    (431,651
    )Retained earnings
    
    
    449,310
    
    
    
    428,538Accumulated other comprehensive income
    
    
    199
    
    
    
    229TOTAL STOCKHOLDERS EQUITY
    
    
    534,758
    
    
    
    512,025$
    1,594,731
    
    
    $
    1,597,802
   4




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##### Table of Contents



APRIA HEALTHCARE GROUP INC.
 
 CONDENSED CONSOLIDATED INCOME STATEMENTS
 (Unaudited)
 Three Months EndedMarch 31,(in thousands, except per share data)
    
    2008
    
    
    2007(As Restated See Note 2)Net revenues:Fee for service/product arrangements
    
    $
    485,356
    
    
    $
    349,495Capitation arrangements
    
    
    42,622
    
    
    
    41,284TOTAL NET REVENUES
    
    
    527,978
    
    
    
    390,779Costs and expenses:Cost of net revenues:Product and supply costs
    
    
    155,904
    
    
    
    90,891Patient service equipment depreciation
    
    
    27,177
    
    
    
    28,010Home respiratory therapy services
    
    
    9,419
    
    
    
    9,338Nursing services
    
    
    9,053
    
    
    
    2,104Other
    
    
    3,717
    
    
    
    4,274TOTAL COST OF NET REVENUES
    
    
    205,270
    
    
    
    134,617Provision for doubtful accounts
    
    
    10,681
    
    
    
    9,698Selling, distribution and administrative
    
    
    268,661
    
    
    
    206,480Amortization of intangible assets
    
    
    1,068
    
    
    
    992TOTAL COSTS AND EXPENSES
    
    
    485,680
    
    
    
    351,787OPERATING INCOME
    
    
    42,298
    
    
    
    38,992Interest expense
    
    
    8,316
    
    
    
    6,320Interest income and other
    
    
    (508
    )
    
    
    (494
    )INCOME BEFORE TAXES
    
    
    34,490
    
    
    
    33,166Income tax expense
    
    
    13,718
    
    
    
    12,316NET INCOME
    
    $
    20,772
    
    
    $
    20,850Basic net income per common share
    
    $
    0.47
    
    
    $
    0.48Diluted net income per common share
    
    $
    0.47
    
    
    $
    0.47
   5




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##### Table of Contents



APRIA HEALTHCARE GROUP INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Unaudited)
 Three Months EndedMarch 31,(in thousands)
    
    2008
    
    
    2007(As Restated See Note 2)OPERATING ACTIVITIESNet income
    
    $
    20,772
    
    
    $
    20,850Items included in net income not requiring cash:Provision for doubtful accounts
    
    
    10,681
    
    
    
    9,698Depreciation and amortization
    
    
    35,510
    
    
    
    33,955Amortization of deferred debt issuance costs
    
    
    445
    
    
    
    445Deferred income taxes
    
    
    14,831
    
    
    
    4,724Share-based compensation
    
    
    3,150
    
    
    
    1,436Gain on disposition of assets and other
    
    
    (77
    )
    
    
    (64
    )Excess tax benefits from share-based compensation
    
    
    (7
    )
    
    
    (3,364
    )Changes in operating assets and liabilitiesAccounts receivable
    
    
    (14,981
    )
    
    
    (10,926
    )Inventories, net
    
    
    (1,592
    )
    
    
    (2,074
    )Prepaid expenses and other assets
    
    
    4,368
    
    
    
    863Accounts payable, exclusive of book-cash overdraft
    
    
    7,021
    
    
    
    1,846Accrued payroll and related taxes and benefits
    
    
    (13,664
    )
    
    
    (10,564
    )Income taxes payable
    
    
    (2,022
    )
    
    
    4,701Deferred revenue, net of related expenses
    
    
    365
    
    
    
    (977
    )Accrued expenses
    
    
    (16,248
    )
    
    
    (5,660
    )NET CASH PROVIDED BY OPERATING ACTIVITIES
    
    
    48,552
    
    
    
    44,889INVESTING ACTIVITIESPurchases of patient service equipment and property,
equipment and improvements
    
    
    (41,480
    )
    
    
    (32,672
    )Proceeds from disposition of assets
    
    
    33
    
    
    
    26Cash paid for acquisitions
    
    
    (3,031
    )
    
    
    NET CASH USED IN INVESTING ACTIVITIES
    
    
    (44,478
    )
    
    
    (32,646
    )FINANCING ACTIVITIESProceeds from revolving credit facilities
    
    
    5,000
    
    
    
    Payments on revolving credit facilities
    
    
    (20,000
    )
    
    
    (25,000
    )Payments on other long-term debt
    
    
    (1,247
    )
    
    
    (1,605
    )Change in book-cash overdraft included in accounts payable
    
    
    4,712
    
    
    
    (413
    )Excess tax benefits from share-based compensation
    
    
    7
    
    
    
    3,364Issuances of common stock
    
    
    49
    
    
    
    13,297NET CASH USED IN FINANCING ACTIVITIES
    
    
    (11,479
    )
    
    
    (10,357
    )NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
    
    
    (7,405
    )
    
    
    1,886Cash and cash equivalents at beginning of period
    
    
    28,451
    
    
    
    14,657CASH AND CASH EQUIVALENTS AT END OF PERIOD
    
    $
    21,046
    
    
    $
    16,543
      6




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APRIA HEALTHCARE GROUP INC.
 
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 NOTE 1  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 Basis of Presentation:
  Use of Accounting Estimates:
 Revenue Recognition and Concentration of Credit Risk:
 Revenue Arrangements with Multiple
Deliverables,
 Deferred Revenue and Deferred Expense: Accounting for Leases.
  7




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APRIA HEALTHCARE GROUP INC.
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 Accounting
for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct
Costs of Leases.
 Cash and Cash Equivalents:
 Accounts Receivable:
    Capitalized Software: Accounting for the Costs of Computer Software Developed or Obtained for Internal Use
 Home Respiratory Therapy Expenses:
  8




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APRIA HEALTHCARE GROUP INC.
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 Distribution Expenses: Accounting for Shipping and Handling Fees and Costs,
 Sales and Certain Other Taxes:
 NOTE 2  RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS
 Accounting for Leases.
 Accounting
for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct
Costs of Leases.
   9




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APRIA HEALTHCARE GROUP INC.
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  CONDENSED CONSOLIDATED STATEMENT OF INCOME ITEMS
 Three Months Ended March 31, 2007(As Previously
    
    
    
    
    
    
    (As(in thousands, except per share data)
    
    Reported)
    
    
    (Adjustments)
    
    
    Restated)Fee for service/product arrangements
    
    $
    348,006
    
    
    $
    1,489
    
    
    $
    349,495Total net revenues
    
    
    389,290
    
    
    
    1,489
    
    
    
    390,779Product and supply costs
    
    
    91,070
    
    
    
    (179
    )
    
    
    90,891Total cost of net revenues
    
    
    134,796
    
    
    
    (179
    )
    
    
    134,617Selling, distribution and administrative expenses
    
    
    206,579
    
    
    
    (99
    )
    
    
    206,480Total costs and expenses
    
    
    352,065
    
    
    
    (278
    )
    
    
    351,787Operating income
    
    
    37,225
    
    
    
    1,767
    
    
    
    38,992Income before taxes
    
    
    31,399
    
    
    
    1,767
    
    
    
    33,166Income tax expense
    
    
    12,255
    
    
    
    61
    
    
    
    12,316Net income
    
    
    19,144
    
    
    
    1,706
    
    
    
    20,850Basic net income per common share
    
    
    0.44
    
    
    
    
    
    
    
    0.48Diluted net income per common share
    
    $
    0.44
    
    
    
    
    
    
    $
    0.47
 CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS ITEMS
 Three Months Ended March 31, 2007(As Previously
    
    
    
    
    
    
    (As(in thousands)
    
    Reported)
    
    
    (Adjustments)
    
    
    Restated)Net income
    
    $
    19,144
    
    
    $
    1,706
    
    
    $
    20,850Deferred income taxes
    
    
    4,663
    
    
    
    61
    
    
    
    4,724Deferred revenue, net of deferred expenses
    
    $
    790
    
    
    $
    (1,767
    )
    
    $
    (977
    )
 NOTE 3  RECENT ACCOUNTING PRONOUNCEMENTS
 Fair
Value Measurements,
 Application of FASB Statement No. 157 to
FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for
Purposes of Lease Classification or Measurement under Statement 13 Accounting for Leases
 Effective Date of FASB Statement No.
157
  10




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APRIA HEALTHCARE GROUP INC.
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 Fair Value Hierarchy.
    The Fair Value Option for Financial Assets and
Financial Liabilities.
 Business Combinations Business Combinations.
 Noncontrolling Interests in Consolidated
Financial StatementsAn Amendment of ARB No. 51
 , “Determination of the
Useful Life of Intangible Assets” Goodwill and Other Intangible
Assets”
 NOTE 4  BUSINESS COMBINATIONS
  NOTE 5  GOODWILL AND INTANGIBLE ASSETS
 Business
Combinations, Goodwill and Other Intangible Assets,
  11




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##### Table of Contents



APRIA HEALTHCARE GROUP INC.
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  March 31, 2008
    
    
    March 31, 2007Average
    
    
    Gross
    
    
    
    
    
    
    
    
    
    
    Gross
    
    
    
    
    
    
    NetLife in
    
    
    Carrying
    
    
    Accumulated
    
    
    Net Book
    
    
    Carrying
    
    
    Accumulated
    
    
    Book(dollars in thousands)
    
    Years
    
    
    Amount
    
    
    Amortization
    
    
    Value
    
    
    Amount
    
    
    Amortization
    
    
    ValueIntangible assets
subject to
amortization:Covenants not to
compete
    
    
    5.0
    
    
    $
    10,849
    
    
    $
    (7,773
    )
    
    $
    3,076
    
    
    $
    13,145
    
    
    $
    (7,631
    )
    
    $
    5,514Patient referral
sources
    
    
    20.0
    
    
    
    34,300
    
    
    
    (572
    )
    
    
    33,728
    
    
    
    
    
    
    
    
    
    
    
    Customer lists
    
    
    1.0
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    208
    
    
    
    (162
    )
    
    
    46Favorable leases
    
    
    2.4
    
    
    
    628
    
    
    
    (100
    )
    
    
    528
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    7.1
    
    
    
    45,777
    
    
    
    (8,445
    )
    
    
    37,332
    
    
    
    13,353
    
    
    
    (7,793
    )
    
    
    5,560Intangible assets not
subject to
amortization:Trade names
    
    
    
    
    
    
    69,400
    
    
    
    
    
    
    
    69,400
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    7.1
    
    
    $
    115,177
    
    
    $
    (8,445
    )
    
    $
    106,732
    
    
    $
    13,353
    
    
    $
    (7,793
    )
    
    $
    5,560
  Year Ending December 31,
    
    (in thousands)2008
    
    $
    7,1942009
    
    
    4,4252010
    
    
    2,6112011
    
    
    2,1292012
    
    
    1,992
 NOTE 6  LONG-TERM DEBT
 Revolving Credit Facility:
 Convertible Senior Notes:
   12




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##### Table of Contents



APRIA HEALTHCARE GROUP INC.
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  Hedging Activities:
 Accounting for Derivative Instruments
and Hedging Activities.
   NOTE 7  STOCKHOLDERS EQUITY
  Net income
    
    $
    20,772Issuances of common stock (including non-cash issuances)
    
    
    49Excess tax benefits from share-based compensation
    
    
    7Tax shortfalls on share-based compensation
    
    
    (276
    )Restricted stock retained in treasury upon vesting
    
    
    (939
    )Share-based compensation
    
    
    3,150Other comprehensive loss, net of taxes
    
    
    (30
    )$
    22,733
   13




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##### Table of Contents



APRIA HEALTHCARE GROUP INC.
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 NOTE 8  SHARE-BASED COMPENSATION
    Three Months EndedMarch 31,2008
    
    
    2007Expected option term(1)
    
    6.1 years
    
    
    4.6 yearsExpected volatility(2)
    
    
    37.2%
    
    
    
    29.9%Risk-free interest rate(3)
    
    
    3.0%
    
    
    
    4.6%Expected annual dividend yield
    
    
    0%
    
    
    
    0%
 
 (1)
    
    The expected option term is based on historical exercise and post-vesting termination patterns.(2)
    
    The expected volatility represents a combination of historical stock price volatility and
implied volatility from publicly-traded options on Aprias common stock.(3)
    
    The risk-free interest rate is based on the implied yield on a U.S. Treasury zero coupon issue
with a remaining term equal to the expected term of the option. Stock Options:
  14




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APRIA HEALTHCARE GROUP INC.
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  Weighted-AverageRemaining
    
    
    AggregateWeighted-Average
    
    
    Contractual Term
    
    
    IntrinsicOptions
    
    
    Exercise Price
    
    
    (in Years)
    
    
    ValueOutstanding at January 1, 2008
    
    
    3,733,383
    
    
    $
    26.60Granted
    
    
    15,000
    
    
    $
    21.02Exercised
    
    
    (3,166
    )
    
    $
    15.33Forfeited
    
    
    (60,000
    )
    
    $
    29.32Outstanding at March 31, 2008
    
    
    3,685,217
    
    
    $
    26.54
    
    
    
    6.09
    
    
    $
    1,174,882Vested or expected to vest as of March 31, 2008
    
    
    3,558,264
    
    
    $
    26.51
    
    
    
    5.99
    
    
    $
    1,174,005Exercisable at March 31, 2008
    
    
    2,862,894
    
    
    $
    26.36
    
    
    
    5.33
    
    
    $
    1,169,281
   Restricted Stock Purchase Rights:
  Restricted
    
    
    
    
    
    
    Weighted-AverageStock
    
    
    
    
    
    
    Remaining
    
    
    AggregatePurchase
    
    
    Weighted-Average
    
    
    Contractual Term
    
    
    IntrinsicRights
    
    
    Exercise Price
    
    
    (in Years)
    
    
    ValueOutstanding at January 1, 2008
    
    
    277,000
    
    
    $
    6.82Granted
    
    
    
    
    
    $
    Exercised
    
    
    
    
    
    $
    Forfeited
    
    
    
    
    
    $
    Outstanding at March 31, 2008
    
    
    277,000
    
    
    $
    6.82
    
    
    
    5.53
    
    
    $
    3,582,150Vested or expected to vest as of March 31, 2008
    
    
    220,166
    
    
    $
    6.80
    
    
    
    5.52
    
    
    $
    2,851,929Exercisable at March 31, 2008
    
    
    8,000
    
    
    $
    6.46
    
    
    
    5.37
    
    
    $
    106,320
   Stock Appreciation Rights:
  15




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##### Table of Contents



APRIA HEALTHCARE GROUP INC.
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  Weighted-AverageStock
    
    
    
    
    
    
    Remaining
    
    
    AggregateAppreciation
    
    
    Weighted-Average
    
    
    Contractual Term
    
    
    IntrinsicRights
    
    
    Exercise Price
    
    
    (in Years)
    
    
    ValueOutstanding at January 1, 2008
    
    
    
    
    
    $
    Granted
    
    
    467,890
    
    
    $
    21.71Exercised
    
    
    
    
    
    $
    Forfeited
    
    
    
    
    
    $
    Outstanding at March 31, 2008
    
    
    467,890
    
    
    $
    21.71
    
    
    
    9.92
    
    
    $
    Vested or expected to vest as of March 31, 2008
    
    
    379,553
    
    
    $
    21.71
    
    
    
    9.92
    
    
    $
    Exercisable at March 31, 2008
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    
   Restricted Stock Awards and Units:
  Shares
    
    
    Weighted-Averageor
    
    
    Grant-DateShare Units
    
    
    Fair ValueNonvested restricted stock awards and units at January 1, 2008
    
    
    640,871
    
    
    $
    29.73Granted
    
    
    378,980
    
    
    $
    21.70Vested and released
    
    
    (107,613
    )
    
    $
    30.33Forfeited
    
    
    (6,049
    )
    
    $
    29.26Nonvested restricted stock awards and units at March 31, 2008
    
    
    906,189
    
    
    $
    26.30
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##### Table of Contents



APRIA HEALTHCARE GROUP INC.
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 NOTE 9  INCOME TAXES
   Total gross unrecognized tax benefits at December 31, 2007
    
    $
    115,960Additions for tax positions related to the current year
    
    
    984Additions for tax positions related to prior years
    
    
    1,064Reductions for tax positions related to prior years
    
    
    (5,643
    )Settlements
    
    
    (575
    )Reductions due to lapse in statute of limitations
    
    
    Other
    
    
    (31
    )Total gross unrecognized tax benefits at March 31, 2008
    
    $
    111,759
     
    
    Aggregate gross increase of $2,400,000 for interest and penalties primarily related to
other tax uncertainties taken in prior years and state tax uncertainties involving tax filing
positions. The gross increase is an annual expense which will be accrued until the tax
uncertainties or related tax uncertainties (in the case of interest and penalties) are
extinguished through such means as audit settlements, payment, or the expiration of statutes
of limitations.
    
    Aggregate gross decrease of $8,200,000 related to the timing uncertainty for when certain
deductions should be recognized for tax return purposes, allocation of expenses between
affiliates, and state tax uncertainties. Ultimate realization of this decrease is dependent
upon the occurrence of certain events (including the completion of audits by tax agencies and
expiration of statutes of limitations).
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APRIA HEALTHCARE GROUP INC.
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
   NOTE 10  PER SHARE AMOUNTS
  Three Months EndedMarch 31,(in thousands, except per share data)
    
    2008
    
    
    2007Numerator:Net income
    
    $
    20,772
    
    
    $
    20,850Numerator for basic and diluted per share amounts  net income available
to common stockholders
    
    $
    20,772
    
    
    $
    20,850Denominator:Denominator for basic per share amounts  weighted average shares
    
    
    43,829
    
    
    
    43,112Effect of dilutive securities:Employee stock options and awards  dilutive potential common shares
    
    
    342
    
    
    
    876Denominator for diluted per share amounts  adjusted weighted average
shares
    
    
    44,171
    
    
    
    43,988Basic net income per common share
    
    $
    0.47
    
    
    $
    0.48Diluted net income per common share
    
    $
    0.47
    
    
    $
    0.47Employee stock options excluded from the computation of diluted per share
amounts:Shares for which exercise price exceeds average market price of common stock
    
    
    3,868
    
    
    
    986Average exercise price per share that exceeds average market price of
common stock
    
    $
    26.75
    
    
    $
    31.80
 NOTE 11  COMMITMENTS AND CONTINGENCIES
 Litigation
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APRIA HEALTHCARE GROUP INC.
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  Medicare and Medicaid Reimbursement
 Supplier Concentration:
 Guarantees and Indemnities
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ITEM 2.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
 This Managements Discussion and Analysis of Financial Condition and Results of Operations is
intended to assist in understanding and assessing the trends and significant changes in our results
of operations and financial condition. Historical results may not indicate future performance. Our
forward-looking statements reflect our current views about future events, are based on assumptions
and are subject to known and unknown risks and uncertainties that could cause actual results to
differ materially from those contemplated by these statements. Factors that may cause differences
between actual results and those contemplated by forward-looking statements include, but are not
limited to, those discussed in Part II, Item 1A, Risk Factors, of our Annual Report on Form 10-K
for the fiscal year ended December 31, 2007. As used in this Managements Discussion and Analysis
of Financial Condition and Results of Operations, the words we, our, us and the Company
refer to Apria Healthcare Group Inc. and its consolidated subsidiaries. This Managements
Discussion and Analysis of Financial Condition and Results of Operations should be read in
conjunction with our condensed consolidated financial statements and related notes included in this
report.
   Disclosures
about Segments of an Enterprise and Related Information.
 Strategy
 
    
    achieve strong organic sales growth and increase market share;
    
    leverage our nationwide infrastructure to reduce costs and expand profits;
    
    deliver superior customer service;
    
    attract, develop and advance leaders within the Company;
    
    operate our business ethically; and
    
    maintain independent accreditation at all locations.
 Critical Accounting Policies.
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Government Regulation
  Medicare and Medicaid Reimbursement Revenues.
 Medicare Reimbursement.
    
    
    A five-year freeze on annual consumer price index payment increases for most durable
medical equipment  The freeze commenced in 2004 and will continue through 2008. After 2008,
certain durable medical equipment, prosthetics, orthotics and supplies (DMEPOS) equipment
not subject to competitive bidding will be eligible for a consumer price index increase for
urban consumers.
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
    
    Reimbursement reductions for five durable medical equipment categories  Reimbursement for
most oxygen and oxygen equipment, standard wheelchairs (including standard power wheelchairs),
nebulizers, diabetic supplies consisting of lancets and testing strips, hospital beds, and air
mattresses, became based on the median price paid for such items on behalf of beneficiaries of
federal employee health benefit plans. Subsequent legislation and CMS regulatory actions have
further modified reimbursement methodology for certain items, such as power wheelchairs and
oxygen and oxygen equipment, as described below.
    
    Reimbursement reductions for inhalation drugs  Beginning January 2005, Medicare Part B
reimbursement for most drugs, including inhalation drugs, became based upon the
manufacturer-reported average sales price (ASP) (subject to adjustment each quarter), plus
6%, plus a separate dispensing fee per patient episode. CMS publishes the ASP plus 6% payment
levels several weeks before the first day of each quarter, and we have no way of knowing if
the quarterly ASPs will increase or decrease since manufacturers report applicable sales price
information directly to CMS. Since 2006, dispensing fees have remained at $57.00 for a 30-day
supply for a new patient, $33.00 for each 30-day supply thereafter, and $66.00 for each 90-day
supply. Effective July 1, 2007, Medicare no longer reimbursed providers for compounded
inhalation drugs. Because our compounding levels were minimal, this change had no significant
effect on us. Subsequent regulations and legislation have further modified reimbursement
methodologies for certain inhalation therapies, as described below.
    
    The reimbursement methodology for non-compounded, infused drugs administered through
Durable Medical Equipment (DME), such as infusion pumps, was not affected by this change. It
remains based upon either 95% of the October 1, 2003 Average Wholesale Price (AWP) or, for
those drugs whose AWPs were not published in the applicable 2003 compendia, at 95% of the
first published AWP.
    
    Establishment of a competitive bidding program for Medicare Part B  The MMA required
implementation of a competitive bidding program for certain DME, and on April 10, 2007, CMS
published a final rule implementing such a Medicare Part B competitive bidding program. By
statute, CMS is required to implement the DME competitive bidding program over time, with the
first phase establishing competitive bidding in 10 of the largest metropolitan statistical
areas (MSAs), for 2008, with 70 additional markets to be added in 2009, and nationwide
implementation in 2010. Our bids for the first round were submitted by the CMS deadline, and
CMS has indicated that the first round will go live on July 1, 2008. On January 8, 2008, CMS
announced the 70 MSAs and eight product categories for the second round of the competitive
bidding program. CMS anticipates that the exact Competitive Bidding Areas (CBAs) for the
second round will be further defined later in 2008 as it launches the formal bid process in
the summer of 2008, with implementation in 2009.
    
    Competitive bidding imposes a significant risk to suppliers of DME. If a DME supplier
operating in a CBA is not awarded a contract for that CBA, the supplier generally will not be
able to bill and be reimbursed by Medicare for DME items supplied in that CBA for the time
period covered by the competitive bidding program (unless a supplier is covered by the
grandfathering provision for existing oxygen or capped rental patients discussed below or
acquires a winning bidder). Because the applicable statute mandates savings and CMS bidding
rules require that bids must be less than current Medicare allowable rates, a DME supplier
awarded one of the winning bids for the CBA will receive lower Medicare payment rates than
those in existence prior to competitive bidding. In addition, there is a risk that the new
competitive bidding prices will become a new benchmark for reimbursement from private payors.
As competitive bidding is phased in across the country, we will likely experience a
substantial reduction in reimbursement, as will most if not all other DME suppliers.
    
    Based upon criteria described in the final rule governing competitive bidding, CMS
identified both the 10 MSAs and product categories for the initial phase of the program. We
service nine of the ten markets included in the list of initial CBAs. The only market we do
not service of the original ten CBAs is Puerto Rico. Nine of the 10 product categories
selected for the first phase are common to all nine domestic markets. The tenth product
category is specific to the Miami and Puerto Rico markets only. In the first phase, CMS
accepted bids from suppliers for the following product categories: Oxygen Supplies and
Equipment; Standard Power Wheelchairs, Scooters and Related Accessories; Complex
Rehabilitative Power Wheelchairs and Related Accessories; Mail-Order Diabetic Supplies;
Enteral Nutrients, Equipment and Supplies; Continuous Positive Airway Pressure Devices,
Respiratory Assist Devices and Related Supplies and Accessories; Hospital Beds and Related
Accessories; Negative Pressure Wound Therapy Pumps and Related Supplies and Accessories; Walkers
and Related Accessories; and (Miami and Puerto Rico only) Support Surfaces (group 2 mattresses
and overlays).
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
    
    The bidding process for the first round of competitive bidding was complex and subject to
deadline extensions. The deadline for suppliers to submit bids for participation in the first
round of the program was originally 60 days after issuance of the Request for Bids. However,
after issuing the Request for Bids in mid-May 2007, CMS and its Competitive Bidding
Implementation Contractor, extended the deadline for bid submission three times in response to
concerns raised by individual suppliers, industry associations and Congress about difficulties
experienced with the bid process and Internet-based application process. The revised deadline
for submission was September 25, 2007, and we submitted timely bids. Suppliers also must be
accredited entities to take part in the program. The accreditation deadline was October 31,
2007; we were already an accredited entity at that time.In late March 2008, CMS individually contacted suppliers as part of its initial effort to offer
competitive bidding contracts to qualified bidders. Qualified bidders are defined as those
bidders who meet minimum accreditation and financial standards and submitted a price that was
low enough to ensure that they would be included in the bid array to calculate the Single
Payment Amounts, the Medicare allowed payment amount for competitive bidding items, on a
market-specific basis. On March 20, 2008, CMS issued the single payment amounts for the 10
product categories for the first round and the number of contracts offered to suppliers per CBA.
As required by the Medicare statute, these rates are below the historic fee schedule rates, and
also are below the value that CMS and the industry anticipated. CMS offered us contracts in
several CBAs for the first round of competitive bidding; we accepted the contracts for certain
product categories and declined others due to the unacceptably low Single Payment Amounts in
certain markets, which would not adequately cover the cost of providing services to patients in
those markets. The process is not yet complete, and CMS has not yet published a list of winning
suppliers. In fact, we are continuing to receive, evaluate and negotiate contract offers from
CMS. It is our understanding that the process will be completed some time in May 2008.We are unable to predict what percentage of the market we may capture for any given product
category in any given CBA. In cases where we do not receive and accept a contract for a
particular CBA or product category, we have the option, for all product categories other than
enteral nutrition and diabetic supplies, to continue servicing Medicare beneficiaries presently
on service with us in that CBA if we agree to continue providing service to those patients at
the new reduced rates of reimbursement and satisfy certain other conditions under the
grandfathering provisions of the final competitive bidding rule described below. For the CBAs
and products for which we do not currently expect to receive a contract, we have determined to
act as a grandfathered supplier for most, but not all, product categories. In addition, we will
be able to provide and be reimbursed for services to Medicare beneficiaries not currently on
service with us in a CBA if we acquire a winning bidder and assume that bidders contract with
CMSs approval. We have not yet made any final decisions concerning whether to acquire any
winning bidders in the CMAs where Apria was not a successful bidder.The new payment levels will go into effect for the selected DMEPOS product categories in the
initial 10 CBAs beginning July 1, 2008. Contracts with winning bidders for the first round of
competitive bidding are expected to be three years in length, except for diabetic supplies,
which are 21 months in length. Consequently, the contract period for mail order diabetic
supplies is expected to be from July 1, 2008 to March 31, 2010 and the contract period for all
other first round product categories is expected to be from July 1, 2008 to June 30, 2011. New
competitive bidding periods in the initial ten markets are expected to begin after the initial
contracts end. Due to the documented problems that arose with the CMS provider selection process
in round one, there are legislative and administrative efforts to delay implementation of round
one and/or round two of competitive bidding or to add additional winning contractors. We cannot
predict whether or to what extent these efforts will be successful or what their ultimate impact
will be.
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
    
    The final rule governing competitive bidding, among other things, generally requires
Medicare beneficiaries who live in a CBA to receive equipment and services that are included
within the competitive bidding program exclusively from suppliers who are awarded contracts by
CMS, with a few exceptions. The reimbursement rate for the items and services will be the
single payment rate that is determined through the bid process. The revenue associated with
the items subject to competitive bidding in the initial year of the program represents less
than 2%
of our 2007 total net revenue. The original CMS estimation for the average weighted level of
payment cuts was a 10% to 15% reduction in payment for products and services included in round
one. We estimated that this would have caused less than a 0.3% decline in our 2007 total net
revenue if 2007 had been the initial year of competitive bidding. However, the actual impact of
the initial year of competitive bidding on our total net revenue will likely be different given
the March 2008 announcement by CMS that the average, weighted level of cuts will be 26%. We now
estimate, without giving effect to the possibility that we may elect to acquire one or more
winning bidders in CBAs where Apria was not the successful bidder, that the competitive bidding
reductions will result in a decline of approximately 0.4% in our 2008 total net revenue from the
level we would have expected if competitive bidding had not been in effect.
    
    In the second and subsequent years of competitive bidding, we expect that the adverse
financial impact will increase substantially in amounts that cannot currently be determined.
If we are selected as a winning contract supplier in any CBA during any of the subsequent
competitive bidding periods, we believe that our geographic coverage, clinical marketing
programs and purchasing strength provide competitive advantages to maintain and enhance market
share, but at lower reimbursement rates. However, there is no guarantee that we will be
selected as a winning contract supplier and be awarded a competitive bidding contract by CMS
in any of the second round CBAs or subsequent rounds of bidding in the first ten markets. If
we are not selected as a contract supplier for a particular CBA, we will generally not be
allowed to supply Medicare beneficiaries with products subject to competitive bidding within
that CBA for the contract period, unless we elect to continue providing service to existing
patients under the grandfathering provision of the final rule or acquire a winning bidder.
Under the grandfathering provision, a supplier may continue to supply certain existing
patients that were serviced prior to the implementation of competitive bidding even if the
supplier was not awarded a contract, provided certain conditions are met. Because of our
combination of both managed care and traditional business, we believe we can nevertheless
maintain a favorable overall market position even if we are not selected as a contract
supplier for a particular CBA.
    
    Incentives for the expansion of Medicare Part C (Medicare Advantage)  The MMA included
financial incentives for managed care plans to expand their provision of Medicare Advantage
plans in 2006 in an effort to attract more Medicare beneficiaries to managed care models. We
maintain contracts to provide home respiratory therapy, home infusion therapy services, home
medical equipment and related services to a significant number of managed care companies who
maintain Medicare Advantage plans nationwide.
    
    Reimbursement for home infusion therapy under Medicare Part D  A limited number of
infusion therapies, supplies and equipment are covered by Medicare Part B. The MMA, through
the new Medicare Part D program, provided expanded coverage for certain home infusion therapy
drugs, but excluded coverage for the corresponding supplies and clinical services needed to
safely and effectively administer these drugs. We have contracted with a limited number of
Medicare Part D prescription drug plans in order to provide continuity of care for certain
patients. Due to nationwide Part D implementation issues experienced by home infusion
providers, the industry is continuing to work with CMS and Congress to rectify the coverage
and payment limitations that are causing implementation challenges for providers, patients and
referral sources. A bill was introduced in Congress in the summer of 2006 to consolidate home
infusion therapy coverage under Part B, and a similar bill was reintroduced in 2007. This
legislation would provide for infusion benefit coverage in a more comprehensive manner that is
analogous to how the therapy is covered by the managed care sector. Industry representatives
continue to present the cost-saving advantages of home infusion therapy to members of Congress
and the Administration. At this time, we cannot assess whether any of the proposed
legislation, or similar legislation that may be introduced in 2008 or 2009, will become law in
2008 or subsequent years.
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
    
    Beginning with patients who received DMEPOS products and services as of January 2006,
ownership of durable medical equipment currently categorized in the capped rental category by
CMS, such as hospital beds, wheelchairs, nebulizers, patient lifts and continuous positive
airway pressure devices, automatically transfers to the Medicare beneficiary at the end of a
maximum rental period. As of January 1, 2006, the maximum rental period became 13 months.
Therefore the first month in which the new policy had an impact on our revenue was February
2007. In addition, the service and maintenance fee, which had been paid to suppliers twice
yearly after the rental period ended in order to cover various non-equipment service costs for
patients who require use of the equipment, was eliminated for those patients who commenced
service on or after January 1, 2006. Implementing regulations also imposed other repair and
replacement obligations on suppliers with respect to equipment that does not last the useful
lifetime of the equipment, which CMS has generally defined as being five years. We estimate
that the reduction in rental revenues for impacted DME products and the loss of the service
and maintenance fees in 2007 was approximately $4.0 million and
$0.9 million, respectively. The
2007 estimate assumes the loss of the service and maintenance fee component for one quarter as
the effect of the loss primarily impacted the latter part of the year.
    
    Reimbursement for oxygen equipment converted from an ongoing rental method to a capped
rental and rent-to-purchase method. Reimbursement for rental of oxygen equipment is limited to
36 months, after which time the ownership of the equipment transfers to the patient, who
assumes primary responsibility for identifying when repairs or preventive maintenance are
needed. The 36-month rental period was retroactively applied to January 1, 2006 for all
beneficiaries requiring oxygen as of December 31, 2005. Accordingly, January 2009 is the first
month in which the transfer of ownership for oxygen equipment and the new repair and
maintenance policy will impact us. The implementing DRA regulations also established new
payment classes for oxygen equipment, including transfilling and portable equipment, new
monthly rental reimbursement rates, and new reimbursement rates for the delivery of oxygen
contents for patient-owned equipment after title to the equipment transfers. The new
reimbursement amounts went into effect January 1, 2007. CMS will annually review the
utilization patterns and fee schedule rates and consider whether an adjustment to the payment
rates is needed in order to satisfy the statutory mandate of budget neutrality.
    
    Regarding repairs and maintenance of beneficiary-owned oxygen equipment, the implementing
DRA regulations permit payment to suppliers for general maintenance and servicing of certain
patient-owned oxygen equipment every six months, beginning after the first six months the
patient owns the equipment. The first beneficiaries to whom this policy will apply will take
title to their equipment in January 2009 and become eligible for maintenance and servicing
under this policy beginning in June 2009. The final rule governing repairs and maintenance of
oxygen equipment limits payment for general maintenance and servicing visits to 30 minutes of
labor based on rates the Medicare contractors establish. CMS declined to offer general
maintenance and servicing payments for beneficiary-owned liquid and gas equipment with the
exception of a single payment for pick-up and storage or disposal of such equipment that a
beneficiary no longer needs. Once title to the oxygen equipment transfers, CMS will also pay
for certain other reasonable and necessary but non-routine repairs which remain as yet
unspecified by the agency, but CMS will not make separate payment for certain patient support
services, which are currently covered by and included in the monthly bundled payment rate for
oxygen therapy. We may or may not continue to provide repair and maintenance service on
patient-owned equipment and are in the process of evaluating the impact of these changes.
    
    The implementing regulations also limit supplier replacement of oxygen equipment during the
rental period, and require suppliers to replace beneficiary-owned equipment that does not last
the useful lifetime of the equipment, which CMS has generally defined as being five years.
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
    
    In January 2006, CMS published a final regulation that shifted payment for certain
respiratory assist devices from the current frequent and substantial payment category to the
capped rental category. Under frequent and substantial payment, Medicare payment continues
for the duration of time the beneficiary requires the device, while capped rental payment
continues for 13 months. The change in the payment category became effective April 1, 2006.
The policy applies to those respiratory assist devices that have a backup rate feature that
delivers pressure whenever the users spontaneous breathing efforts are insufficient. The first
claims received for each Medicare beneficiary with a date of service on or after April 1, 2006,
including beneficiaries with existing rental equipment, are counted as the first rental month in
the capped rental period. Thus, the first month in which the new categorization impacted our
revenue was May 2007. Our estimate for this change in payment categories was a reduction in 2007
revenues of approximately $2.5 million.
 
    
    In January 2006, CMS announced the designation of four specialty contractors, Durable
Medical Equipment Medicare Administrative Contractors (DME MACs), which are responsible for
handling the administration of all Medicare claims from suppliers of durable medical
equipment. CIGNA Government Services, LLC, protested the contract awards made in Regions C and
D. The Government Accountability Office denied CIGNAs protest for Region D but CMS ultimately
authorized CIGNA for Region C on January 16, 2007. The following DME MACs are currently
processing claims: National Heritage Insurance Company, for Region A (effective July 1, 2006),
AdminaStar Federal for Region B (effective July 1, 2006), CIGNA for Region C (effective
January 16, 2007), and Noridian Administrative Services for Region D (effective September 30,
2006). The transition caused several challenges for all DME suppliers, such as a slight
slowdown in payments from the governments new DME MACs and an increase in certain denials due
to a lack of training resources at the new DME MACs. Industry representatives met with the DME
MACs and largely resolved transaction processing challenges. It is difficult at this time to
predict whether other changes in claims administration made by the DME MACs may affect DME
suppliers in the future, nor can we predict or estimate the potential impact of such changes
on collection of our accounts receivable.
 
    
    In 2007, there were numerous legislative and executive branch efforts to further reduce the
maximum rental period for oxygen therapy, equipment and related services. The industry has
actively shared its concerns with Congress, CMS, and others on these issues. Legislative
proposals were introduced in Congress in 2007 that would have repealed the current oxygen
reimbursement cap and equipment ownership mandate of the DRA, as well as amended or modified
existing laws and regulations pertaining to the competitive bidding program and coverage of
infusion therapy services. The Presidents 2007, 2008 and 2009 healthcare budget proposals
sought to reduce the maximum rental period for oxygen equipment from the now-mandated
36 months to 13 months, which was recommended by the OIG in a limited study of the oxygen
benefit published in 2006. There are other initiatives to reduce the rental period to
13 months or to implement a reduction to the monthly payment rate, but it is uncertain whether
any of these initiatives will ultimately be approved by Congress. For example, in
September 2006, the OIG-published report entitled Medicare Home Oxygen: Equipment Cost and
Servicing, which was the result of an audit survey conducted by the OIG beginning in the fall
of 2005. The surveys stated objective was to study the average acquisition cost of oxygen
concentrators and the nature and frequency of servicing of this single oxygen modality. The
final report included a recommendation that Congress consider further reductions to oxygen
payment levels, including the possibility of limiting the maximum rental period for oxygen
equipment from the DRA-mandated 36 months to 13 months. The industry has analyzed the report
and shared concerns about the narrow scope of the report and its findings with the OIG, CMS,
members of Congress and other government agencies. It is uncertain whether or when any of
these efforts will be repeated or successful in 2008.
  
    
    In October 2006, CMS issued the 2007 Healthcare Procedure Coding System list for Medicare
Part B medications. The 2007 list included new codes for certain compounded medications. The
coding and reimbursement changes did not have a material impact on us due to the extremely low
volume of patient-specific, physician-prescribed compounding that was performed by our
inhalation pharmacies. According to the state licensing agencies associated with the states in
which our inhalation pharmacies operate, the pharmacies conform to current quality and
sterility standards. CMS stated that patient safety and sterility issues were found at other
providers pharmacies, which motivated it to change the policies concerning compounded
medications.
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
    
    In response to the 2006 efforts of three Program Safeguard Contractors that oversee DME
suppliers, CMS considered issuing a National Coverage Decision for certain inhalation drug
therapies. In the third quarter of 2007, CMS concluded that it would not issue a National
Coverage Decision. Rather, CMS indicated that it
would continue to defer decisions about the medical necessity of individual respiratory drugs to
the local contractors. We cannot predict if or when CMS may reconsider this issue and how any
subsequent National Coverage Decisions might impact our operations. Future decisions with
respect to the coverage of inhalation drugs may have a materially adverse impact on us.
    
    In 2007, there also were changes to the reimbursement methodology for certain inhalation
drugs. CMS announced in the second quarter of 2007 that beginning in the third quarter of
2007, it would reimburse providers of inhalation drugs a blended average sales price for the
drugs albuterol and Xopenex
®.1 On December 29, 2007, the President signed into law the
Medicare, Medicaid, and State Childrens Health Insurance Program Extension Act of 2007, which
partially reversed the CMS regulatory decision regarding Xopenex and albuterol. Beginning on
April 1, 2008, Medicare began to reimburse for Xopenex in the same manner as in the third
quarter of 2007 by blending the average sales prices of Xopenex and albuterol, but it will no
longer reimburse for albuterol at the blended price.Subsequently, on April 10, 2008, the DME MACs issued a revision of the Nebulizer LCD which will
change the reimbursement methodology for certain inhalation drugs dispensed by Aprias
pharmacies in a way that will effectively eliminate coverage for those drugs. Unless changes are
made, the effective date of the revised coverage policy will be July 1, 2008. Both the
Department of Health & Human Services and Congress reportedly are reviewing this policy
implementation, but we cannot predict what, if any, changes, may be made to it.We estimate that these two changes to inhalation drug
reimbursement will result in a total incremental $12 million
decline in revenue for 2008. However, we have undertaken strategies
intended to partially mitigate this negative impact.
    
    In late 2006, CMS revised the Local Coverage Determination (LCD) for power mobility
devices resulting in reductions to the Medicare power mobility devices fee schedule. The
revised fee schedule imposes reductions for certain power mobility devices of about 15%. The
initial changes took effect November 15, 2006. The reduction in our revenues for 2007
resulting from these fee schedule changes was approximately $1 million. The industry is
continuing work with CMS to obtain clarification and modification of the LCD. The industry
also believes that Medicare beneficiary access to power mobility will be restricted by this
LCD and therefore has requested revisions to the fee schedule.
  
    
    On July 2, 2007, the Secretary of HHS announced a two-year effort designed to further
protect Medicare beneficiaries from fraudulent DME suppliers for certain DMEPOS. The
initiative is focused on preventing deceptive companies from operating in South Florida and
Southern California. Based on the results of the project, it could be expanded nationwide.
Subsequently, on July 27, 2007, CMS issued a proposed rule requiring all DMEPOS suppliers to
provide CMS with a surety bond of at least $65,000 for each National Provider Identifier, the
supplier holds. The rule would ensure that Medicare can recover any erroneous payment amounts
or civil money penalties up to $65,000 that result from fraudulent or abusive supplier billing
practices. There is a similar legislative proposal, introduced on February 7, 2008 in the
Senate, the provides increased civil and criminal penalties, as well as increasing the amount
of the surety bond requirement for DME suppliers to $500,000. In addition, in August 2007, CMS
announced that it would require infusion therapy providers in certain South Florida counties
to resubmit applications to be enrolled as qualified Medicare suppliers. We fully support the
elimination of fraudulent suppliers and are working with CMS to support these initiatives.
 
    
    On January 25, 2008, CMS proposed regulations expanding and strengthening enrollment
requirements that DME suppliers must meet to establish and maintain Medicare billing
privileges. These revisions would impose additional requirements in the areas of provider
insurance, marketing practices, document retention, facility location, and hours of operation.
We submitted comments to the proposal prior to the March 25, 2008 deadline. Although we have
not yet had sufficient time to fully evaluate the proposed revisions and their potential
impact
on our operations, an initial review suggests that there will be no material impact if the
proposal is finalized in its current form. It is uncertain whether any or all of these proposed
regulations will be finalized, however, and we cannot predict or estimate the impact of the
final changes, if any.
 
 1
    
    Xopenex is a registered trademark of Sepracor, Inc.  27




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##### Table of Contents




    
    Accreditation is becoming mandatory as a condition of enrollment and continuing
participation as a Medicare DME supplier, not just for those DME suppliers participating in
the competitive bidding program. We and all of our branches are accredited. DME suppliers
enrolling in Medicare for the first time between January 1, 2008 and February 28, 2008, must
obtain approved accreditation by January 1, 2009. DME suppliers enrolled in the Medicare
program prior to January 1, 2008, must obtain approved accreditation by September 30, 2009. If
we or any of our branches lose accreditation, or if any of our new branches are unable to
become accredited, that could have a material adverse effect on our results of operations,
cash flow and capital resources.
 
    
    On February 7, 2008, the Medicare Fraud Prevention Act of 2008 was introduced in the U.S.
Senate. The bill would increase financial penalties and prison sentences for certain civil and
criminal violations of the Social Security Act, including making false statements and
violating the federal anti-kickback statute. We cannot predict whether this Act, or some
revised form of it, will or will not become law.
  Medicaid Reimbursement.
 HIPAA.
 Anti-Kickback Statutes.
  28




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##### Table of Contents



Physician Self-Referrals.
  False Claims.
    29




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##### Table of Contents



Other Fraud and Abuse Laws.
  Healthcare Reform Legislation.
 Facility and Clinician Licensure.
 Results of Operations
 Net Revenues.
 
    
    the reduction in the equipment rental period from 15 to 13 months for certain respiratory
equipment such as Continuous Positive Air Pressure Units, Nebulizer Units, Hospital Beds and
Wheelchairs (regulation effective date of February 2007);
  30




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##### Table of Contents




    
    changing the maximum rental period on certain equipment such as bi-level airway pressure
devices from an unlimited rental period to 13 months (regulation effective date of May
2007); and
 
    
    transfer of equipment ownership from us to the patient at the end of the 13-month rental
period (regulation effective date of February 2007).
 Government Regulation .
  Three Months Ended March 31,Percentage(in thousands)
    
    2008
    
    
    2007
    
    
    Increase
    
    
    ChangeHome respiratory therapy
    
    $
    276,448
    
    
    $
    269,761
    
    
    $
    6,687
    
    
    
    2.5
    %Home infusion therapy
    
    
    200,518
    
    
    
    68,968
    
    
    
    131,550
    
    
    
    190.7Home medical equipment/other
    
    
    51,012
    
    
    
    52,050
    
    
    
    (1,038
    )
    
    
    (2.0
    )Total net revenues
    
    $
    527,978
    
    
    $
    390,779
    
    
    $
    137,199
    
    
    
    35.1
    %
 Home Respiratory Therapy .
 Home Infusion Therapy .
 Home Medical Equipment/Other .
 Gross Profit.
  31




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##### Table of Contents



Provision for Doubtful Accounts.
 Selling, Distribution and Administrative Expenses.
   Amortization of Intangible Assets.
 Interest Expense.
 Interest Income.
 Income Tax Expense.
   32




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##### Table of Contents



Liquidity and Capital Resources
     Three Months EndedMarch 31,(dollars in thousands)
    
    2008
    
    
    2007Reconciliation  Free Cash Flow:Net cash provided by operating activities
    
    $
    48,552
    
    
    $
    44,889Less: Purchases of patient service equipment and
property, equipment and improvements
    
    
    (41,480
    )
    
    
    (32,672
    )Free cash flow
    
    $
    7,072
    
    
    $
    12,217
 Cash Flow.
 Quarter Ended March 31,(in thousands)
    
    2008
    
    
    2007Net cash provided by operating activities
    
    $
    48,552
    
    
    $
    44,889Net cash used in investing activities
    
    
    (44,478
    )
    
    
    (32,646
    )Net cash used in financing activities
    
    
    (11,479
    )
    
    
    (10,357
    )Net (decrease) increase in cash and equivalents
    
    
    (7,405
    )
    
    
    1,886Cash and equivalents at beginning of period
    
    
    28,451
    
    
    
    14,657Cash and equivalents at end of period
    
    $
    21,046
    
    
    $
    16,543
  33




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##### Table of Contents



Three Months Ended March 31, 2008 and 2007
   
    
    $4.1 million increase in cash used in accounts receivable, to a $15.0 million use of cash
in the three months ended March 31, 2008 from a $10.9 million use of cash in the three
months ended March, 31 2007. This increase in use of cash was primarily due to a net
increase in accounts receivable primarily related to Coram.
 
    
    $3.1 million increase in cash used by the change in accrued payroll and related taxes and
benefits, to a $13.7 million use of cash in the three months ended March 31, 2008 from a
$10.6 million use of cash in the three months ended March 31, 2007. The increase was
primarily due to an additional accrual day in 2008, an increase in accrued vacation and the Coram acquisition.
 
    
    $10.6 million increase in cash used by accrued expenses to a $16.2 million use of cash in
the three months ended March 31, 2008 from a $5.6 million use of cash in the three months
ended March 31, 2007. The increase was primarily due to $4.5 million in accrued incentive
compensation and $5.2 million related to expenses from our Coram acquisition and a pay-down
of an installment purchase.
 
    
    $6.7 million increase in cash used by income taxes payable to a $2.0 million use of
cash in the three months ended March 31, 2008 from a $4.7 million provision of cash in the
three months ended March 31, 2007. The increase in cash used primarily relates to 2008
reductions in unrecognized tax benefits under FIN 48 and a lower amount of 2008 current tax
liabilities due to utilization of Corams tax net operating losses.
  
    
    $3.5 million increase in cash provided by prepaid expenses and other current assets to a
$4.4 million provision of cash in the three months ended March 31, 2008 from a $0.9 million
provision of cash in the three months ended March 31, 2007. The increase was primarily due
to decrease in the prepaid infusion therapy inventory balance of $6.1 million from the prior
year and a $2.9 million decrease in prepaid insurance, offset by a $6.5 million increase in
the balance of prepaid other, principally due to our Coram acquisition.
 
    
    $5.2 million increase in cash provided by accounts payable to a $7.0 million provision of
cash in the three months ended March 31, 2008 from a $1.8 million provision of cash in the
three months ended March 31, 2007. The increase was primarily due to an $10.4 million
increase in trade accounts payable offset by a $4.7 million change in book cash overdraft.
    34




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##### Table of Contents



Accounts Receivable.
  March 31,
    
    
    December 31,2008
    
    
    2007Medicare
    
    
    16.0
    %
    
    
    23.9
    %Medicaid
    
    
    21.1
    %
    
    
    23.2
    %Self pay
    
    
    40.7
    %
    
    
    40.7
    %Managed care/other
    
    
    18.9
    %
    
    
    19.3
    %Total
    
    
    19.0
    %
    
    
    21.1
    %
 Unbilled Receivables.
 Inventories and Patient Service Equipment.
  Long-term Debt.
 Convertible Senior Notes.
 Hedging Activities.
  35




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##### Table of Contents



Accounting for Derivative Instruments
and Hedging Activities.
 Treasury Stock.
 Business Combinations.
  Contractual Cash Obligations.
  Off-Balance Sheet Arrangements
  
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
     36




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##### Table of Contents



ITEM 4. CONTROLS AND PROCEDURES
 Disclosure Controls and Procedures.
 Changes in Internal Control Over Financial Reporting.
  37




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##### Table of Contents



PART II  OTHER INFORMATION
 
 ITEM 1. LEGAL PROCEEDINGS
  
 ITEM 1A. RISK FACTORS
  Medicare/Medicaid Reimbursement Rates  Continued reductions in Medicare and Medicaid
Reimbursement Rates could have a material adverse effect on our results of operations and financial
conditions.
 Medicare Reimbursement Reductions.
   38




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##### Table of Contents



Medicaid Reimbursement Reductions.
   
 ITEM 2. UNREGISTERED SALE OF EQUITY SECURITIES AND USE OF PROCEEDS
  
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES
  
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  
 ITEM 5. OTHER INFORMATION
   39




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##### Table of Contents



ITEM 6. EXHIBITS
 ExhibitNumber
    
    Reference3.1
    
    
    Apria Healthcare Group Inc. Bylaws, as amended and restated as of February 19, 2008. (a)10.30 #
    
    
    Form of Employee Time-Based Stock Appreciation Rights Award Agreement under the Registrants
2003 Performance Incentive Plan. (b)10.31 #
    
    
    Revised Form of Employee Performance-Based Restricted Stock Unit Award Agreement under the
Registrants 2003 Performance Incentive Plan. (b)10.32 #
    
    
    Registrants 2008 Executive Bonus Plan. (b)10.33 #
    
    
    Revised Form of Employee Time-Based Restricted Stock Unit Award Agreement under the
Registrants 2003 Performance Incentive Plan. (b)10.34 #
    
    
    Employment offer letter from Registrant to Daniel E. Greenleaf dated April 7, 2008*31.1
    
    
    Certification of Chief Executive Officer pursuant to Securities Exchange Act Rule 13a-14(a).*31.2
    
    
    Certification of Chief Financial Officer pursuant to Securities Exchange Act Rule 13a-14(a).*32.1
    
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350.*32.2
    
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350.*
 #
    
    Management contract or compensatory plan or arrangement.*
    
    Filed Herewith.(a)
    
    Incorporated by reference to Current Report on Form 8-K dated February 19, 2008, as filed on
February 26, 2008.(b)
    
    Incorporated by reference to Current Report on Form 8-K dated February 29, 2008, as filed on
March 6, 2008.  40




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##### Table of Contents



SIGNATURES
  APRIA HEALTHCARE GROUP INC.
Registrant/s/  CHRIS A. KARKENNYChris A. KarkennyExecutive Vice President and Chief
Financial Officer
(Principal Financial Officer)/s/  PETER A. REYNOLDSPeter A. ReynoldsChief Accounting Officer and Controller
(Principal Accounting Officer)   41




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##### Table of Contents



EXHIBIT INDEX
 ExhibitNumber
    
    Reference3.1
    
    
    Apria Healthcare Group Inc. Bylaws, as amended and restated as of February 19, 2008. (a)10.30 #
    
    
    Form of Employee Time-Based Stock Appreciation Rights Award Agreement under the Registrants
2003 Performance Incentive Plan. (b)10.31 #
    
    
    Revised Form of Employee Performance-Based Restricted Stock Unit Award Agreement under the
Registrants 2003 Performance Incentive Plan. (b)10.32 #
    
    
    Registrants 2008 Executive Bonus Plan. (b)10.33 #
    
    
    Revised Form of Employee Time-Based Restricted Stock Unit Award Agreement under the
Registrants 2003 Performance Incentive Plan. (b)10.34 #
    
    
    Employment offer letter from Registrant to Daniel E. Greenleaf dated April 7, 2008*31.1
    
    
    Certification of Chief Executive Officer pursuant to Securities Exchange Act Rule 13a-14(a).*31.2
    
    
    Certification of Chief Financial Officer pursuant to Securities Exchange Act Rule 13a-14(a).*32.1
    
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350.*32.2
    
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350.*
 #
    
    Management contract or compensatory plan or arrangement.*
    
    Filed Herewith.(a)
    
    Incorporated by reference to Current Report on Form 8-K dated February 19, 2008, as filed on
February 26, 2008.(b)
    
    Incorporated by reference to Current Report on Form 8-K dated February 29, 2008, as filed on
March 6, 2008.