Edgar Filing: LHC Group, Inc

LHC GROUP, INC.

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 June 30, 2006


o		Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from to

Commission file number:0-8082

LHC GROUP, INC.

(Exact Name of Registrant as Specified in Charter)


Delaware (State or Other Jurisdiction of Incorporation or Organization)		71-0918189 (I.R.S. Employer Identification No.)

420 West Pinhook Rd, Suite A
Lafayette, LA 70503
(Address of principal executive offices including zip code)

(337) 233-1307
(Registrant’s telephone number, including area code)

Indicate by check mark whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):


Large accelerated filero		Accelerated Filer o		Non-accelerated filer þ

Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act). Yeso Noþ

Number of shares of common stock, par value $0.01, outstanding as of August 10, 2006: 17,815,775 shares

LHC GROUP, INC.

INDEX


		Page
Part I. Financial Information

Item 1. Financial Statements (unaudited)		1

Condensed Consolidated Balance Sheets — June 30, 2006 (unaudited) and December 31, 2005		1

Condensed Consolidated Statements of Income (unaudited) — Three and Six months ended June 30, 2006 and 2005		2

Condensed Consolidated Statements of Cash Flows (unaudited) — Six months ended June 30, 2006 and 2005		3

Notes to Condensed Consolidated Financial Statements (unaudited)		4

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		20

Item 3. Quantitative and Qualitative Disclosure of Market Risk		35

Item 4. Controls and Procedures		36

Part II. Other Information		36

Item 1. Legal Proceedings		37

Item 1A. Risk Factors		37

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		47

Item 3. Defaults Upon Senior Securities		48

Item 4. Submission of Matters to a Vote of Security Holders		48

Item 5. Other Information		48

Item 6. Exhibits		48

Signatures		50
EX-31.1 SECTION 302 CERTIFICATION OF CEO
EX-31.2 SECTION 302 CERTIFICATION OF CFO
EX-32.1 SECTION 906 CERTIFICATION OF CEO
EX-32.2 SECTION 906 CERTIFICATION OF CFO

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PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

LHC GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS


	June 30,			December 31,
	2006			2005
	(unaudited)
	(in thousands, except share data)
ASSETS
Current assets:
Cash	$	19,109		$	17,398
Receivables:
Patient accounts receivable, less allowance for uncollectible accounts of $3,328, and $2,544 at June 30, 2006 and December 31, 2005, respectively		43,442			34,810
Other receivables		2,542			3,365
Employee receivables		35			1,888
Amounts due from governmental entities		4,066			4,519

		50,085			44,582
Deferred income taxes		998			152
Income taxes recoverable		—			869
Prepaid expenses and other current assets		3,574			3,714
Assets held for sale		935			—

Total current assets		74,701			66,715
Property, building, and equipment, net		11,110			10,224
Goodwill		29,400			26,103
Other assets		2,584			1,576

Total assets	$	117,795		$	104,618


LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
Accounts payable and other accrued liabilities	$	4,527		$	6,474
Salaries, wages, and benefits payable		7,273			6,124
Amounts due to governmental entities		3,937			3,080
Amounts payable under cooperative endeavor agreements		46			37
Income taxes payable		3,705			—
Current portion of capital lease obligations		326			400
Current portion of long-term debt		425			1,406

Total current liabilities		20,239			17,521
Deferred income taxes, less current portion		2,040			1,573
Capital lease obligations, less current portion		190			347
Long-term debt, less current portion		3,190			3,274
Minority interests subject to exchange contracts and/or put options		472			1,511
Other minority interests		3,371			1,948
Stockholders’ equity:
Common stock — $0.01 par value: 40,000,000 shares authorized; 19,507,887 shares issued and 16,557,828 shares outstanding at June 30, 2006 and December 31, 2005, respectively		166			166
Treasury stock — 2,950,059 shares at cost		(2,856	)		(2,856	)
Additional paid-in capital		59,039			58,596
Retained earnings		31,944			22,538

Total stockholders’ equity		88,293			78,444

Total liabilities and stockholders’ equity	$	117,795		$	104,618

See accompanying notes.

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LHC GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME


	Three Months Ended June 30,						Six Months Ended June 30,
	2006			2005			2006			2005
	(unaudited)
	(in thousands, except share and per share data)
Net service revenue	$	49,557		$	36,024		$	94,961		$	71,425
Cost of service revenue		25,014			18,711			48,999			36,282

Gross margin		24,543			17,313			45,962			35,143
General and administrative expenses		16,805			10,547			31,678			20,415
Equity-based compensation expense⁽¹⁾		—			3,352			—			3,856

Operating income		7,738			3,414			14,284			10,872
Interest expense		60			426			146			758
Non-operating income, including (gain) or loss on sales of assets		(116	)		(22	)		(280	)		(565	)

Income from continuing operations before income taxes and minority interest and cooperative endeavor allocations		7,794			3,010			14,418			10,679
Income tax expense		2,451			364			4,205			2,744
Minority interest and cooperative endeavor allocations		1,070			1,192			2,099			2,632

Income from continuing operations		4,273			1,454			8,114			5,303
Loss from discontinued operations (net of income taxes of $37 and $347 in the three months ended June 30, 2006 and 2005, respectively and $219 and $691 in the six months ended June 30, 2006 and 2005, respectively)		(60	)		(567	)		(360	)		(1,129	)
Gain on sale of discontinued operations (net of income taxes of $27 and $390 for the three and six months ended June 30, 2006 respectively)		43			—			637			—

Net income		4,256			887			8,391			4,174
Redeemable minority interests		172			(1,487	)		1,015			(1,487	)

Net income (loss) available to common stockholders	$	4,428		$	(600	)	$	9,406		$	2,687


Earnings per share — basic:
Income from continuing operations	$	0.26		$	0.11		$	0.49		$	0.42
Loss from discontinued operations, net		—			(0.04	)		(0.02	)		(0.09	)
Gain on sale of discontinued operations, net		—			—			0.04			—

Net income		0.26			0.07			0.51			0.33
Redeemable minority interests		0.01			(0.11	)		0.06			(0.12	)

Net income (loss) available to common shareholders	$	0.27		$	(0.04	)	$	0.57		$	0.21


Earnings per share — diluted:
Income from continuing operations	$	0.26		$	0.11		$	0.49		$	0.42
Loss from discontinued operations, net		—			(0.04	)		(0.02	)		(0.09	)
Gain on sale of discontinued operations, net		—			—			0.04			—

Net income		0.26			0.07			0.51			0.33
Redeemable minority interests		0.01			(0.11	)		0.06			(0.12	)

Net income (loss) available to common shareholders	$	0.27		$	(0.04	)	$	0.57		$	0.21


Weighted average shares outstanding:
Basic		16,561,398			13,174,690			16,559,623			12,632,932
Diluted		16,576,068			13,277,039			16,569,727			12,741,401


⁽¹⁾		Equity-based compensation related to the KEEP units is allocated as follows, and does not include stock-based compensation related to FAS 123(R):


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	(unaudited)
	(in thousands)
	2006		2005		2006		2005
Cost of service revenue	$	—	$	546	$	—	$	565
General and administrative expenses		—		2,806		—		3,291

Total equity-based compensation expense	$	—	$	3,352	$	—	$	3,856

See accompanying notes.

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LHC GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


	Six Months Ended
	June 30,
	2006			2005
	(unaudited)
	(in thousands)
Operating activities
Net income	$	8,391		$	4,174
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation expense		1,135			775
Provision for bad debts		2,044			1,132
Equity-based compensation expense		—			3,856
Compensation expense		350			98
Minority interest in earnings of subsidiaries		2,099			2,656

Deferred income taxes		(379	)		511
Gain on divestitures and sale of assets		(637	)		(510	)
Changes in operating assets and liabilities, net of acquisitions:
Receivables		(6,007	)		(18,638	)
Prepaid expenses, other assets		(329	)		(1,339	)
Accounts payable and accrued expenses		4,100			(1,382	)
Net amounts due under cooperative endeavor agreements		9			207
Net amounts due governmental entities		1,310			1,526

Net cash provided by (used in) operating activities		12,086			(6,934	)
Investing activities
Purchases of property, building, and equipment		(2,014	)		(1,462	)
Proceeds from sale of entities		1,440			873
Cash paid for acquisitions, primarily goodwill		(6,219	)		(386	)

Net cash used in investing activities		(6,793	)		(975	)
Financing activities
Issuance of common stock, net of underwriting discounts of $3,430		—			45,570
Dividends paid		—			(227	)
Principal payments on debt		(1,065	)		(1,468	)
Payments on capital leases		(231	)		(343	)
Proceeds from issuance of debt		—			483
Net payments from lines of credit and revolving debt arrangements		—			(14,288	)
Proceeds from exercise of options		33			—
Offering costs incurred		—			(1,704	)
Minority interest distributions, net		(2,319	)		(2,714	)


Net cash provided by (used in) financing activities		(3,582	)		25,309

Change in cash		1,711			17,400
Cash at beginning of period		17,398			2,911

Cash at end of period	$	19,109		$	20,311

Supplemental disclosures of cash flow information
Interest paid	$	162		$	700

Income taxes paid	$	120		$	5,821

Supplemental disclosure of non-cash transactions:

The Company sold a clinic for promissory notes totaling $946,000 and recognized a loss on the sale of $28,000.

See accompanying notes.

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LHC GROUP, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. Organization

LHC Group, Inc. (the “Company”) is a healthcare provider specializing in the post-acute continuum of care primarily for Medicare beneficiaries in rural markets in the southern United States. The Company provides home-based services, primarily through home nursing agencies and hospices, and facility-based services, primarily through long-term acute care hospitals and outpatient rehabilitation clinics. The Company, through its wholly and majority-owned subsidiaries, equity joint ventures, and controlled affiliates, currently operates in Louisiana, Mississippi, Arkansas, Alabama, West Virginia and Texas.

The Company operated as Louisiana Health Care Group, Inc. (“LHCG”), until March 2001, when the shareholders of LHCG transferred to The Health Care Group, Inc. (“THCG”), all of the issued and outstanding shares of common stock of LHCG in exchange for shares in THCG. On January 1, 2003, the Company began operating as LHC Group, LLC, a Louisiana limited liability company. The THCG shareholders exchanged their shares for membership interests in the Company (“units”).

Prior to February 9, 2005, the Company operated under the terms of an operating agreement which provided that the Company did not have a finite life and that the members’ personal liability was limited to his or her capital contribution. There was only one class of member interest.

Plan of Merger and Recapitalization

In January 2005, LHC Group, LLC established a wholly-owned Delaware subsidiary, LHC Group, Inc. Effective February 9, 2005, LHC Group, LLC merged with and into LHC Group, Inc. In connection with the merger, each outstanding membership unit in LHC Group, LLC was converted into shares of the $0.01 par value common stock of LHC Group, Inc. based on an exchange ratio of three-for-two. LHC Group, Inc. has 40,000,000 shares of $0.01 par value common stock authorized and 5,000,000 shares of $0.01 par value preferred stock authorized. All references to common stock, share, and per share amounts have been retroactively restated to reflect the merger and recapitalization as if the merger and recapitalization had taken place as of the beginning of the earliest period presented.

As used herein, the “Company” includes LHC Group, Inc. and all predecessor entities.

Initial Public Offering

On June 9, 2005, the Company began its initial public offering of 4,800,000 shares of its common stock at a price of $14.00 per share. The Company offered 3,500,000 shares along with 1,300,000 shares that were sold by certain stockholders of LHC Group. The Company received no proceeds from the sale of the shares by the selling stockholders. The shares began trading on the NASDAQ National Market under the symbol “LHCG” on June 9, 2005. The initial public offering was completed on June 14, 2005. The underwriters exercised an option to purchase an additional 720,000 shares from certain stockholders solely to cover over-allotments. The Company received $45,570,000, net of underwriting discounts of $3,430,000 in proceeds from the offering. The Company incurred $3,963,000 in costs related to the initial public offering.

Unaudited Interim Financial Information

The condensed consolidated balance sheet as of June 30, 2006 and the related condensed consolidated statements of income and cash flows for the three and six months ended June 30, 2006 and 2005 and related notes (interim financial information) have been prepared by LHC Group, Inc. and are unaudited. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation in accordance with accounting principles generally accepted in the United States have been included. Operating results for the three and

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six months ended June 30, 2006 are not necessarily indicative of the results that may be expected for the year ended December 31, 2006.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted from the interim financial information presented. These consolidated financial statements should be read in conjunction with the notes to the consolidated financial statements included in the Company’s Consolidated Financial Statements our annual report on Form 10-K for the year ended December 31, 2005, which includes information and disclosures not included herein, as filed with the Securities and Exchange Commission in the Form 10-K.

2. Significant Accounting Policies

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported revenue and expenses during the reported period. Actual results could differ from those estimates.

Critical Accounting Policies

The most critical accounting policies relate to the principles of consolidation, revenue recognition, accounts receivable and allowances for uncollectible accounts, and accounting for goodwill.

Principles of Consolidation

The consolidated financial statements include all subsidiaries and entities controlled by the Company. Control is generally defined by the Company as ownership of a majority of the voting interest of an entity. The consolidated financial statements include entities in which the Company absorbs a majority of the entity’s expected losses, receives a majority of the entity’s expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity.

All significant inter-company accounts and transactions have been eliminated in consolidation. Business combinations accounted for as purchases have been included in the consolidated financial statements from the respective dates of acquisition.

The following describes the Company’s consolidation policy with respect to its various ventures excluding wholly owned subsidiaries:

Equity Joint Ventures

The Company’s joint ventures are structured as limited liability companies in which the Company typically owns a majority equity interest ranging from 51% to 98%. Each member of all but one of the Company’s equity joint ventures participates in profits and losses in proportion to their equity interests. The Company has one joint venture partner whose participation in losses is limited. The Company consolidates these entities as the Company absorbs a majority of the entities’ expected losses, receives a majority of the entities’ expected residual returns and generally has voting control.

Cooperative Endeavors

The Company has arrangements with certain partners that involve the sharing of profits and losses. Unlike the equity joint ventures, the Company owns 100% of the equity in these cooperative endeavors. In these cooperative endeavors, the Company possesses interests in the net profits and losses ranging from 67% to 70%. The Company has one cooperative endeavor partner whose participation in losses is limited. The Company consolidates these

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entities as the Company owns 100% of the outstanding equity and the Company absorbs a majority of the entities’ expected losses and receives a majority of the entities expected residual returns.

License Leasing Arrangements

The Company, through wholly owned subsidiaries, leases home health licenses necessary to operate certain of its home nursing agencies. As with wholly owned subsidiaries, the Company owns 100% of the equity of these entities and consolidates them based on such ownership as well as the Company’s right to receive a majority of the entities’ expected residual returns and the Company’s obligation to absorb a majority of the entities’ expected losses.

Management Services

The Company has various management services agreements under which the Company manages certain operations of agencies and facilities. The Company does not consolidate these agencies or facilities, as the Company does not have an ownership interest and does not have a right to receive a majority of the agencies’ or facilities’ expected residual returns or an obligation to absorb a majority of the agencies’ or facilities’ expected losses.

The following table summarizes the percentage of net service revenue earned by type of ownership or relationship the Company had with the operating entity:


	Three Months						Six Months
	Ended June 30,						Ended June 30,
	2006			2005			2006			2005
Wholly owned subsidiaries		35.4	%		22.7	%		35.9	%		26.0	%
Equity joint ventures		49.3			59.6			49.1			56.1
Cooperative endeavors		1.6			2.6			1.7			2.8
License leasing arrangements		11.4			11.6			11.4			11.7
Management services		2.3			3.5			1.9			3.4

		100.0	%		100.0	%		100.0	%		100.0	%

Revenue Recognition

The Company reports net service revenue at the estimated net realizable amount due from Medicare, Medicaid, commercial insurance, managed care payors, patients, and others for services rendered. Under Medicare, the Company’s home nursing patients are classified into a group referred to as a home health resource group prior to the receipt of services. Based on this home health resource group, the Company is entitled to receive a prospective Medicare payment for delivering care over a 60 day period referred to as an episode. Medicare adjusts these prospective payments based on a variety of factors, such as low utilization, patient transfers, changes in condition and the level of services provided. In calculating the Company’s reported net service revenue from home nursing services, the Company adjusts the prospective Medicare payments by an estimate of the adjustments. The Company calculates the adjustments based on a historical average of these types of adjustments. For home nursing services, the Company recognizes revenue based on the number of days elapsed during the episode of care.

Under Medicare, patients in the Company’s long-term acute care facilities are classified into long-term diagnosis-related groups. Based on this classification, the Company is then entitled to receive a fixed payment from Medicare. This fixed payment is also subject to adjustment by Medicare due to factors such as short stays. In calculating reported net service revenue for services provided in the Company’s long-term acute care hospitals, the Company reduces the prospective payment amounts by an estimate of the adjustments. The Company calculates the adjustment based on a historical average of these types of adjustments for claims paid. For the Company’s long-term acute care hospitals, revenue is recognized as services are provided.

For hospice services, the Company is paid by Medicare under a per diem payment system. The Company receives one of four predetermined daily or hourly rates based upon the level of care the Company furnished. The Company records net service revenue from hospice services based on the daily or hourly rate. The Company recognizes revenue for hospice as services are provided.

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Under Medicare, the Company is reimbursed for rehabilitation services based on a fee schedule for services provided adjusted by the geographical area in which the facility is located. The Company recognizes revenue as these services are provided.

The Company’s Medicaid reimbursement is based on a predetermined fee schedule applied to each service provided. Therefore, revenue is recognized for Medicaid services as services are provided based on this fee schedule. The Company’s managed care payors reimburse the Company in a manner similar to either Medicare or Medicaid. Accordingly, the Company recognizes revenue from managed care payors in the same manner as the Company recognizes revenue from Medicare or Medicaid.

The Company records management services revenue as services are provided in accordance with the various management services agreements to which the Company is a party. The agreements generally call for the Company to provide billing, management, and other consulting services suited to and designed for the efficient operation of the applicable home nursing agency, hospice, or inpatient rehabilitation facility. The Company is responsible for the costs associated with the locations and personnel required for the provision of the services. The Company is generally compensated based on a percentage of net billings or an established base fee. In addition, for certain of the management agreements, the Company may earn incentive compensation.

Net service revenue was comprised of the following:


	Three Months						Six Months
	Ended June 30,						Ended June 30,
	2006			2005			2006			2005
Home-based services		73.9	%		68.8	%		72.8	%		69.4	%
Facility-based services		26.1			31.2			27.2			30.6

		100.0	%		100.0	%		100.0	%		100.0	%

The following table sets forth the percentage of net service revenue earned by category of payor:


	Three Months						Six Months
	Ended June 30,						Ended June 30,
	2006			2005			2006			2005
Payor:
Medicare		84.7	%		88.0	%		84.8	%		86.3	%
Medicaid		4.3			4.7			4.8			4.5
Other		11.0			7.3			10.4			9.2

		100.0	%		100.0	%		100.0	%		100.0	%

Home-Based Services

Home Nursing Services. The Company receives a standard prospective Medicare payment for delivering care. The base payment, established through federal legislation, is a flat rate that is adjusted upward or downward based upon differences in the expected resource needs of individual patients as indicated by clinical severity, functional severity, and service utilization. The magnitude of the adjustment is determined by each patient’s categorization into one of 80 payment groups, known as home health resource groups, and the costliness of care for patients in each group relative to the average patient. The Company’s payment is also adjusted for differences in local prices using the hospital wage index. The Company performs payment variance analyses to verify the models utilized in projecting total net service revenue are accurately reflecting the payments to be received.

Medicare rates are subject to change. Due to the length of the Company’s episodes of care, a situation may arise where Medicare rate changes affect a prior period’s net service revenue. In the event that Medicare rates experience change, the net effect of that change will be reflected in the current reporting period.

Final payments from Medicare may reflect one of five retroactive adjustments to ensure the adequacy and effectiveness of the total reimbursement: (a) an outlier payment if the patient’s care was unusually costly; (b) a low utilization adjustment if the number of visits was fewer than five; (c) a partial payment if the patient transferred to another provider before completing the episode; (d) a change-in-condition adjustment if the patient’s medical status changes significantly, resulting in the need for more or less care; or (e) a payment adjustment based upon the level

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of therapy services required in the population base. Management estimates the impact of these payment adjustments based on historical experience and records this estimate during the period the services are rendered.

Hospice Services. The Company’s Medicare hospice reimbursement is based on an annually-updated prospective payment system. Hospice payments are also subject to two caps. One cap relates to individual programs receiving more than 20% of its total Medicare reimbursement from inpatient care services. The second cap relates to individual programs receiving reimbursements in excess of a “cap amount,” calculated by multiplying the number of beneficiaries during the period by a statutory amount that is indexed for inflation. The determination for each cap is made annually based on the 12-month period ending on October 31 of each year. This limit is computed on a program-by-program basis. None of the Company’s hospices exceeded either cap during the six months ended June 30, 2006 or 2005.

Facility-Based Services

Long-Term Acute Care Services. The Company is reimbursed by Medicare for services provided under the long-term acute care hospital prospective payment system, which was implemented on October 1, 2002. Each patient is assigned a long-term care diagnosis-related group. The Company is paid a predetermined fixed amount applicable to that particular group. This payment is intended to reflect the average cost of treating a Medicare patient classified in that particular long-term care diagnosis-related group. For selected patients, the amount may be further adjusted based on length of stay and facility-specific costs, as well as in instances where a patient is discharged and subsequently readmitted, among other factors. Similar to other Medicare prospective payment systems, the rate is also adjusted for geographic wage differences.

Outpatient Rehabilitation Services. Outpatient therapy services are reimbursed on a fee schedule, subject to annual limitations. Outpatient therapy providers receive a fixed fee for each procedure performed, adjusted by the geographical area in which the facility is located. The Company recognizes revenue as the services are provided. There are also annual per Medicare beneficiary caps that limit Medicare coverage for outpatient rehabilitation services.

Accounts Receivable and Allowances for Uncollectible Accounts

The Company reports accounts receivable net of estimated allowances for uncollectible accounts and adjustments. Accounts receivable are uncollateralized and primarily consist of amounts due from third-party payors and patients. To provide for accounts receivable that could become uncollectible in the future, the Company establishes an allowance for uncollectible accounts to reduce the carrying amount of such receivables to their estimated net realizable value. The credit risk for other concentrations of receivables is limited due to the significance of Medicare as the primary payor. The Company does not believe that there are any other significant concentrations of receivables from any particular payor that would subject it to any significant credit risk in the collection of accounts receivable.

The amount of the provision for bad debts is based upon the Company’s assessment of historical and expected net collections, business and economic conditions, and trends in government reimbursement. Uncollectible accounts are written off when the Company has determined the account will not be collected.

A portion of the estimated Medicare prospective payment system reimbursement from each submitted home nursing episode is received in the form of a request for accelerated payment before all services are rendered. The estimated episodic payment is billed at the commencement of the episode. The Company requests an accelerated payment for 60% of the estimated reimbursement at the initial billing for the initial episode of care per patient and the remaining reimbursement is requested upon completion of the episode. For any subsequent episodes of care contiguous with the first episode of care for the patient, the Company requests an accelerated payment for 50% of the estimated reimbursement at initial billing. The remaining 50% reimbursement is requested upon completion of the episode. The Company has earned net service revenue in excess of billings rendered to Medicare. Only a nominal portion of the amounts due to the Medicare program represent cash collected in advance of providing services.

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Goodwill

Goodwill and other intangible assets with indefinite lives are reviewed annually, or more frequently if circumstances indicate impairment may have occurred. Principally all of the Company’s intangible assets are goodwill.

The Company estimates the fair value of its identified reporting units and compares those estimates against the related carrying value. For each of the reporting units, the estimated fair value is determined based on a multiple of earnings before interest, taxes, depreciation, and amortization or on the estimated fair value of assets in situations when it is readily determinable.

The Company has concluded that licenses to operate home-based and/or facility-based services have indefinite lives, as management has determined that there are no legal, regulatory, contractual, economic or other factors that would limit the useful life of the licenses and the Company intends to renew and operate the licenses indefinitely. Accordingly, the Company has elected to recognize the fair value of these indefinite-lived licenses and goodwill as a single asset for financial reporting purposes.

Components of the Company’s home nursing operating segment are generally represented by individual subsidiaries or joint ventures with individual licenses to conduct specific operations within geographic markets as limited by the terms of each license. Components of the Company’s facility-based services are represented by individual operating entities. Effective January 1, 2004, management began aggregating the components of these two segments into two reporting units for purposes of evaluating impairment. Prior to January 1, 2004, management evaluated each operating entity separately for impairment. Modifications to the Company’s management of the segments and reporting provided management with a basis to change the reporting unit structure.

Other Significant Accounting Policies

Due to/from Governmental Entities

The Company records revenue related to their critical access hospital at the lower of cost or charges, limited by cost caps depending on the payor. Final reimbursement is determined based on submission of annual cost reports and audits by the fiscal intermediary. Adjustments are accrued on an estimated basis in the period the related services were rendered and further adjusted as final settlements are determined. These adjustments are accounted for as changes in estimates.

Also included in the due to/from governmental entities account are reimbursements that the Company is due from the government as well as payments that are expected to be recouped by the government from the Company related to outlier payments for two long term acute care hospitals.

Property, Building, and Equipment

Property, building, and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the individual assets, generally ranging from three to ten years and up to thirty-nine years on buildings. Depreciation expense for the three months ended June 30, 2006 and 2005 was $577,000 and $384,000, respectively and $1,135,000 and $775,000 for the six months ended June 30, 2006 and 2005, respectively.

Capital leases are included in equipment. Capital leases are recorded at the present value of the future rentals at lease inception and are amortized over the shorter of the applicable lease term or the useful life of the equipment. Amortization of assets under the capital lease obligations is included in depreciation and amortization expense.

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Long-Lived Assets

The Company reviews the recoverability of long-lived assets whenever events or circumstances occur which indicate recorded costs may not be recoverable. If the expected future cash flows (undiscounted) are less than the carrying amount of such assets, the Company recognizes an impairment loss for the difference between the carrying amount of the assets and their estimated fair value.

Income Taxes

The Company accounts for income taxes using the liability method. Under the liability method, deferred taxes are determined based on differences between the financial reporting and tax bases of assets and liabilities, and are measured using the enacted tax laws that will be in effect when the differences are expected to reverse. Management provides a valuation allowance for any net deferred tax assets when it is more likely than not that a portion of such net deferred tax assets will not be recovered.

Minority Interest and Cooperative Endeavor Agreements

The interest held by third parties in subsidiaries owned or controlled by the Company is reported on the consolidated balance sheets as minority interest. Minority interest reported in the consolidated statements of income reflects the respective interests in the income or loss of the subsidiaries attributable to the other parties, the effect of which is removed from the Company’s consolidated results of operations.

Two of the Company’s home health agencies have cooperative endeavor agreements with third parties that allow the third parties to be paid or recover a fee based on the profits or losses of the respective agencies. The Company accrues for the settlement of the third party’s profits or losses during the period the amounts are earned. Under the agreements, the Company has incurred net amounts due to the third parties of $55,000 and $95,000 for the three months ended June 30, 2006 and 2005, respectively and $120,000 and $231,000 for the six months ended June 30, 2006 and 2005, respectively. The cooperative endeavor agreements have terms expiring through at the end of June 2008.

For agreements where the third party is a healthcare institution, the agreements typically require the Company to lease building and equipment and receive housekeeping and maintenance from the healthcare institutions. Ancillary services related to these arrangements are also typically provided by the healthcare institution.

Minority Interest Subject to Exchange Contracts and/or Put Options

During 2004, in conjunction with the acquisition/sale of joint venture interests, the Company entered into agreements with minority interest holders in three of its majority owned subsidiaries that allowed these minority interest holders to put their minority interests to the Company in the event the Company is sold, merged or otherwise acquired or completes an initial public offering (“IPO”). These put options were deemed to be part of the underlying minority interest shares, thus rendering the shares to be puttable shares. In September and November of 2004, the Company entered into forward exchange contracts with the minority interest holders in two of these subsidiaries, Acadian Home Health Care Services, LLC (“Acadian”) and Hebert, Thibodeaux, Albro and Touchet Therapy Group, Inc. (“Hebert”) which required the minority interest holders in these subsidiaries to sell their interests to the Company in the event of an IPO. In conjunction with the Company’s IPO, the forward exchange contracts were consummated and the minority interest holders of Acadian and Hebert sold their minority interests to the Company in exchange for cash and shares of the Company’s common stock. The Company had accrued the cash payment of approximately $2.2 million to be paid under these forward exchange contracts. This amount was paid in full in 2005.

In the third majority-owned subsidiary, St. Landry Extended Care Hospital, LLC (“St. Landry”), the put option allows the minority interest holders to convert their minority interests into shares of the Company based upon St. Landry’s EBITDA for the prior fiscal year in relation to the Company’s EBITDA over the same period. The put option became exercisable by the minority interest holders in St. Landry upon the completion of the IPO. However, due to applicable laws and regulations, the minority interest holders can not convert their minority interests in St. Landry unless certain conditions are met including, but not limited to, the Company having stockholders’ equity in excess of $75 million at the end of its most recent fiscal year or on average during the previous three fiscal years. If the St. Landry minority interest holders do not or are unable to convert their minority interests into shares of the Company, the minority interest holders shall have the option to redeem their minority interests at any time following

- 10 -

thirty days after the IPO for cash consideration equal to the value of the shares the minority interest holders would have received if they had converted their minority interests into shares of the Company multiplied by the average closing price of the Company’s shares for the thirty days preceding the date of the minority interest holders’ exercise of the redemption option. As of December 31, 2005 and June 30, 2006, the Company had exceeded $75 million in stockholders’ equity. As of June 30, 2006, approximately 59% of the doctors have converted their minority interests to cash.

The above put/redemption options and exchange agreements have been presented in the historical financial statements under the guidance in Accounting Series Release (ASR) No. 268 and Emerging Issues Task Force (EITF) Topic D-98, which generally require a public company’s stock subject to redemption requirements that are outside the control of the issuer to be excluded from the caption “stockholders’ equity” and presented separately in the issuer’s balance sheet. Under EITF Topic D-98, once it becomes probable that the minority interest would become redeemable, the minority interest should be adjusted to its current redemption amount. As noted above, the St. Landry put option allowed the minority interest holders in St. Landry to have their interests redeemed for cash upon the completion of the IPO and therefore the Company recorded an adjustment of approximately $1.5 million to minority interests subject to exchange contracts and/or put options and to retained earnings which represents the redemption value of St. Landry’s interests at June 30, 2005. In September 2005, certain minority interest holders redeemed their interests in St. Landry. This resulted in a cash payment of approximately $214,000. In connection with the partial redemption of certain minority interests in September 2005, we decreased our minority interests by approximately $149,000 and increased our retained earnings by the same amount. Simultaneously, we recorded goodwill of $214,000 to represent the value of the minority interests redeemed. Also at the end of the third quarter of 2005, we recorded a mark to market charge of $404,000.

In November 2005, the agreement was amended to allow minority interest holders to redeem their minority interests based on the St. Landry’s rolling twelve month EBITDA in relation to the Company’s EBITDA over the same period. At December 31, 2005, the Company recorded an additional mark-to-market benefit of $266,000 to mark the liability to redemption value at the end of the quarter.

In connection with the partial redemption of certain minority interest in the six months ended June 30, 2006, the Company decreased our minority interests by approximately $939,000 and increased our retained earnings by the same amount. Simultaneously, the Company recorded goodwill of $889,000 to represent the value of the minority interests redeemed. Also for the six months ended June 30, 2006, the Company recorded a mark-to-market benefit of $76,000.

Equity-Based Compensation Expense

During 2003, the Company began sponsoring a Key Employee Equity Participation Plan (“KEEP Plan”) whereby certain individuals are granted participation equity units (“KEEP Units”). The KEEP Plan was terminated in conjunction with the initial public offering when the outstanding units were converted to 481,680 shares of common stock. The KEEP Plan functioned as a stock appreciation rights plan whereby an individual was entitled to receive, on a per KEEP Unit basis, the increase in estimated fair value of the Company’s common stock from the date of grant until the date that the employee dies, retires, or is terminated for other than cause. Accordingly, the KEEP Units were subject to variable accounting until such time as the obligation to the employee was settled. The Company had a call right, under which it could purchase all or portion of the KEEP Units. The individuals receiving KEEP Units vested in those rights in a graded manner over a five-year period and, accordingly, the Company recorded compensation expense for the vested portion of the KEEP Units. The KEEP Units had no exercise price.

Compensation expense, and a corresponding increase in paid-in capital, was also recognized each period for any change in value associated with certain KEEP Units that were held by an officer of the Company.

In conjunction with the initial public offering, the outstanding KEEP Units were converted to common stock. In conjunction with this conversion, the Company incurred a charge to equity based compensation of approximately $3.0 million. The Company did not incur any expenses relating to the KEEP Units in 2006.

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Stock-based Compensation

On January 20, 2005, the 2005 Long-Term Incentive Plan was adopted by the Company’s board of directors. There are 1,000,000 shares available for issuance under this plan. The Plan went into effect at the close of the initial public offering. Also during 2005, stock options and restricted stock were granted to the independent members of our Board of Directors in accordance with the 2005 Director Compensation Plan. Both the shares and options were issued from the 1,000,000 shares reserved for issuance under the 2005 Long-Term Incentive Plan.

The Company previously accounted for these issuances of restricted stock and stock option grants in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations (“APB 25”). Accordingly, the Company did not recognize compensation cost in connection with the issuance of the stock options, as the options granted had an exercise price equal to the market value of LHC Group, Inc. common stock on the date of grant. The Company did recognize compensation cost in connection with the issuance of restricted stock.

The Company adopted Statement of Financial Accounting Standards (SFAS) No. 123(R) (revised 2004), Share-Based Payment, a revision of SFAS No. 123, Accounting for Stock-Based Compensation, on January 1, 2006 using the modified prospective method. This method requires compensation cost to be recognized beginning with the effective date (a) based on the requirements of SFAS No. 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of SFAS No. 123 for all awards granted to employees prior to the effective date of SFAS No. 123(R) that remain unvested on the effective date.

SFAS 123(R) applies to new awards issued on or after January 1, 2006, as well as awards that were outstanding as of December 31, 2005. Prior periods were not restated to reflect the impact of adopting the new standard.

Stock Options

The Company uses the Black-Scholes option pricing model to estimate the fair value of stock-based awards with the following weighted-average assumptions.


	Six Months Ended June 30,
	2006			2005
Risk free interest rate		5.03	%		3.72	%
Expected life (years)		5			5
Volatility		38.39			41.62
Expected annual dividend yield		—			—

The following table represents stock options activity for the six month period ended June 30, 2006:


				Weighted
	Number of			average exercise
	Shares			price
Options outstanding at December 31, 2005		13,500		$	14.45
Options granted		15,500			19.75
Options exercised		(2,000	)		14.45
Options forfeited or expired		—			—
Options outstanding at June 30, 2006		27,000			17.49
Options exercisable at June 30, 2006		27,000			17.49

The Company has recorded $134,000 in compensation expense related to stock option grants in the periods ended June 30, 2006. The proforma expense for the same periods in 2005 was $66,000.

Restricted Stock

During 2005, 24,500 shares of restricted stock were issued to our independent directors under the 2005 Director Compensation Plan. One third of these shares vested immediately, and the remaining will vest over a two year period. On January 3, 2006, the Company granted 76,114 shares of restricted stock to certain members of management. These shares were granted pursuant to the 2005 Long-Term Incentive Plan. These shares vest over a five year period. During the three month period ended June 30, 2006, 8,731 shares of restricted stock were forfeited

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and 13,500 shares were granted to newly appointed directors and officers with the same vesting schedules as shares previously issued.

As of January 1, 2006, there were 16,333 shares of restricted stock outstanding at an average market value at the date of award of $14.44. During the six months ended June 30, 2006, the Company granted 89,614 shares of restricted stock at the fair value of $18.14. During the six months ended June 30, 2006, 8,168 shares of restricted stock vested and 8,731 shares were forfeited.

The Company has recorded $222,000 in compensation expense related to restricted stock grants in the six month period ended June 30, 2006.

Earnings Per Share

Basic per share information is computed by dividing the item by the weighted-average number of shares outstanding during the period. Diluted per share information is computed by dividing the item by the weighted-average number of shares outstanding plus dilutive potential shares.

The following table sets forth shares used in the computation of basic and diluted per share information for the three and six months ended June 30, 2006 and 2005.


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2006		2005		2006		2005
Weighted average number of shares outstanding for basic per share calculation		16,561,398		13,174,690		16,559,623		12,632,932
Effect of dilutive potential shares:
Options		1,454		—		1,197		—
Restricted stock		13,216		102,349		8,907		108,469

Adjusted weighted average shares for diluted per share calculation		16,576,068		13,277,039		16,569,727		12,741,401

Recently Issued Accounting Pronouncements

In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for the Uncertainty in Income Taxes,” (“FIN 48”). FIN 48 is an interpretation of FASB Statement No. 109, “Accounting for Income Taxes,” and it seeks to reduce the diversity in practice associated with certain aspects of measurement and recognition in accounting for income taxes. In addition, FIN 48 requires expanded disclosure with respect to the uncertainty in income taxes and is effective as of the beginning of our 2007 fiscal year. The Company is currently evaluating the impact, if any, that FIN 48 will have on the financials statements.

3. Acquisitions and Divestitures

The following acquisitions were completed pursuant to the Company’s strategy of becoming the leading provider of post-acute healthcare services to Medicare patients in selected rural markets in the southern United States. The purchase price of each acquisition was determined based on the Company’s analysis of comparable acquisitions and target market’s potential cash flows. Goodwill generated from the acquisitions was recognized based on the expected contributions of each acquisition to the overall corporate strategy. The Company expects the goodwill recognized in connection with the acquisition of existing operations to be fully tax deductible.

2006 Acquisitions

During the six month period ended June 30, 2006, the Company acquired the existing operations of four entities and the minority interest in one of its joint ventures for $4,950,000 in cash and $238,000 in acquisition costs. Goodwill of $3.9 million was assigned to the home based services segment.

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In conjunction with certain minority interest holders redeeming their interests in St. Landry, $889,000 of goodwill, which is deductible for income tax purposes, was recognized in the facility based services segment.

2006 Divestitures

The Company sold one of its long-term acute care hospitals during the six month period ended June 30, 2006 for $1.2 million. The Company recognized a gain of $960,000 on the sale of this hospital. In conjunction with this transaction, the Company allocated and retired $155,000 of goodwill related to this hospital. The Company sold a clinic in the three months ended June 30, 2006 for promissory notes totaling $946,000 and recognized a loss on the sale of $28,000. Goodwill of $891,000 was retired in conjunction with the sale of the clinic. Additionally, the Company closed one location of another clinic and terminated virtually all of its private duty business during the six month period ended June 30, 2006. Finally, the Company also sold one of its home health agencies during the three month period ended June 30, 2006 for $250,000 and retired goodwill of $50,000. The Company recognized a gain of $98,000 on the sale of this agency. The Company has identified a long-term acute care hospital as held for sale as of June 30, 2006. Goodwill of $402,000 and other assets related to this hospital are classified as assets held for sale on the balance sheet.

The following table summarizes the operating results of these divestitures which have been presented as loss from discontinued operations in the accompanying consolidated statements of income:


	Three Months						Six Months
	Ended						Ended
	June 30,						June 30,
	2006			2005			2006			2005
Net service revenue	$	1,683		$	2,434		$	4,343		$	4,568
Costs, expenses and minority interest and cooperative endeavor allocations		1,780			3,348			4,922			6,388

Loss from discontinued operations before income taxes		(97	)		(914	)		(579	)		(1,820	)
Income taxes		37			347			219			691

Loss from discontinued operations	$	(60	)	$	(567	)	$	(360	)	$	(1,129	)

The changes in recorded goodwill by segment for the three month period ended June 30, 2006 were as follows:


	Six Months
	Ended
	June 30,
	2006
	(in thousands)
Home-based services segment:
Balance at December 31, 2005	$	21,692
Goodwill acquired during the period from acquisitions		3,411
Goodwill retired during the period		(50	)
Goodwill acquired during the period from purchase of minority interest		495


Balance at June 30, 2006	$	25,548

Facility-based services segment:
Balance at December 31, 2005	$	4,411
Goodwill retired during the period from sale of business		(1,046	)
Goodwill classified as held for sale during the period		(402	)
Goodwill acquired during the period from redemption of minority interest		889

Balance at June 30, 2006	$	3,852

The above transactions were considered to be immaterial individually and in the aggregate. Accordingly, no supplemental pro forma information is required.

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4. Credit Arrangements

Long-Term Debt

Long-term debt consisted of the following:


	June 30,		December 31,
	2006		2005
	(in thousands)
Notes payable:
Due in monthly installments of $143,000 through July 2006 at 5.5%	$	—	$	842
Due in yearly installments of $50,000 through August 2010 at 6.25%		250		250
Due in monthly installments of $20,565 through October 2015 at LIBOR plus 225 basis points (8.02% at June 30, 2006)		2,911		2,929
Due in monthly installments of $48,500 through March 2006 at 5.7%		—		144
Due in monthly installments of $12,500 through November 2009 at 3.08%		454		515

		3,615		4,680
Less current portion of long-term debt		425		1,406

	$	3,190	$	3,274

In August 2005, the Company entered into a promissory note with Bancorp Equipment Finance, Inc. to purchase an airplane, for a principal amount of $2,975,000 with interest on any outstanding principal balance at the one month LIBOR rate plus 225 basis points. The note is collateralized by the airplane and is payable in 119 monthly installments of $20,565 followed by one balloon installment in the amount of $1,920,565.

In August 2005, the Company entered into a promissory note with the seller of A-1 Nursing Registry, Inc. (“A-1”) in conjunction with the purchase of the assets of A-1. The principal amount of the note is $250,000 and it bears interest at 6.25%.

Certain of the Company’s loan agreements contain certain restrictive covenants, including limitations on indebtedness and the maintenance of certain financial ratios. At June 30, 2006 and at December 31, 2005, the Company was in compliance with all covenants.

Other Credit Arrangements

The Company maintains a revolving-debt arrangement. Under the terms of this arrangement, the Company may be advanced funds up to a defined limit of eligible accounts receivable not to exceed the borrowing limit. At June 30, 2006 and December 31, 2005, the borrowing limit was $22,500,000, and the amounts outstanding were $0. Interest accrues on outstanding amounts at a varying rate and is based on the Wells Fargo Bank, N.A. prime rate plus 1.5% (9.75% at June 30, 2006). The annual facility fee is 0.5% of the total availability. The agreement expires on April 15, 2010.

5. Key Employee Equity Participation Plan

The Company had reserved up to 6.5% of the value of the Company’s stock for issuance under the KEEP Plan. In conjunction with the initial public offering the 481,680 units became completely vested and were converted to common stock. During 2005, the Company incurred a charge to equity based compensation of $3.9 million. A summary of the changes in the KEEP Units outstanding is as follows:


	June 30,		December 31,
	2006		2005
Outstanding at beginning of period		—		481,680
Granted		—		375,180
Exercised		—		—
Converted		—		(481,680	)

Outstanding at end of period		—		—

Number of KEEP Units vested at end of period		—		—

The KEEP Units were accounted for at their estimated fair value. Accordingly, no pro forma net income or per share information was required for prior periods.

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6. Shareholders’ Equity

The following table summarizes the activity in stockholders’ equity for the six month period ended June 30, 2006 (amounts in thousands, except per share data):


	Common Stock									Additional
	Issued				Treasury					Paid-In		Retained
	Amount		Shares		Amount			Shares		Capital		Earnings		Total
Balances at December 31, 2005	$	166		19,507,887	$	(2,856	)		2,950,059	$	58,596	$	22,538	$	78,444
Net income		—		—		—			—		—		8,391		8,391
Compensation expense											282				282
Stock options issued											128				128
Stock options exercised											33				33
Recording minority interest in joint venture at redemption value		—		—		—			—		—		1,015		1,015

Balances at June 30, 2006	$	166		19,507,887	$	(2,856	)		2,950,059	$	59,039	$	31,944	$	88,293

7. Commitments and Contingencies

Contingent Convertible Minority Interests

In the third majority owned subsidiary, St. Landry Extended Care Hospital, LLC (“St. Landry”), the put option allows the minority interest holders to convert their minority interests into shares of the Company based upon St. Landry’s EBITDA for the prior fiscal year in relation to the Company’s EBITDA over the same period. The put option became exercisable by the minority interest holders in St. Landry upon the completion of the IPO. However, due to applicable laws and regulations, the minority interest holders can not convert their minority interests in St. Landry unless certain conditions are met including, but not limited to, the Company having stockholders’ equity in excess of $75 million at the end of its most recent fiscal year or on average during the previous three fiscal years. If the St. Landry minority interest holders do not or are unable to convert their minority interests into shares of the Company, the minority interest holders shall have the option to redeem their minority interests at any time following thirty days after the IPO for cash consideration equal to the value of the shares the minority interest holders would have received if they had converted their minority interests into shares of the Company multiplied by the average closing price of the Company’s shares for the thirty days preceding the date of the minority interest holders’ exercise of the redemption option. As of December 31, 2005 and June 30, 2006, the company had exceeded $75 million in stockholders’ equity. As of June 30, 2006, approximately 59% of the doctors have converted their minority interests to cash.

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Landry put option allowed the minority interest holders in St. Landry to have their interests redeemed for cash upon the completion of the IPO and therefore the Company recorded an adjustment of approximately $1.5 million to minority interests subject to exchange contracts and/or put options and to retained earnings which represents the redemption value of St. Landry’s interests at June 30, 2005. In September 2005, certain minority interest holders redeemed their interests in St. Landry. This resulted in a cash payment of approximately $214,000. In connection with the partial redemption of certain minority interests in September 2005, we decreased our minority interests by approximately $149,000 and increased our retained earnings by the same amount. Simultaneously, we recorded goodwill of $214,000 to represent the value of the minority interests redeemed. Also at the end of the third quarter of 2005, we recorded a mark-to-market charge of $404,000.

In November 2005, the agreement was amended to allow minority interest holders to redeem their minority interests based on the St. Landry’s rolling twelve month EBITDA in relation to the Company’s EBITDA over the same period. At December 31, 2005, the Company recorded an additional mark to market benefit of $266,000 to mark the liability to redemption value at the end of the quarter.

In connection with the partial redemption of certain minority interest in the six months ended June 30, 2006, we decreased our minority interests by approximately $939,000 and increased our retained earnings by the same amount. Simultaneously, we recorded goodwill of $889,000 to represent the value of the minority interests redeemed. Also for the six months ended June 30, 2006, we recorded a mark-to-market benefit of $76,000.

Contingencies

The terms of several joint venture operating agreements grant a buy/sell option that would require the Company to either purchase or sell the existing membership interest in the joint venture within 30 days of the receipt of the notice to exercise the provision. Either the Company or its joint venture partner has the right to exercise the buy/sell option. The party receiving the exercise notice has the right to either purchase the interests held by the other party or sell its interests to the other party. The purchase price formula for the interests is set forth in the joint venture agreement and is typically based on a multiple of the earnings before income taxes, depreciation and amortization of the joint venture. Total revenue earned by the Company from joint ventures subject to these arrangements was $3.7 million and $3.5 million for the three months ended June 30, 2006 and 2005, respectively and $7.2 million and $6.7 million for the six months ended June 30, 2006 and 2005, respectively. The Company has not received notice from any joint venture partners of their intent to exercise the buy/sell option nor has the Company notified any joint venture partners of any intent to exercise the buy/sell option.

The Company is involved in various legal proceedings arising in the ordinary course of business. Although the results of litigation cannot be predicted with certainty, management believes the outcome of pending litigation will not have a material adverse effect, after considering the effect of the Company’s insurance coverage, on the Company’s consolidated financial statements.

Compliance

The laws and regulations governing the Company’s operations, along with the terms of participation in various government programs, regulate how the Company does business, the services offered, and interactions with patients and the public. These laws and regulations, and their interpretations, are subject to frequent change. Changes in existing laws or regulations, or their interpretations, or the enactment of new laws or regulations could materially and adversely affect the Company’s operations and financial condition.

The Company is subject to various routine and non-routine governmental reviews, audits, and investigations. In recent years, federal and state civil and criminal enforcement agencies have heightened and coordinated their oversight efforts related to the healthcare industry, including with respect to referral practices, cost reporting, billing practices, joint ventures, and other financial relationships among healthcare providers. Violation of the laws governing the Company’s operations, or changes in the interpretation of those laws, could result in the imposition of fines, civil or criminal penalties, the termination of the Company’s rights to participate in federal and state-sponsored programs, and the suspension or revocation of the Company’s licenses.

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If the Company’s long-term acute care hospitals fail to meet or maintain the standards for Medicare certification as long-term acute care hospitals, such as average minimum length of patient stay, they will receive payments under the prospective payment system applicable to general acute care hospitals rather than payment under the system applicable to long-term acute care hospitals. Payments at rates applicable to general acute care hospitals would likely result in the Company receiving less Medicare reimbursement than currently received for patient services. Moreover, all of the Company’s long-term acute care hospitals are subject to additional Medicare criteria because they operate as separate hospitals located in space leased from, and located in, a general acute care hospital, known as a host hospital. This is known as a “hospital within a hospital” model. These additional criteria include requirements concerning financial and operational separateness from the host hospital.

The Company anticipates there may be changes to the standard episode-of-care payment from Medicare in the future. Due to the uncertainty of the revised payment amount, the Company cannot estimate the impact that changes in the payment rate, if any, will have on its future financial statements. In August 2004, the Centers for Medicare and Medicaid Services, or CMS, adopted new regulations that implement significant changes affecting long-term acute care hospitals. Among other things, these new regulations, which became effective in October 2004, implemented new rules that provide long-term acute care hospitals operating in the hospital within a hospital model with lower rates of reimbursement for Medicare admissions from their host hospitals that are in excess of specified percentages.

These new rules also reclassified certain long-term acute care hospital diagnosis related groups, which could result in a decrease in reimbursement rates. Further, the new rules kept in place the financial penalties associated with the failure to limit to no greater than 5% the total number of Medicare patients discharged to the host hospital and subsequently readmitted to a long-term acute care hospital located within the host hospital.

The Company believes that it is in material compliance with all applicable laws and regulations and is not aware of any pending or threatened investigations involving allegations of potential wrongdoing. While no such regulatory inquiries have been made, compliance with such laws and regulations can be subject to future government review and interpretation as well as significant regulatory action, including fines, penalties, and exclusion from the Medicare program.

8. Segment Information

The Company’s segments consist of (a) home-based services and (b) facility-based services. Home-based services include home nursing services and hospice services. Facility-based serviced include long-term acute care services and outpatient rehabilitation services. The accounting policies of the segments are the same as those described in the summary of significant accounting policies.


	Three Months Ended June 30, 2006
	Home-Based			Facility-Based
	Services			Services			Total
	(in thousands)
Net service revenue	$	36,602		$	12,955		$	49,557
Cost of service revenue		17,435			7,579			25,014
General and administrative expenses		12,806			3,999			16,805
Equity-based compensation expense		—			—			—
Operating income		6,361			1,377			7,738
Interest expense		42			18			60
Non operating income, including gain on sale of assets		(77	)		(39	)		(116	)
Income from continuing operations before income taxes and minority interest and cooperative endeavor allocations		6,396			1,398			7,794
Minority interest and cooperative endeavor allocations		647			423			1,070
Income from continuing operations before income taxes		5,749			975			6,724
Total assets	$	84,467		$	33,328		$	117,795

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	Three Months Ended June 30, 2005
	Home-Based			Facility-Based
	Services			Services			Total
	(in thousands)
Net service revenue	$	24,776		$	11,248		$	36,024
Cost of service revenue		11,766			6,945			18,711
General and administrative expenses		8,057			2,490			10,547
Equity-based compensation expense		2,346			1,006			3,352
Operating income		2,607			807			3,414
Interest expense		286			140			426
Non operating income, including gain on sale of assets		(17	)		(5	)		(22	)
Income from continuing operations before income taxes and minority interest and cooperative endeavor allocations		2,338			672			3,010
Minority interest and cooperative endeavor allocations		934			258			1,192
Income from continuing operations before income taxes		1,404			414			1,818
Total assets	$	57,107		$	39,745		$	96,852


	Six Months Ended June 30, 2006
	Home-Based			Facility-Based
	Services			Services			Total
				(in thousands)
Net service revenue	$	69,254		$	25,707		$	94,961
Cost of service revenue		33,780			15,219			48,999
General and administrative expenses		24,145			7,533			31,678
Equity-based compensation expense		—			—			—
Operating income		11,329			2,955			14,284
Interest expense		96			50			146
Non operating income, including gain on sale of assets		(188	)		(92	)		(280	)
Income from continuing operations before income taxes and minority interest and cooperative endeavor allocations		11,421			2,997			14,418
Minority interest and cooperative endeavor allocations		1,238			861			2,099
Income from continuing operations before income taxes		10,183			2,136			12,319
Total assets	$	84,467		$	33,328		$	117,795


	Six Months Ended June 30, 2005
	Home-Based			Facility-Based
	Services			Services			Total
				(in thousands)
Net service revenue	$	49,550		$	21,875		$	71,425
Cost of service revenue		23,267			13,015			36,282
General and administrative expenses		15,135			5,280			20,415
Equity-based compensation expense		2,699			1,157			3,856
Operating income		8,449			2,423			10,872
Interest expense		503			255			758
Non operating gain, including gain on sale of assets		(31	)		(534	)		(565	)
Income from continuing operations before income taxes and minority interest and cooperative endeavor allocations		7,977			2,702			10,679
Minority interest and cooperative endeavor allocations		2,056			576			2,632
Income from continuing operations before income taxes		5,921			2,126			8,047
Total assets	$	57,107		$	39,745		$	96,852

9. Subsequent Events

On July 19, 2006, the Company closed its public offering of 4,000,000 shares of common stock at a price of $19.25 per share. Of the 4,000,000 shares of common stock offered, 1,000,000 shares were offered by the Company, with the remaining 3,000,000 shares of common stock sold by the selling stockholders identified in the prospectus supplement. The underwriters exercised an over-allotment of an additional 600,000 shares.

The Company intends to use the net proceeds of approximately $21 million from the offering to fund future acquisitions and for other general corporate purposes. LHC Group, Inc. will receive no proceeds from the sale of shares by the selling stockholders, all of which were sold by the selling stockholders.

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patient census of 2,400 as well as approximately 350 Lifeline employees. As a result of the acquisition, the Company now has 17 locations in 29 Kentucky counties with a population of over 750,000 people. In 2005, Lifeline reported Kentucky-based revenue of approximately $23 million. Lifeline was purchased for approximately $15 million in cash.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS

This Management’s Discussion and Analysis of Financial Condition and Results of Operations contains “forward-looking statements.” Forward-looking statements relate to expectations, beliefs, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts or that necessarily depend upon future events. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “project,” “predict,” “potential,” and similar expressions. Specifically, this report contains, among others, forward-looking statements about:

	•		our expectations regarding financial condition or results of operations for periods after June 30, 2006;

	•		our future sources of and needs for liquidity and capital resources;

	•		our expectations regarding the size and growth of the market for our services;

	•		our business strategies and our ability to grow our business;

	•		the implementation or interpretation of current or future regulations and legislation;

	•		the reimbursement levels of third-party payors; and

	•		our discussion of our critical accounting policies.

The forward-looking statements contained in this report reflect our current views about future events, are based on assumptions and are subject to known and unknown risks and uncertainties. Many important factors could cause actual results or achievements to differ materially from any future results or achievements expressed in or implied by our forward-looking statements. Many of the factors that will determine future events or achievements are beyond our ability to control or predict. Important factors that could cause actual results or achievements to differ materially from the results or achievements reflected in our forward-looking statements include, among other things, the factors discussed in the Part II, Item 1A “Risk Factors,” included in this report.

You should read this report, the information incorporated by reference into this report and the documents filed as exhibits to this report completely and with the understanding that our actual future results or achievements may be materially different from what we expect or anticipate.

The forward-looking statements contained in this report reflect our views and assumptions only as of the date this report is signed. Except as required by law, we assume no responsibility for updating any forward-looking statements.

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We qualify all of our forward-looking statements by these cautionary statements. In addition, with respect to all of our forward-looking statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

Unless the context otherwise requires, “we,” us,” “our,” and the “Company” refer to LHC Group, Inc. and its consolidated subsidiaries.

Overview

We provide post-acute healthcare services primarily to Medicare beneficiaries in rural markets in the southern United States. We provide these post-acute healthcare services through our home nursing agencies, hospices, long-term acute care hospitals and outpatient rehabilitation clinics. Since our founders began operations in 1994 with one home nursing agency in Palmetto, Louisiana, we have grown to 99 locations in Louisiana, Alabama, Arkansas, Mississippi, Texas, and West Virginia as of June 30, 2006.

Segments

We operate in two segments for financial reporting purposes: home-based services and facility-based services. We derived 73.9% and 68.8% of our net service revenue during the three months ended June 30, 2006 and 2005, respectively, and 72.9% and 69.4% of our net service revenue during the six months ended June 30, 2006 and 2005, respectively, from our home-based services segment and derived the balance of our net service revenue from our facility-based services segment.

Through our home-based services segment we offer a wide range of services, including skilled nursing, private duty nursing, physical, occupational, and speech therapy, medically-oriented social services, and hospice care. As of June 30, 2006, we owned and operated 81 Medicare-certified home nursing locations and six Medicare-certified hospices. Of these 87 home-based services locations, 43 are wholly-owned by us and 44 are majority-owned or controlled by us through joint ventures. We also manage the operations of three home nursing agencies and one hospice in which we have no ownership interest. We intend to increase the number of home nursing agencies that we operate through continued acquisition and development, primarily in underserved rural markets, as we implement our growth strategy. As we acquire and develop home nursing agencies, we anticipate the percentage of our net service revenue and operating income derived from our home-based services segment will increase.

We provide facility-based services principally through our long-term acute care hospitals and outpatient rehabilitation clinics. As of June 30, 2006, we owned and operated four long-term acute care hospitals with seven locations, all located within host hospitals. We also owned and operated one critical access hospital, two outpatient rehabilitation clinics and provided contract rehabilitation services to third parties. Of these ten facility-based services locations, three are wholly-owned by us and seven are majority-owned or controlled by us through joint ventures. We also manage the operations of one inpatient rehabilitation facility in which we have no ownership interest. Because of the recent changes in the regulations applicable to long-term acute care hospitals operated as hospitals within hospitals, we do not intend to expand the number of hospital within a hospital long-term acute care hospitals that we operate. Due to our emphasis on expansion through the acquisition and development of home nursing agencies, we anticipate that the percentage of our net service revenue and operating income derived from our facility-based segment will decline.

Recent Developments

Medicare

Home-Based Services. The current base payment rate for Medicare home nursing is $2,264. Since the inception of the prospective payment system in October 2000, the base episode rate payment has varied due to both the impact of annual market basket based increases and Medicare-related legislation.

Home health payment rates are updated annually by either the full home health market basket percentage, or by the home health market basket percentage as adjusted by Congress. The Centers for Medicare and Medicaid Services, or CMS, establishes the home health market basket index, which measures inflation in the prices of an appropriate mix of goods and services included in home health services.

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The passage of the Medicare Modernization Act of 2003, or MMA, resulted in two changes in Medicare reimbursement. First, for episodes ended on or after April 1, 2004 through December 31, 2006, the base episode rate increase was reduced by 0.8%. Secondly, a 5.0% payment increase was provided for services furnished in a non-Metropolitan Statistical Area, or MSA, setting for episodes ending on or after April 1, 2004 and before April 1, 2005.

On January 1, 2006, a 2.8% market basket increase went into effect along with new Core Based Statistical Area, or CBSA, designations and wage indices. This increase represented a 3.6% market basket update minus the 0.8% reduction mandated by MMA. However, the Deficit Reduction Act, or DRA, provided for a one-year freeze on the Medicare home health payment rate in 2006, in essence, taking away the original 2.8% market basket adjustment. This Act also provided a 5.0% rural add on for one-year beginning January 1, 2006. As of June 30, 2006, approximately 54% of our Medicare census was derived from patients who reside in rural CBSAs. In addition, the DRA instituted quality reporting requirements for home health agencies beginning in 2007. In essence, agencies that report the required data will receive the market basket update. Those that do not report will receive the market basket minus 2%.

In July 2006, CMS issued a proposed rule proposing a 3.1% increase in Medicare payment rates to home health agencies for 2007. In accordance with the DRA, agencies that submit the required quality data would receive payments based on the full proposed home health market basket update of 3.1% for 2007. If an agency does not submit the required quality data, then the home health market basket percentage will be reduced by 2% to 1.1% for 2007. According to CMS, rural home health agencies that participate in the ongoing quality measurement effort will see an estimated 3.3% increase in payment, while urban agencies who continue to provide quality data will experience an estimated 2.9% increase in payments. The final rule relating to these proposals is expected later in the fall. The company cannot predict whether Congress will introduce legislation this year that would negatively impact the anticipated market basket increase.

Additionally, later this year, CMS is anticipated to propose significant case mix changes to the home health payment system. The company cannot predict the impact of those changes at this time.

In August 2006, CMS announced the payment rates for hospice care furnished from October 1, 2006 through September 30, 2007. These rates are 3.4% more than the rates for the previous year. In addition, CMS announced that the hospice cap amount for the year ending October 31, 2006 is $20,585.

Facility-Based Services. Under the long-term acute care hospital prospective payment system implemented on October 1, 2002, each patient discharged from our long-term acute care hospitals is assigned a long-term care diagnosis-related group. CMS establishes these long-term care diagnosis-related groups by categorizing diseases by diagnosis, reflecting the amount of resources needed to treat a given disease. For each patient, we are paid a pre-determined fixed amount applicable to the particular long-term care diagnosis-related group to which that patient is assigned. Effective for discharges on or after October 1, 2005, CMS has published the new relative weights applicable to the long-term care diagnosis-related group system. The updated regulations provide for a 3.4% increase in the standard federal rate, a budget neutrality factor of 0, which became effective July 1, 2005, and a decrease in the high cost outlier fixed loss threshold to $10,501. In addition, on May 6, 2005 CMS published a final rule increasing the Medicare payment rates for long-term acute care hospitals by 3.4% for patient discharges taking place on or after July 1, 2005 through June 30, 2006.

CMS has also stated its intention to develop long-term acute care hospital patient-specific criteria to refine the definition of such facilities. Comments included in the May 6, 2005 rule indicate that CMS has awarded a contract to Research Triangle Institute for the purpose of evaluating patient and facility level characteristics for long-term care hospitals in order to differentiate the role of long-term acute care hospitals from general acute care hospitals. This evaluation is in response to the June 2004 MedPAC Report recommending that CMS examine defining long-

- 22 -

term acute care hospitals by facility and patient criteria. CMS has also charged Research Triangle Institute with examining the present role of Quality Improvement organizations with regard to long-term care acute hospitals.

On May 2, 2006, CMS issued a rule under the long-term care hospital prospective payment system for the 2007 rate year starting July 1, 2006. The rule provides for no increase in the Medicare payment rates to long-term acute care hospitals for discharges taking place on or after July 1, 2006 through June 30, 2007. Therefore, CMS has ruled that the long-term care hospital prospective payment system federal rate will remain at $38,086.04 for the 2007 rate year. In addition, CMS adopted the Rehabilitation, Psychiatric and Long-Term Care market basket to replace the excluded hospital with capital market basket that is currently used as the measure of inflation for calculating the annual update to the long-term care hospital prospective payment system federal rate. The rule also revised the payment adjustment formula for short-stay outlier cases, which overall comprise 37% of long-term care hospital prospective payment system discharges. These are cases where a patient is discharged early and the hospital’s costs are significantly below average. The rule made a number of other regulatory changes aimed at curbing the long-term care hospital Medicare margin growth that has occurred since implementation of the prospective payment system in 2002 (growth CMS says will reach 7.8% in 2006). CMS also contends that long-term care hospital Medicare margins increased from 7.8% in fiscal year 2003 to 12.7% in fiscal year 2004. The high cost outlier will increase for the rate year 2007 to $14,887.

Under Medicare, we are reimbursed for rehabilitation services based on a fee schedule for services provided adjusted by the geographical area in which the facility is located. Outpatient therapy services are subject to an annual cap of $1,750 per beneficiary effective January 1, 2006. The Deficit Reduction Act of 2005 included a medical review policy to the statutory therapy cap that allows claims over the cap to be approved on a case-by-case basis on the basis of medical necessity. This “exceptions” process is in effect for only for one year; it ends on December 31, 2006. We are unable to predict whether Congress will renew the exceptions process this year before it adjourns.

Components of Expenses

Cost of Service Revenue

Our cost of service revenue consists primarily of the following expenses incurred by our clinical and clerical personnel in our agencies and facilities:

	•		salaries and related benefits;

	•		transportation, primarily mileage reimbursement; and

	•		supplies and services, including payments to contract therapists.

General and Administrative Expenses

Our general and administrative expenses consist primarily of the following expenses incurred by our home office and administrative field personnel:

•

Home office:

	•		salaries and related benefits;

	•		insurance;

	•		costs associated with advertising and other marketing activities; and

	•		rent and utilities;

•

Supplies and services:

	•		accounting, legal and other professional services; and

	•		office supplies;

•

Depreciation; and

- 23 -

•

Provision for bad debts.

Equity-Based Compensation Expense

Under our KEEP Plan certain of our employees were granted KEEP Units. The KEEP Units, which have no exercise price, vested over a five-year period. The KEEP Units functioned as stock appreciation rights whereby an individual is entitled to receive, on a per unit basis, the increase in estimated fair value, as determined by us, of our units from the date of grant until the date upon which the employee dies, retires or is terminated for any reason other than cause. Accordingly, the KEEP Units were subject to variable accounting until such time as the obligation to the employee was settled. At the initial public offering price of $14.00 per share, upon the completion of the offering all obligations relating to our KEEP Units were settled by conversion into shares of our common stock and we incurred a final, non-recurring equity-based compensation charge in the amount of approximately $3.0 million (net of taxes of $1.7 million).

Our equity-based compensation expense was allocated to our home-based and facility-based services segments in accordance with our home office allocation, which is calculated based on the percentage of our net service revenue contributed by each segment during the applicable period.

Results of Operations

Three Months Ended June 30, 2006 Compared to Three Months Ended June 30, 2005

Net Service Revenue

Net service revenue for the three months ended June 30, 2006 was $49.6 million, an increase of $13.6 million, or 37.8%, from $36.0 million in 2005. For the three months ended June 30, 2006 and 2005, 84.7% and 88.0%, respectively, of our net service revenue was derived from Medicare.

Home-Based Services

Net service revenue for the three months ended June 30, 2006 was $36.6 million, an increase of 47.6%, from $24.8 million for the three months ended June 30, 2005. Organic growth in this service sector was approximately $7.1 million, or 30.3%. Total admissions were 5,852 during the period, versus 4,006 for the same period in 2005, a 46.1 % increase. Organic admissions increased 13.8%. The Company also monitors patient census as a key performance indicator within its home based services. LHC Group’s average home based patient census for the three months ended June 30, 2006 was 9,807 patients, an increase of 30.5% as compared to 7,517 patients for the three months ended June 30, 2005. Organic home-based patient census increased 12.9%. Organic growth includes growth on “same store” locations (owned for greater than 12 months), and growth from “de novo” locations. Growth from acquired locations owned less than 13 months is not included. The average patient census for the first quarter of 2005 was 6,539. Average census is calculated by taking the average of the ending census of each week during the period. Organic census for the first quarter of 2006 was 7,614 and for the first quarter of 2005 it was 6,164.


	2005		2006		%			2005		2006		%			2005		2006		%
	Revenue		Revenue		Growth			Admissions		Admissions		Growth			Census		Census		Growth
Organic	$	23,588	$	30,734		30.3	%		3,789		4,312		13.8	%		7,080		7,996		12.9	%
Acquired	$	1,188	$	5,868		393.9	%		217		1,540		609.7	%		437		1,811		314.4	%
Total	$	24,776	$	36,602		47.6	%		4,006		5,852		46.1	%		7,517		9,807		30.5	%

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Facility-Based Services

Net service revenue for the three months ended June 30, 2006 was $13.0 million, an increase of $1.8 million, or 16.1%, from $11.2 million for the three months ended June 30, 2005. Organic growth in this service sector was approximately $1.6 million, or 16.4%. The increase in net service revenue resulted in part due to an increase in patient days of 5.6% to 11,110 in the three months ended June 30, 2006 from 10,519 in the three months ended June 30, 2005. Outpatient visits decreased to 5,157 at June 30, 2006, a 55.7% decrease as compared to 11,639 for the three months ended June 30, 2005 due to the sale of one of our clinics and the closing of one location of another clinic.


								2005		2006
	2005		2006		%			Patient		Patient		%			2005		2006		%
	Revenue		Revenue		Growth			Days		Days		Growth			Discharges		Discharges		Growth
Organic	$	9,914	$	11,536		16.4	%		9,351		9,907		5.9	%		358		379		5.9	%
Acquired	$	1,334	$	1,419		6.4	%		1,168		1,203		3.0	%		47		51		8.5	%
Total	$	11,248	$	12,955		15.2	%		10,519		11,110		5.6	%		405		430		6.2	%

Cost of Service Revenue

Cost of service revenue for the three months ended June 30, 2006 was $25.0 million, an increase of $6.3 million, or 33.7%, from $18.7 million for the three months ended June 30, 2005. Cost of service revenue represented approximately 50.5% and 52.0% of our net service revenue for the three months ended June 30, 2006 and 2005, respectively.

Home-Based Services. Cost of service revenue for the three months ended June 30, 2006 was $17.4 million, an increase of $5.6 million, or 47.5%, from $11.8 million for the three months ended June 30, 2005. Approximately $4.3 million of this increase resulted from an increase in salaries and benefits. Approximately $4.1 million of the increase in salaries and benefits expense was due to acquisitions. The remaining increase in salaries and benefits expense of approximately $200,000 was primarily attributable to internal growth. The remaining increase in cost of service revenue was attributable to increases in supplies and services expense and transportation expense of $1.0 million and $300,000, respectively.

Facility-Based Services. Cost of service revenue for the three months ended June 30, 2006 was $7.6 million, an increase of $700,000, or 10.1%, from $6.9 million for the three months ended June 30, 2005. Approximately $500,000 of this increase resulted from an increase in salaries and benefits. Supplies and services expense contributed approximately $100,000 of the increase in cost of service revenue. Transportation expense increased approximately $100,000 compared to the three months ended June 30, 2005.

General and Administrative Expenses

General and administrative expenses for the three months ended June 30, 2006 was $16.8 million, an increase of $6.3 million, or 60.0%, from $10.5 million for the three months ended June 30, 2005. One time fees for recruitment and compensation to new management and directors totaled $0.3 million during the period. Public company costs of SEC filings and Sarbanes-Oxley totaled $0.4 million during the period. The remaining $5.6 million increase was attributable to the Company’s growth. General and administrative expenses represented approximately 33.9% and 29.3% of our net service revenue for the three months ended June 30, 2006 and 2005, respectively.

Home-Based Services. General and administrative expenses for the three months ended June 30, 2006 was $12.8 million, an increase of $4.7 million, or 58.0%, from $8.1 million for the three months ended June 30, 2005. Approximately $1.2 million of this increase resulted from internal growth, $3.5 million was incurred as a result of acquisition or development activity.

Facility-Based Services. General and administrative expenses for the three months ended June 30, 2006 were $4.0 million, an increase of $1.5 million, or 60.0%, from $2.5 million for the same period in 2005. Approximately

- 25 -

$400,000 was attributable to acquisition and internal development activity during 2005. The remaining increase of $1.1 million is attributable to internal growth.

Equity-Based Compensation Expense

There was no equity-based compensation expense for the three months ended June 30, 2006, which was a decrease of $3.4 million from the same period in 2005. Equity-based compensation expense related to the Key Equity Employee Participation Units, or KEEP Units, was zero in the three months ended June 30, 2006 due to the conversion of all of the KEEP units to common stock in connection with the initial public offering in the second quarter of 2005.

Income Tax Expense

The effective tax rates for the three months ended June 30, 2006 and 2005 were 36.5% and 20.1%, respectively. The effective tax rate for the three months ended June 30, 2005 decreased due to the Company recording an income tax benefit of $342,000 related to a $900,000 equity-based compensation charge stemming from shares issued by one of the Company’s principal shareholders to an officer of the Company in 2001. At the time, the Company did not believe it would be able to deduct the equity-based compensation charge for income tax purposes. In conjunction with the initial public offering, the Company determined that it will be able to deduct the $900,000 equity-based compensation charge and as a result has recognized an income tax benefit associated with that charge of $342,000.

Minority Interest and Cooperative Endeavor Allocations

The minority interest and cooperative endeavor allocations expense for the three months ended June 30, 2006 was $1.1 million, compared to $1.2 million for the same period in 2005.

Discontinued Operations

The Company sold one of its home health agencies during the three month period ended June 30, 2006 for $250,000. The Company recognized a gain of $98,000 on the sale of this agency. The Company also sold a clinic during the three months ended June 30, 2006 for promissory notes totaling $946,000 and recognized a loss on the sale of $28,000. The operations of this home health agency, clinic, the private duty business and the location of another clinic that was closed during the quarter are included in discontinued operations in the consolidated statement of income.

Revenue from discontinued operations for the three months ended June 30, 2006 and 2005 was $1.7 million and $2.4 million, respectively. Costs, expenses, and minority interest and cooperative endeavor allocations were $1.8 million and $3.3 million respectively, for the three months ended June 30, 2006 and 2005. Losses from discontinued operations were $60,000 and $567,000 for the three months ended June 30, 2006 and 2005, respectively.

Six Months Ended June 30, 2006 Compared to Six Months Ended June 30, 2005

Net Service Revenue

Net service revenue for the six months ended June 30, 2006 was $94.7 million, an increase of $23.3 million, or 32.6%, from $71.4 million in 2005. For the six months ended June 30, 2006 and 2005, 84.8% and 86.3%, respectively, of our net service revenue was derived from Medicare.

- 26 -

Home-Based Services

Net service revenue for the six months ended June 30, 2006 was $69.3 million, an increase of 39.8%, from $49.6 million for the six months ended June 30, 2005. Organic growth in this service sector was approximately $13.5 million, or 28.5%. Total admissions were 11,422 during the period, versus 8,157 for the same period in 2005, a 40.0 % increase. Organic admissions increased 14.6%. LHC Group’s average home based patient census for the six months ended June 30, 2006 was 9,535 patients, an increase of 29.7% as compared to 7,349 patients for the six months ended June 30, 2005. Organic home-based patient census increased 12.1%. The average patient census for the first quarter of 2006 was 9,138 while the average patent census for the second quarter of 2006 was 9,807.


	2005		2006		%			2005		2006		%			2005		2006		%
	Revenue		Revenue		Growth			Admissions		Admissions		Growth			Census		Census		Growth
Organic	$	47,520	$	61,064		28.5	%		7,563		8,665		14.6	%		6,942		7,785		12.1	%
Acquired	$	2,030	$	8,190		303.4	%		594		2,757		364.1	%		407		1,750		330.0	%
Total	$	49,550	$	69,254		39.8	%		8,157		11,422		40.0	%		7,349		9,535		29.7	%

Facility-Based Services

Net service revenue for the six months ended June 30, 2006 was $25.7 million, an increase of $3.8 million, or 17.5%, from $21.9 million for the six months ended June 30, 2005. Organic growth in this service sector was approximately $3.6 million, or 19.1%. The increase in net service revenue resulted in part due to an increase in patient days of 9.2% to 22,809 in the six months ended June 30, 2006 from 20,895 in the six months ended June 30, 2005. Outpatient visits decreased to 13,932 at June 30, 2006, a 39.8% decrease as compared to 23,124 for the six months ended June 30, 2005 due to the sale of one of our clinics and the closing of one location of another clinic.


								2005		2006
	2005		2006		%			Patient		Patient		%			2005		2006		%
	Revenue		Revenue		Growth			Days		Days		Growth			Discharges		Discharges		Growth
Organic	$	19,205	$	22,867		19.1	%		18,428		20,341		10.4	%		669		784		17.2	%
Acquired	$	2,670	$	2,840		6.4	%		2,467		2,468		0.0	%		93		99		6.5	%
Total	$	21,875	$	25,707		17.5	%		20,895		22,809		9.2	%		762		883		15.9	%

Cost of Service Revenue

Cost of service revenue for the six months ended June 30, 2006 was $49.0 million, an increase of $12.7 million, or 35.0%, from $36.3 million for the six months ended June 30, 2005. Cost of service revenue represented approximately 51.6% and 50.8% of our net service revenue for the six months ended June 30, 2006 and 2005, respectively.

Home-Based Services. Cost of service revenue for the six months ended June 30, 2006 was $33.8 million, an increase of $10.5 million, or 45.1%, from $23.3 million for the six months ended June 30, 2005. Approximately $7.8 million of this increase resulted from an increase in salaries and benefits due to acquisition or development activity. The increase in salaries and benefits expense due to internal growth accounted for approximately $500,000 of the increase in this category. Supplies and services expense and transportation expense contributed approximately $1.4 million and $800,000, respectively, to the increase in cost of service revenue.

Facility-Based Services. Cost of service revenue for the six months ended June 30, 2006 was $15.2 million, an increase of $2.2 million, or 16.9%, from $13.0 million for the six months ended June 30, 2005. Approximately $1.6 million of this increase resulted from an increase in salaries and benefits. Of this increase in salaries and benefits, $600,000 was incurred as a result of acquisition and internal development activity. The remaining $1.0 million

- 27 -

increase in salaries and benefits resulted from internal growth within our facility-based services segment. Supplies and services expense contributed approximately $500,000 of the increase in cost of service revenue. Transportation expense increased approximately $100,000 over this same period.

General and Administrative Expenses

General and administrative expenses for the six months ended June 30, 2006 were $31.7 million, an increase of $11.3 million, or 55.4%, from $20.4 million for the six months ended June 30, 2005. One time fees for recruitment and compensation to new management and directors totaled $0.3 million during the period. Public company costs of SEC filings and Sarbanes-Oxley totaled $1.0 million during the period. The remaining $10.0 million increase was attributable to the Company’s growth.

Home-Based Services. General and administrative expenses for the six months ended June 30, 2006 were $24.1 million, an increase of $9.0 million, or 59.6%, from $15.1 million for the six months ended June 30, 2005. Approximately $6.1 million of this increase was attributable to acquisition or internal development activity. Internal growth accounted for approximately $2.9 million.

Facility-Based Services. General and administrative expenses for the six months ended June 30, 2006 were $7.5 million, an increase of $2.2 million, or 41.5%, from $5.3 million for the six months ended June 30, 2005. The majority, or $1.5 million, of the increase was attributable to internal growth. The remaining increase of $700,000 was due to acquisition and internal development activity during the 2005 period.

Equity-Based Compensation Expense

There was no equity-based compensation expense for the six months ended June 30, 2006, which was a decrease of $3.9 million from the same period in 2005. Equity-based compensation expense related to the KEEP Units was zero in the six months ended June 30, 2006 due to the conversion of all of the KEEP units to common stock in connection with the initial public offering in the second quarter of 2005.

Income Tax Expense

The effective tax rates for the six months ended June 30, 2006 and 2005 were 34.1% and 34.1%, respectively.

Minority Interest and Cooperative Endeavor Allocations

The minority interest and cooperative endeavor allocations expense for the six months ended June 30, 2006 was $2.1 million, a decrease of approximately $500,000, compared to $2.6 million for the six months ended June 30, 2005. The decrease was attributable to the conversion of certain minority interests after the initial public offering.

Discontinued Operations

The Company sold one of its long-term acute care hospitals during the six month period ended June 30, 2006 for $1.2 million. The Company recognized a gain of $960,000 on the sale of this hospital. The Company also sold a clinic in the six months ended June 30, 2006 for promissory notes totaling $946,000 and recognized a loss on the sale of $28,000. The Company also closed one other location of another clinic. Additionally, the Company closed virtually all of its private duty business during the six month period ended June 30, 2006. Finally, the Company sold one of its home health agencies during the six month period ended June 30, 2006 for $250,000. The Company recognized a gain of $98,000 on the sale of this agency. The results of these operations are reported as discontinued operations in the accompanying consolidated statement of income.

Revenue from discontinued operations for the six months ended June 30, 2006 and 2005 was $4.3 million and $4.6 million, respectively. Costs, expenses, and minority interest and cooperative endeavor allocations were $4.9

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million and $6.4 million respectively, for the six months ended June 30, 2006 and 2005. Losses from discontinued operations were $360,000 and $1.1 million for the six months ended June 30, 2006 and 2005, respectively.

Liquidity and Capital Resources

The Company completed its initial public offering on June 14, 2005. The net offering proceeds received by us, after deducting the total expenses of $7,393,000 (including $3,430,000 in underwriting discounts and commissions), were approximately $41,607,000. As of June 30, 2006, $21.9 million of the net offering proceeds have been used to repay the following indebtedness: (1) $21.1 million on the credit facility, bearing interest at prime plus 1.5% and due April 10, 2010, with Residential Funding Corporation; (2) $643,000 of outstanding obligations under our loan agreement, bearing interest at 12.0% and due July 1, 2006, with The Catalyst Fund, Ltd. and Southwest/Catalyst Capital, Ltd.; and (3) approximately $178,000 of outstanding indebtedness assumed by us in connection with acquisitions completed by us in 2004. Additionally, $3.3 million has been used to pay minority interest holders for their interests and $14.0 million has been used to fund acquisitions since the initial public offering.

Our principal source of liquidity for our operating activities is the collection of our accounts receivable, most of which are collected from governmental and third party commercial payors. Our reported cash flows from operating activities are impacted by various external and internal factors, including the following:

	•		Operating Results — Our net income has a significant impact on our operating cash flows. Any significant increase or decrease in our net income could have a material impact on our operating cash flows.

	•		Start Up Costs — Following the completion of an acquisition, we generally incur substantial start up costs in order to implement our business strategy. There is generally a delay between our expenditure of these start up costs and the increase in net service revenue, and subsequent cash collections, which adversely effects our cash flows from operating activities.

	•		Timing of Payroll — Our employees are paid bi-weekly on Fridays; therefore, operating cash flows decline in reporting periods that end on a Friday. Conversely, for those reporting periods ending on a day other than Friday, our cash flows are higher because we have not yet paid our payroll.

	•		Medical Insurance Plan Funding — We are self funded for medical insurance purposes. Any significant changes in the amount of insurance claims submitted could have a direct impact on our operating cash flows.

	•		Medical Supplies — A significant expense associated with our business is the cost of medical supplies. Any increase in the cost of medical supplies, or in the use of medical supplies by our patients, could have a material impact on our operating cash flows.

Cash used in investing activities is primarily for acquisitions of home nursing agencies and other healthcare facilities and property and equipment, while cash provided by financing activities is derived from the proceeds from our revolving debt arrangement.

Operating activities during the six months ended June 30, 2006 provided $12.1 million in cash and used $6.9 million in cash for the six months ended June 30, 2005. Net income provided for cash of $8.4 million. Non-cash items such as depreciation and amortization, provision for bad debts, equity-based compensation, compensation expense, minority interest in earnings of subsidiaries, deferred income taxes and gain on sale of assets totaled $5.6 million. Changes in operating assets and liabilities, excluding cash, offset these non-cash charges.

Days sales outstanding, or DSO, for the three months ended June 30, 2006 was 77 days compared to 94 days for the same three-month period in 2005. DSO, when adjusted for acquisitions and unbilled accounts receivables, was 69 days. The adjustment takes into account $4.6 million of unbilled receivables that the Company is delayed in billing at this time due to the lag time in receiving the change of ownership recognition after acquiring companies. There were no such adjustments for the comparable period in 2005.

Investing activities used $6.8 million and $975,000 in cash for the six months ended June 30, 2006 and 2005, respectively. In the six months ended June 30, 2006, cash provided by investing activities was $1.4 million primarily

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from the sale of one of our long-term acute care hospitals, offset in part by cash used of $2.0 million for the purchases of property and equipment and $6.2 million in business acquisitions.

Financing activities used $3.6 million in the six months ended June 30, 2006 and provided $25.3 million in the six months ended June 30, 2005. Cash used in financing activities in the six months ended June 30, 2006 included net principal payments on debt and capital leases of $1.3 million.

At June 30, 2006, we had working capital of $54.5 million compared to $49.2 million at December 31, 2005, an increase of $5.3 million.

On July 31, 2006, the Company completed its acquisition of the Kentucky-based assets of Lifeline Home Health Care, a privately-held company based in Somerset, Kentucky. This acquisition involves an approximate total patient census of 2,400 as well as approximately 350 Lifeline employees. As a result of the acquisition, the Company now has 17 locations in 29 Kentucky counties with a population of over 750,000 people. In 2005, Lifeline reported Kentucky-based revenue of approximately $23 million. Lifeline was purchased for approximately $15 million in cash.

Indebtedness

Our total long-term indebtedness was $4.1 million at June 30, 2006 and $5.4 million at December 31, 2005, respectively, including the current portions of $751,000 and $1.8 million, respectively. In April 2005, we entered into an amended and restated senior secured credit facility with Residential Funding Corporation due April 15, 2010. We, together with certain of our subsidiaries, are borrowers under the credit facility. Our obligations and the obligations of our subsidiary borrowers under our credit facility agreement are secured by a lien on substantially all of our assets (including the capital stock or other forms of ownership interests we hold in our subsidiaries and affiliates) and the assets of those subsidiaries and affiliates.

Our credit facility makes available to us up to $22.5 million in revolving loans. The total availability may be increased up to a maximum of $25.0 million, subject to certain terms and conditions. Total availability under our credit facility may be limited from time to time based on the value of our receivables. This facility was paid in full as of the quarter ended June 30, 2005. As of June 30, 2006 and December 31, 2005, we had no outstanding balance under our credit facility.

Interest on outstanding borrowings under our credit facility accrues at a variable base rate (based on Wells Fargo Bank’s prime rate or the federal funds rate), plus a margin of 1.5%.

Our credit facility contains customary affirmative, negative and financial covenants. For example, we are restricted in incurring additional debt, disposing of assets, making investments, allowing fundamental changes to our business or organization, and making certain payments in respect of stock or other ownership interests, such as dividends and stock repurchases. Financial covenants include requirements that we maintain: a debt to EBITDA ratio of no greater than 1.5 to 1.0 and a fixed charge coverage ratio of not less than 1.4 to 1.0.

Our credit facility also contains customary events of default. These include bankruptcy and other insolvency events, cross-defaults to other debt agreements, a change in control involving us or any subsidiary guarantor (other than due to this offering), and the failure to comply with certain covenants.

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Contingent Convertible Minority Interests

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Off-Balance Sheet Arrangements

We do not currently have any off-balance sheet arrangements with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships.

Critical Accounting Policies

We prepare our consolidated financial statements in accordance with generally accepted accounting principles, or GAAP. Accordingly, we make estimates and assumptions that affect our reported amounts of assets, liabilities, revenues and expenses, as well as the disclosure of contingent assets and liabilities. In some cases, we could reasonably have used different accounting policies and estimates. Changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ materially from our estimates. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations will be affected. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We refer to accounting estimates of this type as critical accounting policies and estimates, which we discuss further below.

Principles of Consolidation

Our consolidated financial statements include all subsidiaries and entities controlled by us. We define “control” as ownership of a majority of the voting interest of an entity. Our consolidated financial statements also include entities in which we absorb a majority of the entity’s expected losses, receive a majority of the entity’s expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity.

The decision to consolidate or not consolidate an entity would not impact our earnings, as we would include our portion of these entities’ profits and losses either through consolidation or the equity method of accounting if we did not consolidate.

All significant intercompany accounts and transactions have been eliminated in consolidation. Business combinations accounted for as purchases have been included in the consolidated financial statements from the respective dates of acquisition.

The following table summarizes the percentage of net service revenue earned by type of ownership or relationship we had with the operating entity:


	Three Months						Six Months
	Ended June 30,						Ended June 30,
	2006			2005			2006			2005
Wholly owned subsidiaries		35.4	%		22.7	%		35.9	%		26.0	%
Equity joint ventures		49.3			59.6			49.1			56.1
Cooperative endeavors		1.6			2.6			1.7			2.8
License leasing arrangements		11.4			11.6			11.4			11.7
Management services		2.3			3.5			1.9			3.4

		100.0	%		100.0	%		100.0	%		100.0	%

The following discussion sets forth our consolidation policy with respect to our equity joint ventures, cooperative endeavors, license leasing arrangements and management services agreements.

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Equity Joint Ventures

Our equity joint ventures are structured as limited liability companies in which we typically own a majority equity interest ranging from 51.0% to 98.0%. Each member of all but one of our equity joint ventures participates in profits and losses in proportion to their equity interests. We have one equity joint venture partner whose participation in losses is limited. We consolidate these entities, as we absorb a majority of the entities’ expected losses, receive a majority of the entities’ expected residual returns and generally have voting control.

Cooperative Endeavors

We have arrangements with certain partners that involve the sharing of profits and losses. Unlike our equity joint ventures, we own 100.0% of the equity interests in our cooperative endeavors. In these cooperative endeavors, we possess interests in the net profits and losses ranging from 67.0% to 70.0%. We have one cooperative endeavor partner whose participation in losses is limited. We consolidate these entities, as we own 100.0% of the outstanding equity interests, absorb a majority of the entities’ expected losses and receive a majority of the entities’ expected residual returns.

License Leasing Arrangements

We lease, through our wholly-owned subsidiaries, home health licenses necessary to operate certain of our home nursing agencies. As with our wholly owned subsidiaries, we own 100.0% of the equity interests of these entities and consolidate them based on such ownership, as well as our right to receive a majority of the entities’ expected residual returns and our obligation to absorb a majority of the entities’ expected losses.

Management Services

We have various management services agreements under which we manage certain operations of agencies and facilities. We do not consolidate these agencies or facilities, as we do not have an equity interest and do not have a right to receive a majority of the agencies’ or facilities’ expected residual returns or an obligation to absorb a majority of the agencies’ or facilities’ expected losses.

Revenue Recognition

We report net service revenue at the estimated net realizable amount due from Medicare, Medicaid, commercial insurance, managed care payors, patients, and others for services rendered. Under Medicare, our home nursing patients are classified into a home health resource group prior to the receipt of services. Based on this home health resource group we are entitled to receive a prospective Medicare payment for delivering care over a 60 day period. Medicare adjusts these prospective payments based on a variety of factors, such as low utilization, patient transfers, changes in condition and the level of services provided. In calculating our reported net service revenue from our home nursing services, we adjust the prospective Medicare payments by an estimate of the adjustments. We calculate the adjustments based on a rolling average of these types of adjustments for claims paid during the preceding three months. Historically we have not made any material revisions to reflect differences between our estimate of the Medicare adjustments and the actual Medicare adjustments. For our home nursing services, we recognize revenue based on the number of days elapsed during the episode of care.

Under Medicare, patients in our long-term acute care facilities are classified into long-term care diagnosis-related groups. Based on this classification, we are then entitled to receive a fixed payment from Medicare. This fixed payment is also subject to adjustment by Medicare due to factors such as short stays. In calculating our reported net service revenue for services provided in our long-term acute care hospitals, we reduce the prospective payment amounts by an estimate of the adjustments. We calculate the adjustment based on a historical average of these types of adjustments for claims paid during the preceding three months. For our long-term acute care hospitals we recognize revenue as services are provided.

For hospice services we are paid by Medicare under a prospective payment system. We receive one of four predetermined daily or hourly rates based upon the level of care we furnish. We record net service revenue from our hospice services based on the daily or hourly rate. We recognize revenue for hospice as services are provided.

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Under Medicare we are reimbursed for our rehabilitation services based on a fee schedule for services provided adjusted by the geographical area in which the facility is located. We recognize revenue as these services are provided.

Our Medicaid reimbursement is based on a predetermined fee schedule applied to each service we provide. Therefore, we recognize revenue for Medicaid services as services are provided based on this fee schedule. Our managed care payors reimburse us in a manner similar to either Medicare or Medicaid. Accordingly, we recognize revenue from our managed care payors in the same manner as we recognize revenue from Medicare or Medicaid.

We record management services revenue as services are provided in accordance with the various management services agreements to which we are a party. The agreements generally call for us to provide billing, management, and other consulting services suited to and designed for the efficient operation of the applicable home nursing agency, hospice or inpatient rehabilitation facility. We are responsible for the costs associated with the locations and personnel required for the provision of the services. We are generally compensated based on a percentage of net billings or an established base fee. In addition, for certain of the management agreements, we may earn incentive compensation.

Accounts Receivable and Allowances for Uncollectible Accounts

We report accounts receivable net of estimated allowances for uncollectible accounts and adjustments. Accounts receivable are uncollateralized and primarily consist of amounts due from third-party payors and patients who receive final bills once all documentation is completed. Using detailed accounts receivable aging reports produced by our billing system, our collections department monitors and pursues payment. We have adopted a charity care policy that provides the criteria a patient must meet in order to be considered indigent and his or her balance considered for write-off. All other accounts that are deemed uncollectible are turned over to an outside collection agency for further collection efforts. To provide for accounts receivable that could become uncollectible in the future, we establish an allowance for uncollectible accounts to reduce the carrying amount of such receivables to their estimated net realizable value. The credit risk for concentrations of receivables is limited due to the significance of Medicare as the primary payor. The amount of the provision for bad debts is based upon our assessment of historical and expected net collections, business and economic conditions, trends in government reimbursement and other collection indicators.

A portion of the estimated Medicare prospective payment system reimbursement from each submitted home nursing episode is received in the form of a request for accelerated payment, or RAP, before all services are rendered. The estimated episodic payment is billed at the commencement of the episode. We receive a RAP for 60.0% of the estimated reimbursement at the initial billing for the initial episode of care per patient and the remaining reimbursement is received upon completion of the episode. For any subsequent episodes of care contiguous with the first episode of care for a patient we receive a RAP for 50.0% of the estimated reimbursement at initial billing. The remaining 50.0% reimbursement is received upon completion of the episode. We have earned net service revenue in excess of billings rendered to Medicare. Only a nominal portion of the amounts due to the Medicare program represent cash collected in advance of providing services.

Our Medicare population is paid at a prospectively set amount that can be determined at the time services are rendered. Our Medicaid reimbursement is based on a predetermined fee schedule applied to each individual service we provide. Our managed care contracts are structured similar to either the Medicare or Medicaid payment methodologies. Because of our payor mix, we are able to calculate our actual amount due at the patient level and adjust the gross charges down to the actual amount at the time of billing. This negates the need for an estimated contractual allowance to be booked at the time we report net service revenue for each reporting period.

At June 30 2006, our allowance for doubtful accounts, as a percentage of patient accounts receivable, was approximately 7.1%. For the six months ended June 30, 2006, the provision for doubtful accounts increased to 2.2% of net service revenue compared to 1.6% of net service revenue for the six months ended June 30, 2005. Adverse changes in general economic conditions, billing operations, payor mix, or trends in federal or state governmental coverage could affect our collection of accounts receivable, cash flows and results of operations.

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The following table sets forth our aging of accounts receivable as of June 30, 2006:


Payor	0-30		31-60		61-90		91-120		121-150		150+		Total
	(in thousands)
Medicare	$	14,082	$	1,526	$	1,886	$	2,696	$	2,744	$	5,612	$	28,546
Medicaid		1,249		354		577		563		708		3,771		7,222
Other		921		701		1,180		962		1,056		6,182		11,002

Total	$	16,252	$	2,581	$	3,643	$	4,221	$	4,508	$	15,565	$	46,770

Intangible Assets

Goodwill represents substantially all of the intangible assets reflected on our consolidated balance sheet, included elsewhere in this prospectus. Goodwill is the excess purchase price over the estimated fair market value of the net assets we have acquired in business combinations. On June 29, 2001, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standard, or SFAS No. 142, Goodwill and Other Intangible Assets, which changed the accounting for goodwill and intangible assets. Under SFAS No. 142, goodwill and indefinite lived intangible assets are no longer amortized but are reviewed annually or more frequently if impairment indicators arise, for impairment. Prior to the adoption of SFAS No. 142, goodwill had been amortized on a straight-line basis over 25 years through December 31, 2001. We adopted SFAS No. 142 effective January 1, 2002.

We completed our annual impairment test under SFAS No. 142 as of October 1, 2005, based on the estimated fair value of the business and we determined that no impairment of goodwill existed. Due to the allocation of goodwill to businesses that have been sold or have been held for sale as of March 31, 2006, we also completed an impairment test as of March 31, 2006. No impairment of goodwill existed. We concluded no impairment indicators were present at December 31, 2005.

We have concluded that licenses to operate home-based and/or facility-based services have indefinite lives, as we have determined that there are no legal, regulatory, contractual, economic or other factors that would limit the useful life of the licenses and we intend to renew and operate the licenses indefinitely. Accordingly, we have elected to recognize the fair value of these indefinite-lived licenses and goodwill as a single asset for financial reporting purposes, as permitted by SFAS No. 141, Business Combinations.

We estimate the fair value of our identified reporting units and compare those estimates against the related carrying value. For each of the reporting units, the estimated fair value is determined based on a multiple of EBITDA or on the estimated fair value of assets in situations when it is readily determinable.

Components of our home-based services segment are generally represented by individual subsidiaries or joint ventures with individual licenses to conduct specific operations within geographic markets as limited by the terms of each license. Components of our facility-based services are represented by individual operating entities. Effective January 1, 2004 we began aggregating the components of these two segments into two reporting units for purposes of evaluating impairment. Prior to January 1, 2004 we evaluated each operating entity separately for impairment. Modifications to our management of the segments and reporting provided us with a basis to change the reporting unit structure.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As of June 30, 2006, we had cash of $19.1 million, which consisted of highly liquid money market instruments with maturities less than 90 days. Because of the short maturities of these instruments, a sudden change in market interest rates would not be expected to have a material impact on the fair value of the portfolio. We would not expect our operating results or cash flows to be materially affected by the effect of a sudden change in market interest rates on our portfolio. At times, cash in banks is in excess of the FDIC insurance limit. The Company has not experienced any loss as a result of those deposits and does not expect any in the future.

Our exposure to market risk relates to changes in interest rates for borrowings under the new senior secured

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credit facility we entered into in April 2005. There were no amounts outstanding under our credit facility as of June 30, 2006; however, any future borrowings are expected to bear interest at variable rates.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

(a) We maintain disclosure controls and procedures designed to provide reasonable assurance that information required to be disclosed in our reports under the Securities and Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. Our management, with the participation and oversight of our chief executive officer and chief financial officer, evaluated the design and effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. As previously reported in our Form 10-K for the year ended December 31, 2005, in conducting this evaluation for the period ended December 31, 2005 a material weakness was identified in our internal control over financial reporting relating to preventing posting errors within the patient billing system for certain rebilled accounts. Specifically, our personnel lacked sufficient knowledge and experience in our billing and revenue management software and we did not establish appropriate controls to detect or correct errors relating to these rebilled transactions. On the basis of this finding, our chief executive officer and our chief financial officer concluded that our disclosure controls and procedures were not effective, as of the end of the December 31, 2005 period. The correction of these posting errors resulted in a $900,000 increase to revenue for the year ended December 31, 2005. The potential effects of these posting errors on our financial statements issued during the interim periods of 2005 were not material. In connection with the 2005 audit of our financial statements, Ernst & Young, LLP, our independent registered public accounting firm, issued a management letter which noted that we had this material weakness in our internal control over financial reporting. No other material weaknesses in our internal control over financial reporting were identified in the management letter.

Although the Company’s remediation efforts are well underway with respect to the above referenced material weakness, the deficiency will not be considered remediated until the new internal controls over financial reporting implemented to remediate the material weakness are fully implemented and operational for a period of time and are successfully tested, and management concludes that these controls are operating effectively. As of June 30, 2006, the Company’s chief executive officer and chief financial officer concluded that because additional testing is required to determine if the material weakness described in the Company’s annual report on Form 10-K for the year ended December 31, 2005 has been fully remedied, the Company did not maintain effective disclosure controls and procedures as of the end of the period covered by this report.

(b) There have been no changes in our internal control over financial reporting during the period covered by this report that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Subsequent to identifying the material weakness in our internal control over financial reporting with respect to our rebilled transactions, we initiated the process of improving our internal controls over these transactions through additional training on our software for those individuals recording these transactions, strict procedural controls and documentation requirements over rebilled transactions, and newly established monitoring, review and approval controls over these transactions.

On September 21, 2005, the SEC extended the compliance dates related to Section 404 of the Sarbanes-Oxley Act for non-accelerated filers. Under this extension a company that is not required to file its annual and quarterly reports on an accelerated basis (non-accelerated filer) must begin to comply with the internal control over financial reporting requirements for its first fiscal year ending on or after July 15, 2007. We anticipate that we will become an accelerated filer in calendar 2006 and therefore we will be required to comply with these requirements for the year ending December 31, 2006. We are currently in the process of documenting our internal control structure.

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PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

We are involved in litigation and proceedings in the ordinary course of business. We do not believe that the outcome of any of the matters in which we are currently involved, individually or in the aggregate, will have a material adverse effect upon our business, financial condition, or results of operations.

ITEM 1A. RISK FACTORS.

You should carefully consider the risks described below before investing in the Company. The risks and uncertainties described below are not the only ones we face. Other risks and uncertainties that we have not predicted or assessed may also adversely affect us.

If any of the following risks occurs, our earnings, financial condition or business could be materially harmed, and the trading price of our common stock could decline, resulting in the loss of all or part of your investment.

More than 80% of our net service revenue is derived from Medicare. If there are changes in Medicare rates or methods governing Medicare payments for our services, or if we are unable to control our costs, our net service revenue and net income could decline materially.

For the six months ended June 30, 2006 and 2005, we received 84.8% and 86.3%, respectively, of our net service revenue from Medicare. Reductions in Medicare rates or changes in the way Medicare pays for services could cause our net service revenue and net income to decline, perhaps materially. Reductions in Medicare reimbursement could be caused by many factors, including:

	•		administrative or legislative changes to the base rates under the applicable prospective payment systems;

	•		the reduction or elimination of annual rate increases;

	•		the imposition or increase by Medicare of mechanisms, such as co-payments, shifting more responsibility for a portion of payment to beneficiaries;

	•		adjustments to the relative components of the wage index used in determining reimbursement rates;

	•		changes to case mix or therapy thresholds;

	•		the reclassification of home health resource groups or long-term care diagnosis-related groups; or

	•		further limitations on referrals to long-term acute care hospitals from host hospitals.

We generally receive fixed payments from Medicare for our services based on the level of care provided to our patients. Consequently, our profitability largely depends upon our ability to manage the cost of providing these services. Medicare currently provides for an annual adjustment of the various payment rates, such as the base episode rate for our home nursing services, based upon the increase or decrease of the medical care expenditure category of the Consumer Price Index, which may be less than actual inflation. This adjustment could be eliminated or reduced in any given year. Our base episode rate for home nursing services is also subject to an annual market basket adjustment. Further, Medicare routinely reclassifies home health resource groups and long-term care diagnosis-related groups. As a result of those reclassifications, we could receive lower reimbursement rates depending on the case mix of the patients we service. If our cost of providing services increases by more than the annual Medicare price adjustment, or if these reclassifications result in lower reimbursement rates, our net income could be adversely impacted.

We are subject to extensive government regulation. Any changes in the laws governing our business, or the interpretation and enforcement of those laws or regulations, could cause us to modify our operations and could negatively impact our operating results.

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As a provider of healthcare services, we are subject to extensive regulation on the federal, state and local levels, including with regard to:

	•		agency, facility and professional licensure, certificates of need and permits of approval;

	•		conduct of operations, including financial relationships among healthcare providers, Medicare fraud and abuse, and physician self-referral;

	•		maintenance and protection of records, including the Health Insurance Portability and Accountability Act of 1996, or HIPAA;

	•		environmental protection, health and safety;

	•		certification of additional agencies or facilities by the Medicare program; and

	•		payment for services.

The laws and regulations governing our operations, along with the terms of participation in various government programs, regulate how we do business, the services we offer, and our interactions with patients and other providers. These laws and regulations, and their interpretations, are subject to frequent change. Changes in existing laws or regulations, or their interpretations, or the enactment of new laws or regulations could increase our costs of doing business and cause our net income to decline. If we fail to comply with these applicable laws and regulations, we could suffer civil or criminal penalties, including the loss of our licenses to operate and our ability to participate in federal and state reimbursement programs.

We are subject to various routine and non-routine governmental reviews, audits, and investigations. In recent years federal and state civil and criminal enforcement agencies have heightened and coordinated their oversight efforts related to the healthcare industry, including with respect to referral practices, cost reporting, billing practices, joint ventures and other financial relationships among healthcare providers. A violation or change in the interpretation of the laws governing our operations, or changes in the interpretation of those laws, could result in the imposition of fines, civil or criminal penalties, the termination of our rights to participate in federal and state-sponsored programs, or the suspension or revocation of our licenses to operate. If we become subject to material fines or if other sanctions or other corrective actions are imposed upon us, we may suffer a substantial reduction in net income.

If any of our agencies or facilities fail to comply with the conditions of participation in the Medicare program, that agency or facility could be terminated from Medicare, which would adversely affect our net service revenue and net income.

Our agencies and facilities must comply with the extensive conditions of participation in the Medicare program. These conditions of participation vary depending on the type of agency or facility, but in general require our agencies and facilities to meet specified standards relating to personnel, patient rights, patient care, patient records, administrative reporting and legal compliance. If an agency or facility fails to meet any of the Medicare conditions of participation, that agency or facility may receive a notice of deficiency from the applicable state surveyor. If that agency or facility then fails to institute and comply with a plan of correction to correct the deficiency within the time period provided by the state surveyor, that agency or facility could be terminated from the Medicare program. We respond in the ordinary course to deficiency notices issued by state surveyors, and none of our facilities or agencies have ever been terminated from the Medicare program for failure to comply with the conditions of participation. Any termination of one or more of our agencies or facilities from the Medicare program for failure to satisfy the Medicare conditions of participation would affect adversely our net service revenue and net income.

In addition, if our long-term acute care hospitals fail to meet or maintain the standards for Medicare certification as long-term acute care hospitals, such as for average minimum length of patient stay, they will receive reimbursement under the prospective payment system applicable to general acute care hospitals rather than the system applicable to long-term acute care hospitals. Payments at rates applicable to general acute care hospitals would likely result in our long-term acute care hospitals receiving less Medicare reimbursement than they currently

- 38 -


	Allowable Admissions
	From Host Hospital
	Before Payment
	Reduction
Cost Report Period Beginning	MSAs			Non-MSAs

Until September 30, 2005		100.0	%		100.0	%
October 1, 2005 – September 30, 2006		75.0	%		75.0	%
October 1, 2006 – September 30, 2007		50.0	%		50.0	%
October 1, 2007 – and thereafter		25.0	%		50.0	%


Name of Director	Votes For		Votes Withheld		Abstentions
W. Patrick Mulloy, II		15,184,616		33,300		0
Dan S. Wilford		15,206,866		11,050		0


Votes For	Votes Withheld	Abstentions
15,210,359	4,700	2,857


Votes For	Votes Withheld	Abstentions
14,393,534	15,600	357

		The Lifeline Health Group, Inc. (“Parent”), certain wholly-owned subsidiaries of Parent, and certain owners of Parent, dated June 19, 2006 (previously filed as Exhibit 2.1 to the Registrant’s Current Report on Form 8-K dated June 23, 2006 and filed June 23, 2006).

3.1		Certificate of Incorporation of LHC Group, Inc. (previously filed as an exhibit to the Form S-1/A (File No. 333-120792) on February 14, 2005)

3.2		Bylaws of LHC Group, Inc. (previously filed as an exhibit to the Form S-1/A (File No. 333-120792) on May 9, 2005).

4.1		Specimen Stock Certificate of LHC’s Common Stock, par value $0.01 per share (previously filed as an exhibit to the Form S-1/ A (File No. 333-120792) on February 14, 2005).

4.2		Reference is made to Exhibits 3.1 and 3.2 (previously filed as an exhibit to the Form S-1/A (File No. 333-120792) on February 14, 2005 and May 9, 2005, respectively).

10.1		Employment Agreement, effective June 1, 2006, by and between Barry E. Stewart and LHC Group, Inc. (previously filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K dated May 23, 2006 and filed on May 23, 2006).

10.2		Separation Agreement, General Release of All Claims and Covenant Not to Sue by and between LHC Group, Inc. and R. Barr Brown, dated June 5, 2006 (previously filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K dated June 7, 2006 and filed June 7, 2006).

31.1		Certification of Keith G. Myers, Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of Barry E. Stewart, Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1*		Certification of Keith G. Myers, Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2*		Certification of Barry E. Stewart, Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

99.1		Amendment to the LHC Group, Inc. Amended and Restated 2005 Non-Employee Directors Compensation Plan (previously filed as Exhibit 99.1 to the Registrant’s Current Report on Form 8-K dated June 16, 2006 and filed June 16, 2006).

99.2		LHC Group, Inc. 2006 Employee Stock Purchase Plan (previously filed as Exhibit 99.2 to the Registrant’s Current Report on Form 8-K dated June 16, 2006 and filed June 16, 2006).

	•		The investment interest offered is not based upon actual or expected referrals by the hospital or physician.

	•		Our joint venture partners are not required to make or influence referrals to the joint venture.

	•		At the time the joint venture is formed, each hospital or physician joint venture partner is required to make an actual capital contribution to the joint venture equal to the fair market value of its investment interest and is at risk to lose its investment.

	•		Neither we nor the joint venture entity lends funds to or guarantees a loan to acquire interests in the joint venture for a hospital or physician.

	•		Distributions to our joint venture partners are based solely on their equity interests and not affected by referrals from the hospital or physician.

	•		limitations on persons authorized to call a special meeting of stockholders;

	•		the authorization of undesignated preferred stock, the terms of which may be established and shares of which may be issued without stockholder approval; and

	•		advance notice procedures required for stockholders to nominate candidates for election as directors or to bring matters before an annual meeting of stockholders.

	•		our operating and financial performance;

	•		variances in our quarterly financial results compared to research analyst expectations;

	•		the depth and liquidity of the market for our common stock;

	•		future sales of our common stock or the perception that sales could occur;

	•		investor perception of our business, acquisitions and our prospects;

	•		developments relating to litigation or governmental investigations;

	•		changes or proposed changes in healthcare laws or regulations or enforcement of these laws and regulations, or announcements relating to these matters; or

	•		general economic and stock market conditions.


*		This exhibit is furnished to the SEC as an accompanying document and is not deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that Section, and the document will not be deemed incorporated by reference into any filing under the Securities Act of 1933.


Date August 11, 2006		/s/ Barry E. Stewart Barry E. Stewart
		Senior Vice President and Chief Financial Officer