Home oxygen and respiratory care provider Lincare Holdings (NASDAQ:LNCR) left investors feeling a little winded after reporting year-end earnings Monday evening. While sales were up 7% and net income grew 16% over the prior December, both of those results were short of Wall Street guesstimates.

What's worse, the future won't be getting any easier. Roughly three-quarters of the company's customers are covered by Medicare (and contribute more than two-thirds of revenue), and the Center for Medicare and Medicaid Services (CMS) is presently pondering significant cuts in reimbursement for the products and services offered by Lincare.

Though the details have not been publicly released, speculation among analysts and industry-watchers is that the price for oxygen administration will be cut by about 10% or more, with rates for respiratory medicines possibly cut in half. As of now, not only is the size of the cut unknown but there have also been rumors that CMS may or may not offer an "administration fee" that would help companies like Lincare recoup some revenue.

That said, Lincare has survived prior rate cuts and did so primarily through acquiring more centers and wringing more productivity out of the existing business. In the December quarter, for instance, Lincare posted an operating margin of 37.3% -- up from 34.5% in the year-ago period. On the acquisition front, the market for home respiratory care remains very scattered and the company still has many quality small companies to choose from for future acquisitions.

Lincare generated almost $419 million in operating cash flow for 2004; it spent about $90 million on capital expenditures and $83 million on business acquisitions. Although a free cash flow calculation normally excludes business acquisitions, I'd argue that an exception needs to be made in cases like Lincare. Because small strategic acquisitions have been (and likely will continue to be) such a consistent practice, I'd argue that they are qualitatively similar to expenditures on capital equipment.

With such a large cloud hanging overhead, it's not surprising that Lincare has a reasonable valuation. The stock's trailing P/E is about 16 and the EV-to-FCF (including acquisitions) is about 17. With a return on assets in excess of 17% and a return on equity above 27%, there is no doubt that Lincare has a good base business and a skilled management team.

Investors who already own these shares might just want to hang on -- Lincare has been through this before, and I, for one, would not bet against the company surviving and eventually thriving, even after this new round of reimbursement cuts. Those who don't already own the shares, though, may want to hold off until Medicare makes up its mind, since a decision that's worse than expected could knock the wind out of these shares in the short run.

Fool contributor Stephen Simpson, CFA, has no ownership interest in any stocks mentioned.