Vasta Platform 10Q 2003 Q2 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


[X]		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
		SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2003


[ ]		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File No. 000-50118

VistaCare, Inc.

(Exact name of registrant as specified in its charter)


Delaware		06-1521534
(State or other jurisdiction of		(I.R.S. Employer Identification No.)
incorporation or organization)

4800 North Scottsdale Road, Suite 5000
Scottsdale, Arizona		85251
(Address of principal executive offices)		(Zip code)

(480) 648-4545
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), 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. [X] Yes [ ] No

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). [ ] Yes [X] No

As of June 30, 2003, there were outstanding 15,664,207 shares of the registrant’s Class A Common Stock, $0.01 par value per share.

TABLE OF CONTENTS


PART I — FINANCIAL INFORMATION
	Item 1. Financial Statements
		CONDENSED CONSOLIDATED BALANCE SHEETS
		CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
		CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
		NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosures About Market Risk.
	Item 4. Controls and Procedures.
PART II — OTHER INFORMATION
	Item 1. Legal Proceedings
	Item 2. Changes in Securities and Use of Proceeds
	Item 3. Defaults Upon Senior Securities.
	Item 4. Submission of Matters to a Vote of Security Holders.
	Item 5. Other Information.
	Item 6. Exhibits and Reports on Form 8-K.
SIGNATURES
EXHIBIT INDEX
EX-10.40
EX-31.1
EX-31.2
EX-32.1
EX-32.2

VistaCare, Inc.

TABLE OF CONTENTS


PART I — FINANCIAL INFORMATION		2
	Item 1. Financial Statements	2
Condensed Consolidated Balance Sheets at December 31, 2002 and June 30, 2003		2
Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2002 and June 30, 2003		3
Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2002 and June 30, 2003		4
Notes to Condensed Consolidated Financial Statements		5
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	13
	Item 3. Quantitative and Qualitative Disclosures About Market Risk	33
	Item 4. Controls and Procedures	33
PART II — OTHER INFORMATION		34
	Item 1. Legal Proceedings	34
	Item 2. Changes in Securities and Use of Proceeds	34
	Item 3. Defaults Upon Senior Securities	34
	Item 4. Submission of Matters to a Vote of Security Holders	34
	Item 5. Other Information	35
	Item 6. Exhibits and Reports on Form 8-K	35
SIGNATURES		36
EXHIBIT INDEX		37

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements.

VISTACARE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS


		December 31,			June 30,
		2002			2003

					(unaudited)
		(In thousands, except
		share related amounts)
ASSETS
Current assets:
	Cash and cash equivalents	$	39,104		$	44,534
	Patient accounts receivable		19,075			18,867
	Patient accounts receivable room & board		7,613			10,006
	Prepaid expenses and other current assets		1,312			2,545

Total current assets			67,104			75,952
Equipment, net			2,612			3,344
Goodwill, net of amortization			20,564			20,564
Other assets			4,663			7,898

Total assets		$	94,943		$	107,758

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
	Accounts payable	$	2,288		$	1,424
	Accrued expenses		22,982			27,142
	Current portion of long-term debt		250			250
	Current portion of capital lease obligations		82			78

Total current liabilities			25,602			28,894
Capital lease obligations, less current portion			94			56
Deferred tax liability			—			1,437
Stockholders’ equity:
	Class A Common Stock, $0.01 par value; authorized 33,000,000 shares; 15,420,899 and 15,664,207 shares issued and outstanding at December 31, 2002 and June 30, 2003, respectively		154			157
	Class B Common Stock, $0.01 par value; authorized 200,000 shares; 58,096 shares issued and outstanding at December 31, 2002 and none issued and outstanding at June 30, 2003		1			—
	Additional paid-in capital		101,161			101,310
	Deferred compensation		(2,552	)		(1,225	)
	Accumulated deficit		(29,517	)		(22,871	)

Total stockholders’ equity			69,247			77,371

Total liabilities and stockholders’ equity		$	94,943		$	107,758

See accompanying notes to condensed consolidated financial statements.

VISTACARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)
(In thousands, except share related
information)


		Three Months Ended June 30,						Six Months Ended June 30,

		2002			2003			2002			2003

Net patient revenue		$	31,000		$	46,050		$	58,674		$	88,050
Operating expenses:
	Patient care		18,710			27,713			35,979			51,799
	General and administrative expenses, exclusive of stock-based compensation charges reported below		10,075			13,142			18,988			26,493
	Depreciation and amortization		303			370			574			714
	Stock-based compensation		88			102			137			1,149

	Total operating expenses		29,176			41,327			55,678			80,155

Operating income			1,824			4,723			2,996			7,895

Non-operating (expense) income:
	Interest income		—			108			2			209
	Interest expense		(204	)		(29	)		(405	)		(77	)
	Other expense		(39	)		(36	)		(67	)		(51	)

	Total non-operating (expense) income		(243	)		43			(470	)		81

Net income before income taxes			1,581			4,766			2,526			7,976
Income tax expense			65			944			101			1,330

Net income			1,516			3,822			2,425			6,646
Accrued preferred stock dividends			1,032			—			2,065			—

Net income to common stockholders		$	484		$	3,822		$	360		$	6,646

Net income per common share:
	Basic net income per common share	$	0.09		$	0.24		$	0.07		$	0.43

	Diluted net income per common share	$	0.08		$	0.23		$	0.06		$	0.40

Weighted average shares outstanding:
	Basic		5,110			15,633			5,105			15,595

	Diluted		6,022			16,913			5,874			16,800

See accompanying notes to condensed consolidated financial statements.

VISTACARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


			Six Months Ended
			June 30,
			2002			2003

			(unaudited)
			(In thousands)
Operating activities
Net income			$	2,425		$	6,646
Adjustments to reconcile net income to net cash provided by operating activities:
	Depreciation and amortization			574			714
	Warrant amortization			76			—
	Deferred compensation related to stock options			137			1,149
	Loss on disposal of assets			—			23
	Changes in operating assets and liabilities:
		Patient accounts receivable		(822	)		(2,185	)
		Prepaid expenses and other		(383	)		(3,296	)
		Accounts payable and accrued expenses		923			4,692

Net cash provided by operating activities				2,930			7,743
Investing activities
Purchases of equipment				(541	)		(1,178	)
Increase in other assets				(963	)		(1,463	)

Net cash used in investing activities				(1,504	)		(2,641	)
Financing activities
Net payments on long-term debt				(818	)		—
Cost associated with common stock offering				—			(191	)
Proceeds from issuance of common stock from exercise of stock options				74			519

Net cash (used in) provided by financing activities				(744	)		328

Net increase in cash and cash equivalents				682			5,430
Cash and cash equivalents, beginning of period				1,384			39,104

Cash and cash equivalents, end of period			$	2,066		$	44,534

Non cash activity
	Preferred stock dividends		$	2,065		$	—

See accompanying notes to condensed consolidated financial statements.

VISTACARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Description of Business

VistaCare, Inc. (VistaCare), is a Delaware corporation providing medical care designed to address the physical, emotional, and spiritual needs of patients with a terminal illness and to support their family members. Hospice services are provided predominately in the patient’s home; however, certain patients require inpatient services. These inpatient services are provided by VistaCare at its stand-alone inpatient facility in Cincinnati, Ohio, at its hospital-based inpatient facility in Albuquerque, New Mexico or through leased beds at other unrelated hospitals and skilled nursing facilities on a per diem basis. VistaCare provides services in Alabama, Arizona, Colorado, Georgia, Indiana, Massachusetts, New Mexico, Nevada, Ohio, Oklahoma, Pennsylvania, South Carolina, Texas and Utah.

1. Significant Accounting Policies

Basis of Presentation

The accompanying condensed consolidated financial statements include accounts of VistaCare and its wholly-owned subsidiaries: VistaCare USA, Inc., Vista Hospice Care, Inc., and FHI Health Services, Inc. (including its wholly-owned subsidiaries). Intercompany transactions and balances have been eliminated in consolidation.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. Operating results for the six-month period ended June 30, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003.

The balance sheet at December 31, 2002 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in VistaCare’s annual report on Form 10-K for the year ended December 31, 2002.

Capitalized Software Development Costs

VistaCare capitalizes certain internal salaries related to the development of computer software used in its operations. Such capitalized software development costs are being amortized over three years. Capitalized software development costs, net of amortization, included in other assets, amounted to $3,965,000 at December 31, 2002 and $4,899,000 at June 30, 2003. Costs incurred during the preliminary project stage and post implementation/operations stage are expensed as incurred.

Goodwill

During 1998, VistaCare completed the acquisitions of FHI Health Services, Inc. and Vencor Hospice, Inc. (VistaCare USA, Inc.). During 2002, VistaCare completed the acquisition of Palliative Care Concepts, Inc. The difference between the purchase prices and the fair value of assets acquired and liabilities assumed was recorded as goodwill. Prior to January 1, 2002, VistaCare amortized goodwill over a period of 30 years. Amortization related to goodwill totaled $2,408,000 on January 1, 2002 and 2003. No amortization was recognized in the six-months ended June 30, 2002 and 2003.

In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 141,Business Combinations,and SFAS No. 142,Goodwill and Other Intangible Assets,

which became effective for VistaCare in the first quarter of 2002. Under these rules, goodwill and intangible assets deemed to have indefinite lives are no longer amortized but are subject to impairment tests that must be conducted at least annually, or more often if events or circumstances arise that indicate that the carrying value of the goodwill associated with VistaCare’s acquired businesses exceeds its fair market value. VistaCare determined that no impairment of goodwill existed at December 31, 2002 or at June 30, 2003.

Acquisition

In August 2002, VistaCare completed the acquisition of Palliative Care Concepts, Inc., a hospice program in Albuquerque, New Mexico. VistaCare paid $2,500,000 in cash and issued a $250,000 unsecured promissory note to the seller in connection with the acquisition. The purchase price was allocated primarily to goodwill. The promissory note was paid in full in July 2003.

Net Patient Revenue

Net patient revenue is the amount VistaCare believes it is entitled to collect for its services, adjusted as described below. The amount VistaCare believes it is entitled to collect for its services varies depending on the level of care provided, the payor and the geographic area where services are rendered. Net patient revenue includes adjustments for charity care and estimated payment denials (which VistaCare experiences from time to time for reasons such as its failure to submit complete and accurate claim documentation, its failure to provide timely written physician certifications as to patient eligibility, or the payor deems the patient ineligible for insurance coverage), contractual adjustments, amounts VistaCare estimates it could be required to repay to Medicare, such as payments that VistaCare would be required to make in the event that any of its programs exceed the annual per-beneficiary cap, and subsequent changes to initial level of care determinations. VistaCare adjusts its estimates from time to time based on its billing and collection experience. VistaCare believes that it can reasonably estimate such adjustments to net patient revenue because it has significant historical experience and because it has a centralized billing and collection department that continually monitors the factors that could potentially result in a change in estimate. There were no material changes in estimates to net patient revenue for the year ended December 31, 2002 or the six-month periods ended June 30, 2002 and 2003. VistaCare recognizes net patient revenue once the patient’s hospice eligibility has been certified, the patient’s coverage from a payment source has been verified and services have been provided to that patient.

Approximately 95% and 96% of VistaCare’s net patient revenue was derived from the Medicare and Medicaid programs for the six-month periods ended June 30, 2002 and 2003, respectively. VistaCare operates under arrangements with Medicare, Medicaid and other third-party payors pursuant to which these payors reimburse VistaCare for services it provides to hospice-eligible patients these payors cover, subject only to VistaCare’s submission of adequate and timely claim documentation. VistaCare has a patient intake process that screens patients for hospice eligibility and identifies whether their care will be covered by Medicare, Medicaid, private insurance, managed care or self-pay. Whether Medicare or Medicaid continue to provide reimbursement for hospice care is dependent upon governmental policies.

Medicare and Medicaid Regulation

VistaCare is subject to certain limitations on Medicare payments for services. Specifically, if the number of inpatient care days of care any hospice program provides to Medicare beneficiaries exceeds 20% of the total days of hospice care such program provides to all patients for an annual period beginning September 28, the days in excess of the 20% figure may be reimbursed only at the routine home care rate. None of VistaCare’s hospice programs exceeded the payment limits on inpatient services in the six-month periods ended June 30, 2002 or 2003.

VistaCare is also subject to a Medicare annual per-beneficiary cap. Compliance with the Medicare per-beneficiary cap is measured by comparing the cost of services provided to each Medicare beneficiary by each hospice program during the Medicare fiscal year ending October 31 to the per-beneficiary cap amount for each Medicare beneficiary in such program who elects to receive the Medicare hospice benefit for the first time during such fiscal year. VistaCare recorded reductions to net patient revenue of approximately $1,262,000 for the eight months ended June 30, 2003 as estimates for exceeding the Medicare per-beneficiary cap for the 2003 fiscal cap year that began on November 1, 2002. VistaCare did not record any reduction to net patient revenue for the eight months ended June 30, 2002 as an estimate for exceeding the per-

beneficiary cap for the 2002 fiscal cap year that began November 1, 2001. As of the date of this report, VistaCare had not been assessed any amounts for exceeding the per-beneficiary cap for the assessment periods that began on November 1, 2001 and November 1, 2002. VistaCare management believes that as of June 30, 2003 adequate reserves had been established for this potential liability.

VistaCare monitors each of its programs to determine whether such programs are likely to exceed the foregoing limitations and estimates the extent to which it could be required to repay Medicare. At the time that management estimates the potential impact of having exceeded the Medicare limitations, the estimated assessment is deducted from net patient revenue and accrued as an accrued expense.

Laws and regulations governing the Medicare and Medicaid program are complex and subject to interpretation. VistaCare believes that it is in compliance with all applicable laws and regulations and is not aware of any pending or threatened investigations involving allegations of potential wrongdoing, which would have a material impact on VistaCare’s consolidated financial condition, or results of operations. 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 and Medicaid programs.

Charity Care

VistaCare provides care at no cost to patients who are not eligible for insurance coverage and meet certain financial need criteria established by VistaCare. Charity care totaled approximately $305,000 and $722,000 for the three months ended June 30, 2002 and 2003, respectively, and $818,000 and $1,388,000 for the six months ended June 30, 2002 and 2003, respectively. Because VistaCare does not pursue collection of amounts determined to qualify as charity care, these amounts are not recorded in net patient revenue. Costs VistaCare incurs in providing charity care are recorded as patient care expenses.

Nursing Home Costs

For patients receiving nursing home care under state Medicaid programs who elect hospice care under Medicare or Medicaid, VistaCare contracts with nursing homes for the nursing homes’ provision to patients of room and board services. In most states, the applicable Medicaid program must pay VistaCare, in addition to the applicable Medicare or Medicaid hospice daily or hourly rate, an amount equal to at least 95% of the Medicaid daily nursing home rate for room and board furnished to the patient by the nursing home. In some states, the Medicaid program pays the nursing home directly for these costs or has created a Medicare managed care program that either reduces or eliminates this room and board payment. Under VistaCare’s standard nursing home contracts, VistaCare pays the nursing home for these room and board services at predetermined contract rates. Nursing home costs are offset by nursing home revenue and the net amount is included in patient care expenses.

Nursing home costs totaled approximately $6,351,000 and $7,623,000 for the three months ended June 30, 2002 and 2003, respectively, and $10,002,000 and $15,108,000 for the six months ended June 30, 2002 and 2003, respectively. Nursing home revenue totaled approximately $6,014,000 and $7,191,000 for the three months ended June 30,2002 and 2003, respectively, and $9,505,000 and $14,307,000 for the six months ended June 30, 2002 and 2003, respectively.

Income Taxes

VistaCare accounts for income taxes under the liability method as required by SFAS No. 109,Accounting for Income Taxes.Under the liability method, deferred taxes are determined based on temporary differences between financial statement and tax bases of assets and liabilities existing at each balance sheet date using enacted tax rates for years in which the related taxes are expected to be paid or recovered.

Medical Malpractice

VistaCare is covered by claims-made general and professional liability insurance coverage with limits of $1,000,000 per claim and $3,000,000 in the aggregate. VistaCare has not experienced any uninsured medical

malpractice losses.

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 amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Stock-Based Compensation

VistaCare has elected to follow Accounting Principles Board Opinion No. 25 (APB No. 25),Accounting for Stock Issued to Employeesand related interpretations, in accounting for its employee stock options rather than the alternative fair value accounting allowed by SFAS No. 123 (SFAS 123),Accounting for Stock-Based Compensation. Under APB No. 25, if the exercise price of VistaCare’s stock options equals or exceeds the estimated fair value of the underlying stock on the dates of grant, no compensation expense is recognized. However, if the exercise prices of VistaCare’s stock options are less than the estimated fair value, on the date of grant, then compensation expense will be recognized for the difference over the related vesting periods.

If compensation for options granted under VistaCare’s stock option plan had been determined based on the deemed fair value at the grant date consistent with the method provided under SFAS 123, then VistaCare’s net income would have been as indicated in the pro forma table below (in thousands, except share related information).


		Three Months Ended June 30,						Six Months Ended June 30,
		2002			2003			2002			2003

Net income to common stockholders:
	As reported:	$	484		$	3,822		$	360		$	6,646
	Add: Stock-based employee compensation expense included in reported net income, net of related tax effects		88			102			137			1,149
	Deduct: Total stock-based compensation expense determined under fair value method for all awards		(132	)		(831	)		(277	)		(1,618	)

	Pro forma net income to common stockholders	$	440		$	3,093		$	220		$	6,177

Basic net income per common share:
	As reported	$	0.09		$	0.24		$	0.07		$	0.43
	Pro forma		0.09			0.20			0.04			0.40
Diluted net income per common share:
	As reported	$	0.08		$	0.23		$	0.06		$	0.40
	Pro forma		0.07			0.18			0.04			0.37
Weighted average shares used in computation:
	Basic		5,110			15,633			5,105			15,595
	Diluted		6,022			16,913			5,874			16,800

Initial Public Offering

On December 23, 2002, VistaCare completed its initial public offering of common stock (IPO) at $12.00 per share. VistaCare sold 4,500,000 shares and received $48,145,000 in net proceeds from the IPO. The remaining proceeds will be used to finance potential acquisitions of hospices and for other corporate purposes. Upon the closing of the IPO in December 2002, all of VistaCare’s redeemable and convertible preferred stock was converted into 5,603,111 shares of VistaCare’s Class A common stock. The accumulated dividends on VistaCare’s Series B,

C and D preferred stock of $16,486,000, which were not payable in the event of a mandatory conversion, were reclassified as additional paid-in-capital and no additional dividends will be accrued or recorded subsequent to the IPO.

Earnings Per Share

Basic net income per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per common share is computed by dividing net income by the weighted average number of shares outstanding during the period plus the effect of dilutive securities, including outstanding warrants, employee stock options (using the treasury stock method) and shares of Series A-1 Preferred Stock (using the if-converted method).

Recent Accounting Pronouncements

In April 2002, the FASB issued SFAS No. 145,Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002. This statement eliminates accounting treatment for reporting gains or losses on debt extinguishments and amends certain other existing accounting pronouncements. The adoption of this standard is not expected to have a material effect on VistaCare’s consolidated financial position or results of operations.

In June 2002, the FASB issued SFAS No. 146,Accounting for Costs Associated with Exit or Disposal Activities.SFAS No. 146 nullifies the guidance in EITF Issue No. 94-3,Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity.Under EITF No. 94-3, an entity recognizes a liability for an exit cost on the date that the entity committed itself to an exit plan. In SFAS No. 146, the FASB acknowledges that an entity’s commitment to a plan does not, by itself, create a present obligation to the other parties that meets the definition of a liability and requires that a liability for a cost that is associated with an exit or disposal activities be recognized when the liability is incurred. It also establishes that fair value is the objective for the initial measurement of the liability. SFAS No. 146 will be effective for exit or disposal activity that are initiated after December 31, 2002. The adoption of this standard is not expected to have a material effect on VistaCare’s financial position or results of operations.

In November 2002, the FASB issued Interpretation No. 45,Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.FIN No. 45 requires certain guarantees to be recorded at fair value. FIN No. 45 also requires a guarantor to make certain disclosures about guarantees even when the likelihood of making any payments under the guarantee is remote. FIN No. 45 is effective for financial statements of interim or annual periods ending after December 15, 2002. The adoption of this interpretation did not have a material effect on VistaCare’s consolidated financial position or results of operations.

In December 2002, the FASB issued SFAS No. 148,Accounting for Stock-Based Compensation — Transition and Disclosure.SFAS No. 148 amends SFAS No. 123,Accounting for Stock-Based Compensationand provides alternative methods of transition for a voluntarily change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based compensation and the effect of the method used on reported results. SFAS No. 148 is effective for fiscal years ending after December 15, 2002. While SFAS No. 148 does not amend SFAS No. 123 to require companies to account for employee stock options using the fair value method, the disclosure provisions of SFAS No. 148 are applicable to all companies with stock-based employee compensation, regardless of whether they account for that compensation using the fair value method of SFAS No. 123 or the intrinsic method of APB Opinion No. 25. As allowed by SFAS No. 123, VistaCare has elected to continue to utilize the accounting method prescribed by APB Opinion No. 25 and has adopted the disclosure requirements of SFAS No. 123 as of December 1, 2002.

In January 2003, the FASB issued Interpretation No. 46,Consolidation of Variable Interest Entities.FIN No. 46 addresses the consolidation and financial reporting of variable interest entities. FIN No. 46 is effective for financial statements of interim or annual periods beginning after June 15, 2002 for variable interest entities created before February 1, 2003, or immediately for variable interest entities created after February 1, 2003. The adoption

of this interpretation is not expected to have a material effect on VistaCare’s consolidated financial position or results of operations.

2. Accrued Expenses

A summary of accrued expenses follows (in thousands):


	December 31, 2002		June 30, 2003

Treatment costs	$	10,758	$	12,241
Self-insured health costs		1,994		2,580
Salaries and payroll taxes		5,119		5,823
Medicare cap accrual		1,263		2,239
Other		3,848		4,259

	$	22,982	$	27,142

3. Income Taxes

VistaCare’s provisions for income taxes for the six-month periods ended June 30, 2002 and 2003 reflect its estimates of the effective tax rate applicable for the full year. This estimate is re-evaluated by management each quarter based upon forecasts of income before taxes for the year. VistaCare’s effective tax rate in these periods was lower than the federal statutory rates primarily due to its use of tax credits and net operating loss carryforwards.

4. Long-Term Debt

In April 2001, VistaCare entered into a $30,000,000 revolving line of credit and a $3,000,000 term loan (credit facility). The credit facility is collateralized by substantially all of VistaCare’s assets including cash, accounts receivable and equipment. Loans under the revolving line of credit bear interest at an annual rate equal to, at VistaCare’s option, either the “prime rate” in effect from time to time, as reported in the “Money Rates” section of theWall Street Journal, plus 1.5%, or the one-month London Interbank Borrowing Rate in effect from time to time, plus 3.0%. Accrued interest under the revolving line of credit is due (i) weekly, if VistaCare opts to pay interest at the prime rate, or (ii) on the last business day of the month, if VistaCare opts to pay interest at the London Interbank Borrowing Rate based rate.

Under the revolving line of credit, VistaCare may borrow, repay and reborrow an amount equal to the lesser of: (i) $30,000,000 or (ii) 85% of the estimated net value of eligible accounts receivable. As of June 30, 2003, approximately $26.2 million was available for borrowing under the revolving line of credit. The maturity date of the revolving line of credit is April 30, 2005. As of June 30, 2003, there was no balance outstanding on the revolving line of credit.

The credit facility contains certain customary covenants including those that restrict the ability of VistaCare to incur additional indebtedness, pay dividends under certain circumstances, permit liens on property or assets, make capital expenditures, make certain investments, and prepay or redeem debt or amend certain agreements relating to outstanding indebtedness.

In connection with its acquisition of Palliative Care Concepts, Inc., VistaCare issued a $250,000 unsecured promissory note. The promissory note bears interest at a rate of 4.0% per annum and was paid in full in July 2003.

5. Dilutive Securities

The following table presents the calculation of basic and diluted net income per common share (in thousands, except share related information):


			Three Months Ended June 30,					Six Months Ended June 30,
			2002			2003		2002			2003

Numerator
	Net income		$	1,516		$	3,822	$	2,425		$	6,646
	Series B, C and D
		Preferred stock dividends		(1,032	)		—		(2,065	)		—

Numerator for basic and diluted earnings per share – income available to common stockholders			$	484		$	3,822	$	360		$	6,646

Denominator
	Denominator for basic net income per share – weighted average shares			5,110			15,633		5,105			15,595
	Effect of dilutive securities
		Employee stock options		693			1,260		550			1,185
		Common stock warrants		219			20		219			20

Denominator for diluted net income per share – adjusted weighted average shares and assumed conversion				6,022			16,913		5,874			16,800

Net income per common share:
	Basic net (loss) income to common stockholders		$	0.09		$	0.24	$	0.07		$	0.43

	Diluted net income to common stockholders		$	0.08		$	0.23	$	0.06		$	0.40

6. Allowance for Denials

The allowance for denials for patient accounts receivable is as follows (in thousands):


	Balance at		Provision		Write-Offs,			Balance
	Beginning		for		Net of			at End of
	of Period		Denials		Recoveries			Period

Year ended December 31, 2000	$	3,680	$	3,313	$	(3,616	)	$	3,377
Year ended December 31, 2001		3,377		6,199		(5,086	)		4,490
Year ended December 31, 2002		4,490		2,748		(2,876	)		4,362
Six Months Ended June 30, 2003		4,362		2,743		(1,964	)		5,141

7. Litigation

VistaCare and one of its former employees are currently defendants in an action initiated on February 5, 2003 in the United States District Court in the District of Nevada. The action, Bradeen et al. v. Vista Hospice Care, Inc. and Edward Raymond Lowe, relates to a fatal motor vehicle accident involving a VistaCare former employee. The plaintiffs in the action allege that the former employee, while acting within the scope of his employment by VistaCare, negligently and recklessly caused a motor vehicle collision that resulted in the death of two people. The plaintiff’s seek pecuniary and punitive damages in an unspecified amount. VistaCare maintained aggregate liability insurance of $4.0 million at the time of the accident. VistaCare has determined, without considering any possible insurance recovery, that a loss in connection with this matter is possible, but not probable and estimable. Accordingly, VistaCare has not recorded any liability relating to this matter.

VistaCare is involved in various other litigation and administrative proceedings arising in the normal course of business. In the opinion of management, any liabilities that may result from pending litigation and administrative proceedings will not, individually or in the aggregate, have a material adverse effect on VistaCare’s financial position, results of operations, or cash flows.

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

Overview

During the quarter ended June 30, 2003, we experienced significant growth in patient census and net patient revenue. In particular:

	•		our patient census at June 30, 2003 was approximately 4,700, compared to our patient census of approximately 4,300 at March 31, 2003; and

	•		our net patient revenue for the quarter was $46.1 million, compared to our net patient revenue of $42.0 million for the quarter ended March 31, 2003.

This growth resulted primarily from an increase in average daily census from 4,125 for the quarter ended March 31, 2003 to 4,569 for the quarter ended June 30, 2003 and the opening of a new program in Phenix City, Alabama in June 2003.

Our net income before accrued preferred stock dividends for the quarter ended June 30, 2003 was $3.8 million, compared to $1.5 million for the quarter ended June 30, 2002. Our increase in net income before accrued preferred stock dividends for the quarter ended June 30, 2003 was impacted by, among other things, increased labor expenses resulting from a wage increase of approximately 3.3% per employee that went into effect in April and approximately $100,000 in start-up costs related to the opening of a new program in Phenix City, Alabama that were charged to expense during the quarter. Our cash flow from operations for the six months ended June 30, 2003 was $7.7 million, compared to cash flow from operations of $2.9 million for the six months ended June 30, 2002.

In July 2003, the Centers for Medicare and Medicaid Services announced that Medicare base hospice reimbursement rates for the Medicare fiscal year October 1, 2003 through September 30, 2004 will increase by 3.4% over current base rates. We expect that this increase will have a positive impact on our net patient revenue in the fourth quarter of 2003.

On May 16, 2003, we completed a secondary offering of common stock. All of the 6,325,000 shares sold in the offering were sold by selling stockholders, and we did not receive any of the proceeds. We incurred costs and expenses of $191,000 in connection with the offering, and we recorded such costs and expenses as additional paid-in-capital.

Net Patient Revenue

Net patient revenue is the amount we believe we are entitled to collect for our services, adjusted as described below. The amount we believe we are entitled to collect for our services varies depending on the level of care provided, the payor and the geographic area where the services are rendered. Net patient revenue includes adjustments for:

	•		estimated payment denials and contractual adjustments;

	•		patients who do not have insurance coverage and who are deemed financially in need of charity care;

	•		amounts we estimate we could be required to repay to Medicare, such as amounts that we would be required to repay if any of our programs exceed the annual per-beneficiary cap, as described below under “Critical Accounting Policies and Significant Estimates — Adjustments to Net Patient Revenue for Exceeding the Medicare Per-Beneficiary Cap”; and

	•		subsequent changes to initial level of care determinations.

We adjust our estimates from time to time based on our billing and collection experience. Only after a patient’s hospice eligibility has been determined, a payment source has been identified and services have been provided do

we recognize net patient revenue for services that we provide to that patient.

We derive net patient revenue from billings to Medicare, Medicaid, private insurers, managed care providers, patients and others. We operate under arrangements with those payors pursuant to which they reimburse us for services we provide to hospice eligible patients they cover, subject only to our submission of adequate and timely claim documentation. Our patient intake process screens patients for hospice eligibility and identifies whether their care will be covered by Medicare, Medicaid, private insurance, managed care or self-pay. Medicare reimbursements account for the majority of our net patient revenue. Our net patient revenue is determined primarily by the number of billable patient days, the level of care provided and reimbursement rates. The number of billable patient days is a function of the number of patients admitted to our programs and the number of days that those patients remain in our care (length of stay). We exceeded the industry average in achieving an average length of stay of 86 days and 88 days for the year ended December 31, 2002 and the three months ended June 30, 2003, respectively. We attribute our ability to exceed the industry average in terms of length of stay to several factors. First, our percentage of non-cancer patients has been increasing and those patients have a higher average length of stay than cancer patients. Second, we believe that our open access philosophy and our efforts to educate referral sources about hospice care is encouraging earlier transfers of patients to hospice care. Finally, a significant amount of our growth in recent periods has been in rural markets where more patients turn to hospice care because access to intensive care hospitals or other alternative sites for hospice-eligible patients is more difficult.

The table below sets forth the percentage of our net patient revenue for the three and six-month periods ended June 30, 2002 and June 30, 2003 derived from Medicare, Medicaid, private insurers and managed care payors:


	Three Months Ended						Six Months Ended
	June 30,						June 30,

	2002			2003			2002			2003

Medicare		91.4	%		93.6	%		91.9	%		92.6	%
Medicaid		3.7	%		3.6	%		3.5	%		3.6	%
Private insurers and managed care		4.9	%		2.8	%		4.6	%		3.8	%

Medicare, Medicaid and most private insurers and managed care providers pay for hospice care at a daily or hourly rate that varies depending on the level of care provided. The table below sets forth the percentage of our net patient revenue generated under each of the four Medicare levels of care for the periods indicated:


	Three Months Ended						Six Months Ended
	June 30,						June 30,

Level of Care	2002			2003			2002			2003

Routine Home Care		94.4	%		93.0	%		93.8	%		93.0	%
General Inpatient Care		5.4	%		6.5	%		5.9	%		6.4	%
Continuous Home Care		0.1	%		0.3	%		0.1	%		0.4	%
Respite Inpatient Care		0.1	%		0.2	%		0.2	%		0.2	%

Typically, each October, Medicare adjusts its base hospice care reimbursement rates for the following year based on inflation and other economic factors. Effective April 1, 2001, the Medicare base rates were increased 5.0% over the base rates then in effect. Such rates were further increased by 3.2% effective October 1, 2001, 3.4% effective October 1, 2002 and will be increased an additional 3.4% effective October 1, 2003. These increases have favorably impacted our net patient revenue. Medicare’s base rates are subject to regional adjustments based on local wage levels. These regional adjustments are not necessarily proportional to adjustments in the base rates.

Medicaid reimbursement rates and hospice care coverage rates for private insurers and managed care plans tend to approximate Medicare rates.

Because we generally receive fixed payments for our hospice care services based on the level of care provided to our hospice patients, we are at risk for the cost of services provided to our hospice patients. We cannot assure you that Medicare and Medicaid will continue to pay for hospice care in the same manner or in the same amount that they currently do. Reductions in amounts paid by government programs for our services or changes in methods or regulations governing payments, which would likely result in similar changes by private third-party payors, could adversely affect our net patient revenue and profitability.

Expenses

We recognize expenses as incurred. Our primary expenses include those we classify as either patient care expenses or general and administrative expenses.

Patient care expenses consist primarily of salaries, benefits, payroll taxes and travel costs associated with our hospice care providers and program level administrative and marketing personnel. Patient care expenses also include the cost of pharmaceuticals, durable medical equipment, medical supplies, inpatient arrangements, nursing home costs, net, and purchased services such as ambulance, infusion and radiology. We incur inpatient facility costs primarily through per diem lease arrangements with hospitals and skilled nursing facilities where we provide our services. We also operate a 12-bed, stand-alone inpatient hospice facility and a 10-bed, hospital-based inpatient facility. Patient length of stay impacts our patient care expenses as a percentage of net patient revenue. Patient care expenses are generally higher during the initial and latter days of care. In the initial days of care, expenses tend to be higher because of the initial purchases of pharmaceuticals, medical equipment and supplies and the administrative costs of determining the patient’s hospice eligibility, registering the patient and organizing the plan of care. In the latter days of care, expenses tend to be higher because patients generally require more services, such as pharmaceuticals and nursing care, due to their deteriorating medical condition. Accordingly, if lengths of stay decline, those higher costs are spread over fewer days of care, which increases patient care expenses as a percentage of net patient revenue and negatively impacts profitability. Patient care expenses are also impacted by the geographic concentration of patients. Labor expenses, which represent the single largest category of patient care expenses, tend to be less if patients are geographically concentrated and hospice care providers are required to spend less time traveling and can care for more patients.

For our patients who receive nursing home care under state Medicaid programs in states other than Arizona, Oklahoma, Pennsylvania and South Carolina, the applicable Medicaid program pays us an amount equal to no more than 95% of the Medicaid per diem nursing home rate for room and board services furnished to the patient by the nursing home in addition to the Medicare or Medicaid routine home care per diem payment. We pay the nursing home for these room and board services at a rate between 95% and 100% of the full Medicaid per diem nursing home rate, depending on the terms of the contract between us and the nursing home. We include the difference between the amount we pay the nursing home and the amount we receive from Medicaid in patient care expenses. We refer to this difference as “nursing home costs, net”. Our nursing home costs, net, were $0.3, and $0.4 million for the three months ended June 30, 2002 and 2003, respectively, and $0.5 million and $0.8 million for the six months ended June 30, 2002 and 2003, respectively.

General and administrative expenses primarily include salaries, payroll taxes, benefits and travel costs associated with our staff that is not directly involved with patient care (other than program level administrative and marketing personnel), bonuses for all employees, marketing, office leases, and professional services.

In April 2003, we increased employee salaries by an average of 3.3% per employee, which impacts both patient care expenses and general and administrative expenses.

Stock-Based Compensation

Certain employee stock options which we granted in 2001 and 2002 have resulted in and will continue to result in stock-based compensation charges. In accordance with Accounting Principles Board Opinion No. 25 and related interpretations, if an employee stock option is granted with an exercise price which is less than the deemed fair value

of the underlying stock, the difference is treated as a compensation charge that must be recognized ratably over the vesting period for the option. As a result of employee option grants made in 2001 and 2002 with exercise prices determined to be less than the deemed fair value of our common stock on the respective grant dates, we recognized stock-based compensation expense of $88,000 and $102,000 in the three months ended June 30, 2002 and 2003, respectively, and $137,000 and $1,149,000 in six months ended June 30, 2002 and 2003, respectively. In addition, a stock option granted to our Chief Executive Officer in November 2002 was subject to variable accounting due to the vesting provisions contained in the option. We accelerated the vesting on this option in February 2003, and recorded stock-based compensation expense in relation to this option of $9,000 in 2002 and $953,000 in the three months ended March 31, 2003. As of June 30, 2003, we had accrued a total of $1.2 million of deferred stock-based compensation relating to the foregoing options.

Capitalized Software Development Costs

We have capitalized certain internal costs related to the development of software used in our business. We capitalize all qualifying internal costs incurred during the application development stage. Costs incurred during the preliminary project stage and post-implementation/operation stage are expensed as incurred. We had total capitalized software development costs, net of amortization, of approximately $4.9 million as of June 30, 2003. We amortize the capitalized software development costs related to particular software over a three-year period commencing when that software is substantially complete and ready for its intended use. We are currently testing our billing module that includes approximately $3.5 million of capitalized software development cost as of June 30, 2003. We expect that this application will be substantially complete in October 2003.

Goodwill

Goodwill from our 1998 and 2002 acquisitions, net of accumulated amortization of $2.4 million, was $20.6 million as of December 31, 2002 and June 30, 2003. Prior to 2002, we were amortizing the goodwill from our 1998 acquisitions over 30 years. Rules issued by the Financial Accounting Standards Board, effective for 2002, require that we no longer amortize goodwill. These rules require that we analyze our goodwill for impairment annually, or more often if events or circumstances arise that indicate that the carrying value of our goodwill exceeds its fair market value. We applied these rules beginning January 1, 2002. We have concluded that no basis for impairment of our goodwill existed as of June 30, 2003.

Adjusted EBITDA

Adjusted EBITDA consists of net income before accrued preferred stock dividends, excluding net interest, taxes, depreciation and amortization and stock-based compensation charges. We present adjusted EBITDA to enhance the understanding of our operating results. Adjusted EBITDA is not a measure of financial performance under generally accepted accounting principles. Items excluded from adjusted EBITDA are significant components in understanding and assessing financial performance. Adjusted EBITDA is a key measure we use to evaluate our operations. In addition, we provide our adjusted EBITDA because we believe that investors and securities analysts will find adjusted EBITDA to be a useful measure for evaluating our cash flows from operations, for comparing our operating performance with that of similar companies that have different capital structures and for evaluating our ability to meet our future debt service, capital expenditures and working capital requirements. Adjusted EBITDA should not be considered in isolation or as an alternative to net income, cash flows generated by operating, investing or financing activities, or other financial statement data presented in the consolidated financial statements as indicators of financial performance or liquidity. Because adjusted EBITDA is not a measurement determined in accordance with generally accepted accounting principles and is thus susceptible to varying calculations, adjusted EBITDA as presented may not be comparable to other similarly titled measures of performance of other companies.

The following table reconciles our net income before accrued preferred stock dividends to adjusted EBITDA and also shows cash flows from operating, investing and financing activities for the periods indicated:


		Three Months Ended							Six Months Ended
		June 30,						June 30,
		2002			2003			2002			2003

					(in thousands)
					(unaudited)
Net income before accrued preferred stock dividends		$	1,516		$	3,822		$	2,425		$	6,646
Add:
	Interest income		—			(l08	)		(2	)		(209	)
	Interest expense		204			29			405			77
	Income tax expense		65			944			101			1,330
	Depreciation and amortization		303			370			574			714
	Stock-based compensation		88			102			137			1,149

Adjusted EBITDA		$	2,176		$	5,159		$	3,640		$	9,707

Net cash provided by operating activities		$	6,320		$	6,396		$	2,930		$	7,743
Net cash used in investing activities		$	(1,190	)	$	(1,481	)	$	(1,504	)	$	(2,641	)
Net cash (used in) provided by financing activities		$	(3,938	)	$	108		$	(744	)	$	328

Critical Accounting Policies and Significant Estimates

To understand our financial position and results of operations, you should read carefully the description of our significant accounting policies set forth in “Part I — Item 1. Financial Statements — Notes To Consolidated Financial Statements — Note 1” of this report. You should also be aware that application of our significant accounting policies requires that we make certain judgments and estimates, which are subject to an inherent degree of uncertainty.

Adjustments to Net Patient Revenue for Estimated Payment Denials

More than 95% of our net patient revenue is derived from Medicare and Medicaid programs. The balance of our net patient revenue is derived primarily from private insurers and managed care programs. We operate under arrangements with these payors pursuant to which they reimburse us for services we provide to hospice-eligible patients they cover, subject only to our submission of adequate and timely claim documentation. In some cases, these payors deny our claims for reimbursement for reasons such as:

	•		our claim documentation is incomplete or contains incorrect patient information;

	•		the payor deems the patient ineligible for insurance coverage; or
	•		we have failed to provide timely written physician certifications as to patient eligibility.

We adjust our net patient revenue to the extent we estimate these payors will deny our claims. This estimate is subject to change based on information we receive or data we compile concerning factors such as:

	•		our experience of claim denials by payor class;

	•		the strength and reliability of our billing practices; and

	•		changes in the regulatory environment.

We reflected reductions to net patient revenue for estimated claim denials of $0.6 and $1.0 million for the three months ended June 30, 2002 and 2003 respectively, and $1.2 and $1.8 million for the six months periods ended June 30, 2002 and 2003, respectively.

Adjustments to Net Patient Revenue for Exceeding the Medicare Per-Beneficiary Cap

Each of our hospice programs is subject to the annual Medicare per-beneficiary cap. In effect, the per-beneficiary cap imposes a limit on the amount of payments per beneficiary that we can receive from Medicare with respect to services provided during the twelve-month period between November 1 of one year and October 31 of the following year. To determine whether we have exceeded the per-beneficiary cap at any of our programs, Medicare first multiplies the number of Medicare hospice beneficiaries in that program who have elected Medicare hospice coverage for the first time in that twelve-month period by the annual per-beneficiary cap amount. If actual Medicare reimbursements to that program with respect to services provided during the period exceed that amount, Medicare requires that we repay the difference to Medicare.

We actively monitor each of our programs to determine whether they are likely to exceed the Medicare per-beneficiary cap. If we determine that a program is likely to exceed the cap, we attempt to institute corrective action, such as a change in patient mix. However, to the extent we believe our corrective action will not be successful, we estimate the amount that we could be required to repay to Medicare and accrue that amount as a reduction to net patient revenue. Factors that impact our estimate include:

	•		our success in implementing corrective measures; and

	•		possible enrollment of beneficiaries in our programs who, without our knowledge, may have previously elected Medicare hospice coverage through another hospice provider.

We recorded reductions to net patient revenue of $0.9 million for the year ended December 31, 2002 and $1.0 million for the six-month period ended June 30, 2003, respectively, for exceeding the per-beneficiary cap in those periods.

Goodwill Impairment

On January 1, 2002, we adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, which requires that we conduct a review to determine whether the carrying value of the goodwill associated with our acquired businesses exceeds its fair market value. We are required to conduct such a review annually, or more often if events or circumstances arise that indicate the fair market value of such goodwill may have materially declined. Such events or circumstances could include:

	•		significant under-performance of our acquired businesses relative to historical or projected operating results;

	•		significant negative industry trends; or

	•		significant changes in regulations governing hospice reimbursements from Medicare and state Medicaid programs.

To determine the fair market value of our goodwill, we make estimates regarding future cash flows and the potential sale and liquidation values of our acquired businesses.

In the event we determine that the value of our goodwill has become impaired, we are required to write down the value of the goodwill to its fair market value on our balance sheets and to reflect the extent of the impairment as an expense on our statements of operations. We have determined that no impairment of goodwill existed as of June 30, 2003.

Income Taxes and Deferred Tax Assets

As of December 31, 2002, we had net operating tax loss carryforwards to offset future taxable income of approximately $5.9 million for federal income tax purposes and $6.3 million for state income tax purposes. These carryforwards begin to expire in 2011 for federal income tax purposes and began to expire in 2002 for state income

tax purposes. Future utilization of our net operating tax loss carryforwards may be limited under Internal Revenue Code Section 382 based upon changes in ownership that may occur in the future. We had net deferred tax assets of $6.1 million as of December 31, 2002, of which approximately $2.4 million related to net operating tax loss carryforwards, which were partially offset by a valuation allowance of $3.9 million and further by net deferred tax liabilities of $2.2 million. We recorded a valuation allowance at December 31, 2002 to reduce our net deferred tax assets to the amount that we believed is more likely than not to be realized based upon our recent operating results. During the three months ended June 30, 2003, we estimated the valuation allowance for net deferred tax assets given our operating performance.

Our effective income tax rate for 2003 is expected, at present, to be 16.7% due primarily to the use of net operating loss carryforwards and tax credits. We expect that our effective tax rate for 2004 will be more normalized due to the use of the majority of the net operating loss carryforwards and tax credits in 2003.

Results of Operations

The following table sets forth selected consolidated financial information as a percentage of net patient revenue for the periods indicated:


				Three Months Ended June 30,						Six Months Ended June 30,
				2002			2003			2002			2003

Net patient revenue					100.0	%		100.0	%		100.0	%		100.0	%
Operating expenses:
	Patient care:
		Salaries, benefits and payroll taxes			39.6	%		40.6	%		40.1	%		39.3	%
		Pharmaceuticals			5.8	%		6.0	%		6.0	%		6.0	%
		Durable medical equipment and supplies			5.0	%		4.6	%		5.2	%		4.6	%
		Other (including inpatient arrangements, nursing home costs, net, purchased services and travel)			10.0	%		9.0	%		10.0	%		8.9	%

			Total		60.4	%		60.2	%		61.3	%		58.8	%

General and administrative (exclusive of stock-based compensation charges reported below):
	Salaries, benefits and payroll taxes				16.1	%		15.5	%		15.9	%		15.4	%
	Office leases				2.4	%		2.0	%		2.5	%		2.1	%
	Other (including severance, travel, marketing and charitable contributions)				13.9	%		11.1	%		14.0	%		12.6	%

			Total		32.4	%		28.6	%		32.4	%		30.1	%

	Depreciation and amortization				1.0	%		0.8	%		1.0	%		0.8	%
Stock-based compensation					0.3	%		0.2	%		0.2	%		1.3	%
Operating income					5.9	%		10.2	%		5.1	%		9.0	%
Non-operating (expense) income					(0.8	)%		0.1	%		(0.8	)%		0.1	%
Income tax expense					0.2	%		2.0	%		0.2	%		1.6	%
Net income before accrued dividends to preferred stockholders					4.9	%		8.3	%		4.1	%		7.5	%
Adjusted EBITDA(1)					7.0	%		11.2	%		6.2	%		11.0	%

(1)

Adjusted EBITDA consists of net income before accrued preferred stock dividends excluding net interest, taxes, depreciation and amortization and stock-based compensation charges. We present adjusted EBITDA to enhance the understanding of our operating results. Adjusted EBITDA is not a measure of financial performance under generally accepted accounting principles. Items excluded from adjusted EBITDA are significant components in understanding and assessing financial performance. Adjusted EBITDA is a key measure we use to evaluate our operations. In addition, we provide our adjusted EBITDA because we believe that investors and securities analysts will find adjusted EBITDA to be a useful measure for evaluating our cash flows from operations, for comparing our operating performance with that of similar companies that have different capital structures and for evaluating our ability to meet our future debt service, capital expenditures and working capital requirements. Adjusted EBITDA should not be considered in isolation or as an alternative to net income, cash flows generated by operating, investing or financing activities, or other financial statement data presented in the consolidated financial statements as indicators of financial performance or liquidity. Because adjusted EBITDA is not a measurement determined in accordance with generally accepted accounting principles and is thus susceptible to varying calculations, adjusted EBITDA as presented may not be comparable to other similarly titled measures of performance of other companies.

Three and Six Months Ended June 30, 2003, Compared to Three and Six Months Ended June 30, 2002

Net Patient Revenue

Net patient revenue increased $15.1 million, or 48.7% from $31.0 million for the three-month period ended June 30, 2002, to $46.1 million for the three-month period ended June 30, 2003. Net patient revenue increased $29.4 million, or 50.1%, from $58.7 million for the six-month period ended June 30, 2002 to $88.1 million for the six-month period ended June 30, 2003. These increases were due to:

	•		increases in billable patient days of 127,457 and 239,730 for the three- and six months ended June 30, 2003 compared to the same periods in the prior year;

	•		our acquisition in August 2002 of a hospice program with approximately 85 patients in Albuquerque, New Mexico; and

	•		the Medicare reimbursement rate increase that went into effect on October 1, 2002.

Net patient revenue per day of care was approximately $108 for the three-month period ended June 30, 2002, compared to net patient revenue per day of care of approximately $111 for the three-month period ended June 30, 2003. Net patient revenue per day of care was approximately $107 for the six-month period ended June 30, 2002, compared to net patient revenue per day of care of approximately $112 for the six-month period ended June 30, 2003. These increases were due primarily to the Medicare reimbursement rate increase, an increase in the number of patients receiving care in geographic regions where reimbursement rates are relatively higher and an increase in the number of general inpatient days of service.

Our average daily census of patients increased from 3,166 for the three-month period ended June 30, 2002, to 4,569 for the three-month period ended June 30, 2003. This growth is primarily attributable to growth in patient census in our existing programs. To a lesser extent, this growth is also attributable to our August 2002 acquisition of a hospice program with approximately 85 patients in Albuquerque, New Mexico and our development of new hospice programs in Salt Lake City, Utah and Phenix City, Alabama in January and June 2003, respectively.

Patient Care Expenses

Patient care expenses increased $9.0 million, or 48.1%, from $18.7 million for the three-month period ended June 30, 2002 to $27.7 million for the three-month period ended June 30, 2003. Of this increase, 71.1% was due to a $6.4 million increase in salaries, benefits, payroll taxes and travel costs of hospice care providers. Patient care expenses increased $15.8 million, or 43.9%, from $36.0 million for the six-month period ended June 30, 2002 to $51.8 million for the six-month period ended June 30, 2003. Of this increase, 70.3% was due to an $11.1 million increase in salaries, benefits, payroll taxes and travel costs of hospice care providers.

As a percentage of net patient revenue, patient care expenses decreased from 60.4% for the three-month period ended June 30, 2002 to 60.2% for the three-month period ended June 30, 2003. This decrease was primarily due to the increase in net patient revenue coupled with a decrease in cost per patient day of purchased services, durable medical equipment and supplies partially offset by the wage increase of approximately 3.3% per employee that went into effect in April 2003, increases in benefit costs from contract renewals effective in June 2003 and increased contract labor and pharmaceutical costs on a per patient, per day basis.

As a percentage of net patient revenue, patient care expenses decreased from 61.3% for the six-month period ended June 30, 2002 to 58.8% for the six-month period ended June 30, 2003. This decrease was primarily due to an increase in net patient revenue in the six-month period ended June 30, 2003, coupled with a decrease in the average cost of purchased services, durable medical equipment and supplies on a per patient, per day basis in that period.

General and Administrative Expenses (Exclusive of Stock-Based Compensation)

General and administrative expenses increased $3.0 million, or 29.7% from $10.1 million for the three-month period ended June 30, 2002, to $13.1 million for the three-month period ended June 30, 2003. As a

percentage of net patient revenue, general and administrative expenses decreased from 32.4% for the three-month period ended June 30, 2002 to 28.6% for the three-month period ended June 30, 2003.

General and administrative expenses increased $7.5 million, or 39.5%, from $19.0 million for the six-month period ended June 30, 2002 to $26.5 million for the six-month period ended June 30, 2003. As a percentage of net patient revenue, general and administrative expenses decreased from 32.4% for the six-month periods ended June 30, 2002 to 30.1% for the six-month period ended June 30, 2003.

Of the overall increase in general and administrative expenses from the three-month period ended June 30, 2002 to the three-month period ended June 30, 2003, 70.0% was due to a $2.1 million increase in salaries, payroll taxes and benefits. The remainder of the increase was primarily due to increases in insurance expenses and charitable contributions. Of the overall increase in general and administrative expenses from the six-month period ended June 30, 2002 to the six-month period ended June 30, 2003, 57.3% was due to a $4.3 million increase in salaries, payroll taxes and benefits. The remainder of the increase was primarily due to increases in accrued performance bonuses for all employees, insurance expenses, program facility leases and charitable contributions.

Stock-Based Compensation

Stock-based compensation expense was approximately $0.1 million for each of the three-month periods ended June 30, 2002 and 2003. Stock-based compensation expense for the six-month period ended June 30, 2002 was $0.1 million, compared to $1.1 million for the six-month period ended June 30, 2003. Of the $1.1 million of stock based compensation expense we incurred in the six-month period ended June 30, 2003, $953,000 was related to the acceleration of the vesting of a stock option that was recognized in the three-month period ended March 31, 2003.

Non-Operating Income (Expense)

Non-operating income (expense) for the three-month period ended June 30, 2003 was $43,000, compared to non-operating income (expense) of $(243,000) for the three-month period ended June 30, 2002. Non-operating income (expense) for the six-month period ended June 30, 2003 was $81,000, compared to non-operating income (expense) of $(470,000) for the six-month period ended June 30, 2002. These increases were due to an increase in interest income that we derived from our investment of a significant portion of the net proceeds we received from our initial public offering of common stock in December 2002 and a decrease in interest expense as a result of our repayment of outstanding indebtedness under our bank credit facility with proceeds from our initial public offering.

Income Tax

Our income tax expense for the three-month period ended June 30, 2003 was $944,000, compared to $65,000 for the three-month period ended June 30, 2002. Our income tax expense for the six-month period ended June 30, 2003 was $1,330,000, compared to $101,000 for the six-month period ended June 30, 2002.

For the year ended December 31, 2002, we did not have any federal income tax liability, and our state income tax liability was partially offset by our net operating loss carryforwards. We expect to fully utilize those carryforwards for federal income tax purposes in 2003, and accordingly, will experience an increase in our effective tax rate for the year.

Liquidity and Capital Resources

Our principal liquidity requirements have been for working capital and capital expenditures. We have financed these requirements primarily with cash flow from operations. In December 2002, we completed our initial public offering of common stock in which we raised net proceeds of $48.1 million. As of June 30, 2003, we had cash and cash equivalents of $44.5 million, working capital of approximately $47.1 million and the ability to borrow $26.2 million under our revolving credit facility described below.

Net cash provided by operating activities for the six months ended June 30, 2003 was $7.7 million and resulted from the increase in our overall profitability, partially offset by the timing of scheduled receipts.

Net cash used in investing activities was $2.6 million for the six months ended June 30, 2003. This was due primarily to the continued investment in internally developed software and expenditures relating to its implementation.

Net cash provided by financing activities was $0.3 million for the six months ended June 30, 2003, which resulted from the exercise of employee stock options partially offset by costs associated with a secondary stock offering in May 2003.

We currently maintain a revolving line of credit with Healthcare Business Credit Corporation, or HBCC, under which we may borrow, repay and re-borrow from time to time up to $30 million, based on the amount of our eligible accounts receivable. As of June 30, 2003, there were no borrowings under this facility and there was $26.2 million available for borrowing.

Advances under the HBCC revolving line of credit bear interest at an annual rate equal to, at our option, either the “prime rate” in effect from time to time, as reported in the “Money Rates” section of the Wall Street Journal, plus 1.5%, or the one-month London Interbank Borrowing Rate in effect from time to time, plus 3.0%. The applicable interest rate increases by 3.5% if there is an event of default. Accrued interest is due and payable weekly on advances under the revolving line of credit bearing interest at the prime rate. Accrued interest on advances bearing interest at the London Interbank Offering Rate is due and payable on the last business day of the month. The maturity date for the revolving line of credit is April 30, 2005. As of June 30, 2003, the effective interest rate for borrowings under this facility was 4.1% per annum.

The HBCC credit facility is collateralized by substantially all of our assets. In addition, our credit agreement with HBCC contains customary covenants including covenants restricting our ability to incur additional indebtedness, permit liens on property or assets, make capital expenditures, make certain investments, pay dividends or make restricted payments, and prepay or redeem debt or amend certain agreements relating to our indebtedness.

Each of our hospice programs is subject to the annual Medicare per-beneficiary cap. If we are found by Medicare to have exceeded the per-beneficiary cap, Medicare will require that we make restitution for payments made to us in excess of the per-beneficiary cap. We have not been assessed any amount for exceeding the per-beneficiary cap for the assessment periods that began on November 1, 2001 and November 1, 2002. We believe adequate reserves have been established for potential assessments for exceeding the pre-beneficiary cap for the assessment periods that began on November 1, 2001 and November 1, 2002. We actively monitor each of our programs to determine whether they are likely to exceed the pre-beneficiary cap and attempt corrective action when necessary. However, we cannot assure you that we will not be assessed for exceeding the pre-beneficiary cap in future periods.

We expect that our principal liquidity requirements will be for working capital, the development of new hospice programs, the acquisition of other hospice programs and capital expenditures. We expect that our existing funds, cash flows from operations and borrowing capacity under our credit agreement will be sufficient to fund our principal liquidity requirements for at least the next twelve months. Our future liquidity requirements and the adequacy of our available funds will depend on many factors, including payment for our services, regulatory changes and compliance with new regulations, expense levels, capital expenditures and future development of new hospice programs and acquisitions.

Interest Rate and Foreign Exchange Risk

Interest Rate Risk

We do not expect our cash flow to be affected to any significant degree by a sudden change in market interest rates. We have not implemented a strategy to manage interest rate market risk because we do not believe that our exposure to this risk is material at this time. We invest excess cash balances in money market accounts with average maturities of less than 90 days.

Foreign Exchange

We operate our business within the United States and execute all transactions in U.S. dollars.

Payment, Legislative and Regulatory Changes

We are highly dependent on payments from the Medicare and Medicaid programs. These programs are subject to statutory and regulatory changes, possible retroactive and prospective rate adjustments, administrative rulings, rate freezes and funding reductions. Reductions in amounts paid by these programs for our services or changes in methods or regulations governing payments for our services could materially adversely affect our net patient revenue and profitability.

Inflation

The healthcare industry is labor intensive. Wages and other expenses increase during periods of inflation and when labor shortages occur in the marketplace. In addition, suppliers pass along rising costs to us in the form of higher prices. We have implemented control measures designed to curb increases in operating expenses. To date, reimbursement rate increases and our increasing patient census have offset increases in operating costs. However, we cannot predict our ability to cover or offset future cost increases.

Recent Accounting Pronouncements

In April 2002, FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44 and 64,Amendment of FASB Statement No. 13 and Technical Corrections. This statement eliminates corresponding treatment for reporting gains or losses on debt extinguishment and amends certain other existing accounting pronouncements. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002. The adoption of this standard is not expected to have a material effect on our financial position or results of operations.

In June 2002, FASB issued SFAS No. 146,Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 nullifies the guidance in EITF Issue No. 94-3,Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity. Under EITF No. 94-3, an entity recognized a liability for an exit cost on the date that the entity committed itself to an exit plan. In SFAS No. 146, the FASB acknowledges that an entity’s commitment to a plan does not, by itself, create a present obligation to the other parties that meets the definition of a liability and requires that a liability for a cost that is associated with an exit or disposal activities be recognized when the liability is incurred. It also establishes that fair value is the objective for the initial measurement of the liability. SFAS No. 146 will be effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of this standard is not expected to have a material effect on our financial position or results of operations.

In November 2002, FASB issued Interpretation No. 45,Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guaranteed of Indebtedness of Others. FIN 45 requires certain guarantees to be recorded at fair value. FIN 45 also requires a guarantor to make certain disclosures about guarantees even when the likelihood of making any payments under the guarantee is remote. FIN 45 is effective for financial statements of interim or annual periods ending after December 15, 2002. The adoption of this interpretation is not expected to have a material effect on our financial position or results of operations.

In December 2002, FASB issued SFAS No. 148,Accounting for Stock-Based Compensation — Transition and Disclosure. SFAS No. 148 amends SFAS No. 123,Accounting for Stock-Based Compensationand provides alternative methods of transition for a voluntarily change to the fair value based method of accounting for stock-

based employee compensation. SFAS No. 148 also amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based compensation and the effect of the method used on reported results. SFAS No. 148 is effective for fiscal years ending after December 15, 2002. Accordingly, we have adopted the disclosure provisions of SFAS No. 148 as of December 31, 2002. We have continued to follow APB No. 25, Accounting for Stock Issued to Employees, in accounting for employee stock options.

In January 2003, FASB issued Interpretation No. 46,Consolidation of Variable Interest Entities. FIN 46 addressed the consolidation and financial reporting of variable interest entities. FIN 46 is effective for financial statements of interim or annual periods beginning after June 15, 2002 for variable interest entities created before February 1, 2003, or immediately for variable interest entities created after February 1, 2003. The adoption of this interpretation is not expected to have a material effect on our financial position or results of operations.

Forward-Looking Statements

This quarterly report on Form 10-Q contains or incorporates forward-looking statements within the meaning of section 27A of the Securities Act of 1933 and section 21E of the Securities Exchange Act of 1934. These forward-looking statements are based on current expectations, estimates, forecasts and projections about the industry and markets in which we operate and management’s beliefs and assumptions. In addition, other written or oral statements that constitute forward-looking statements may be made by or on our behalf. Words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek,” “estimate,” variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. We have included important factors in the cautionary statements below under the heading “Factors That May Affect Future Results” that we believe could cause our actual results to differ materially from the forward-looking statements we make. We do not intend to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

Factors That May Affect Future Results

We are dependent on payments from Medicare and Medicaid. Changes in the rates or methods governing these payments for our services could adversely affect our net patient revenue and profitability.

Approximately 96.6%, and 97.5% of our net patient revenue for the year ended December 31, 2002 and the six months ended June 30, 2003, respectively, consisted of payments from Medicare and Medicaid programs. Because we generally receive fixed payments for our hospice care services based on the level of care provided to our hospice patients, we are at risk for the cost of services provided to our hospice patients. We cannot assure you that Medicare and Medicaid will continue to pay for hospice care in the same manner or in the same amount that they currently do. Reductions in amounts paid by government programs for our services or changes in methods or regulations governing payments, which would likely result in similar changes by private third-party payors, could adversely affect our net patient revenue and profitability.

Our profitability may be adversely affected by limitations on Medicare payments.

Medicare payments for hospice services are subject to an annual per-beneficiary cap, which for the twelve months ending October 31, 2003 is $18,661. Compliance with the cap is measured by calculating the annual Medicare payments received by a hospice program with respect to services provided to all Medicare hospice care beneficiaries and comparing the result with the product of the per-beneficiary cap amount and the number of Medicare beneficiaries electing hospice care for the first time from that program during that year. We reflected as a reduction to net patient revenue of approximately $1.1 million in 2001, $0.9 million in 2002 and $1.0 million in the six-month period ended June 30, 2003 as a result of estimated reimbursements in excess of the per-beneficiary cap in those periods. Our ability to comply with this limitation depends on a number of factors relating to a given hospice program, including the rate at which our patient census increases, the average length of stay and the mix in level of care. Our profitability may be adversely affected if, in the future, we are unable to comply with this and other Medicare payment limitations.

If our costs were to increase more rapidly than the fixed payment adjustments we receive from Medicare and Medicaid for our hospice services, our profitability could be negatively impacted.

We generally receive fixed payments for our hospice services based on the level of care that we provide to patients and their families. Accordingly, our profitability is largely dependent on our ability to manage costs of providing hospice services and to maintain a patient base with a sufficiently long length of stay to attain profitability. We are susceptible to situations, particularly because of our “open access” philosophy, where we may be referred a disproportionate share of patients requiring more intensive and therefore more expensive care than other providers. Although Medicare and Medicaid currently provide for an annual adjustment of the various hospice payment rates based on the increase or decrease of the medical care expenditure category of the Consumer Price Index, these hospice care increases have historically been less than actual inflation. If these annual adjustments were eliminated or reduced, or if our costs of providing hospice services, over one-half of which consist of labor costs, increased more than the annual adjustment, our profitability could be negatively impacted. In addition, cost pressures resulting from shorter patient lengths of stay and the use of more expensive forms of palliative care, including drugs and drug delivery systems, could negatively impact our profitability.

We may be adversely affected by governmental decisions regarding our nursing home patients.

For our patients receiving nursing home care under certain state Medicaid programs, the applicable Medicaid program pays us an amount equal to no more than 95% of the Medicaid per diem nursing home rate for “room and board” services furnished to the patient by the nursing home in addition to the applicable Medicare or Medicaid hospice per diem payment.

We, in turn, are generally obligated to pay the nursing home for these room and board services at a rate between 95% and 100% of the full Medicaid per diem nursing home rate. In the past, we have experienced situations where both we and the Medicaid program have paid a nursing home for the same room and board service and the Medicaid program has imposed on us the burden of recovering the amount we previously paid to the nursing home. There can be no assurance these situations will not recur in the future or that if they do, we will be able to fully recover from the nursing home.

In addition, many of our patients residing in nursing homes are eligible for both Medicare and Medicaid benefits. In these cases, the patients’ state Medicaid program pays their nursing home room and board charges and Medicare pays their hospice services benefit. Government audits conducted in the last several years have suggested that the reimbursement levels for these dual-eligible hospice patients as well as for Medicare-only patients living in nursing homes may be excessive. Specifically, the government has expressed concerns that hospice programs may provide fewer services to patients who reside in nursing homes than to patients living in other settings due to the presence of the nursing home’s own staff to address problems that might otherwise be handled by hospice personnel. Because hospice programs are paid a fixed daily amount, regardless of the volume or duration of services provided, the government is concerned that by shifting the responsibility and cost for certain patient care or counseling services to the nursing home, hospice programs may inappropriately increase their profitability. In the case of these dual-eligible patients, the government’s concern is that the cost of providing both the room and board and hospice services may be significantly less than the combined reimbursement paid to the nursing homes and hospice programs as a result of the overlap in services.

From time to time, there have been legislative proposals to reduce or eliminate Medicare reimbursement for hospice patients residing in nursing homes and to require nursing homes to provide end-of-life care, or alternatively to reduce or eliminate the Medicaid reimbursement of room and board services provided to hospice patients. The likelihood of this type of change may be greater when the federal and state governments experience budgetary shortfalls. If any such proposal were adopted, it could significantly affect our ability to obtain referrals from and continue to serve patients residing in nursing homes.

Medical reviews and audits by governmental and private payors could result in material payment recoupments and payment denials, which could negatively impact our business.

Medicare fiscal intermediaries and other payors periodically conduct pre-payment or post-payment medical reviews or other audits of our reimbursement claims. In order to conduct these reviews, the payor requests

documentation from us and then reviews that documentation to determine compliance with applicable rules and regulations, including the eligibility of patients to receive hospice benefits, the appropriateness of the care provided to those patients, and the documentation of that care. We cannot predict whether medical reviews or similar audits by federal or state agencies or commercial payors of our hospice programs’ reimbursement claims will result in material recoupments or denials, which could have a material adverse effect on our financial condition and results of operations.

We have a limited history of profitability and may incur substantial net losses in the future.

We began operations in November 1995. For 1999, 2000 and 2001, we recorded net losses before accrued preferred stock dividends of $0.8 million, $0.4 million and $6.7 million, respectively. Although we recorded net income before accrued preferred stock dividends of $7.6 million for the year ended December 31, 2002 and $6.6 million for the six months ended June 30, 2003, respectively, we had an accumulated deficit of $22.9 million at June 30, 2003. We cannot assure you that we will operate profitably in the future. In addition, we may experience significant quarter-to-quarter variations in operating results. We are pursuing a growth strategy focused primarily on same-store growth but also involving the development of new programs and acquisitions. Our growth strategy may involve, among other things, increased marketing expenses, significant cash expenditures, debt incurrence and other expenses that could negatively impact our profitability on a quarterly and an annual basis. Our net patient revenue could be adversely impacted by a number of factors, in particular, reductions in Medicare payment rates and patient lengths of stay, which may not be within our control.

If we are unable to attract qualified nurses and other healthcare professionals at reasonable costs, it could limit our ability to grow, increase our operating costs and negatively impact our business.

We rely significantly on our ability to attract and retain qualified nurses and other healthcare professionals who possess the skills, experience and licenses necessary to meet the Medicare certification requirements and the requirements of the hospitals, nursing homes and other healthcare facilities with which we work. We compete for qualified nurses and other healthcare professionals with hospitals, nursing homes, other hospices and other healthcare organizations. Currently, there is a shortage of qualified nurses in most areas of the United States. Competition for nursing personnel is increasing, and nurses’ salaries and benefits have risen.

Our ability to attract and retain qualified nurses and other healthcare professionals depends on several factors, including our ability to provide attractive assignments and competitive benefits and wages. We cannot assure you that we will be successful in any of these areas. Because we operate in a fixed reimbursement environment, increases in the wages and benefits that we must provide to attract and retain qualified nurses and other healthcare professionals or increases in our reliance on contract nurses or temporary healthcare professionals could negatively affect our profitability. We may be unable to continue to increase the number of qualified nurses and other healthcare professionals that we recruit, decreasing the potential for growth of our business. Moreover, if we are unable to attract and retain qualified nurses and other healthcare professionals, we may have to limit the number of patients for whom we can provide hospice care to maintain the quality of our hospice services.

We may not be able to attract and retain a sufficient number of volunteers to grow our business or maintain our Medicare certification.

Medicare requires certified hospice programs to recruit and train volunteers to provide patient care services or administrative services. Volunteer services must be provided in an amount equal to at least five percent of the total patient care hours provided by all paid hospice employees and contract staff of a hospice program. If we are unable to attract and retain volunteers, it could limit our potential for growth and our hospice programs could lose their Medicare certifications, which would make those hospice programs ineligible for Medicare reimbursement.

If we fail to cultivate new or maintain established relationships with existing patient referral sources our net patient revenue may decline.

Our success is heavily dependent on referrals from physicians, nursing homes, assisted living facilities, hospitals, managed care companies, insurance companies and other patient referral sources in the communities that our hospice programs serve. Because we and many of our referral sources are dependent upon Medicare, we are limited

in our ability to engage in business practices that are commonplace among referring businesses in other industries such as referral fees, or bonuses and long-term exclusive contracts.

Our growth and profitability depend significantly on our ability to establish and maintain close working relationships with patient referral sources and to increase awareness and acceptance of hospice care by our referral sources and their patients. We cannot assure you that we will be able to maintain our existing referral source relationships or that we will be able to develop and maintain new relationships in existing or new markets. Our loss of existing relationships or our failure to develop new relationships could adversely affect our ability to expand our operations and operate profitably. Moreover, we cannot assure you that awareness or acceptance of hospice care will increase.

Our growth strategy may not be successful, which could adversely impact our growth and profitability.

The primary focus of our growth strategy is same-store growth. To achieve this growth, we intend to increase our marketing and other expenditures. If our resources are not deployed effectively and we do not achieve the same-store growth we seek, it could adversely impact our profitability.

Our growth strategy also involves the development of new programs. When we develop new programs, we first engage a small staff and obtain office space, contracts and referral sources. Then we admit a small number of patients and request a Medicare certification survey. Following Medicare certification, we spend significant management and financial resources in an effort to increase patient census of that program. This aspect of our growth strategy may not be successful, which could adversely impact our growth and profitability. In this regard, we cannot assure you that we will be able to:

	•		identify markets that meet our selection criteria for new hospice programs;

	•		hire and retain a qualified management team to operate each of our new hospice programs;

	•		manage a large and geographically diverse group of hospice programs;

	•		become Medicare and Medicaid certified in new markets;

	•		generate sufficient hospice admissions in new markets to operate profitably in these new markets; or

	•		compete effectively with existing hospice programs in new markets.

Competition for acquisition opportunities may restrict our future growth by limiting our ability to make acquisitions at reasonable valuations.

In addition to same-store growth and the development of new programs, our business strategy includes increasing our market share and presence in the hospice care industry through strategic acquisitions of companies that complement or enhance our business. We have historically faced competition for acquisitions. In the future, this could limit our ability to grow by acquisitions or could raise the prices of potential acquisition targets and make them less attractive to us.

Our ability to grow through acquisitions may be limited by increasing government oversight and review of sales of not-for-profit healthcare providers.

Approximately 73% of hospice programs in the United States are not-for-profit programs. Accordingly, it is likely that a substantial number of acquisition opportunities will involve hospice programs operated by not- for-profit entities. In recent years, several states have increased review and oversight of transactions involving the sale of healthcare facilities by not-for-profit entities. Although the level of oversight varies from state to state, the current trend is to provide for increased governmental review, and in some cases approval, of transactions in which a not-for-profit entity sells a healthcare facility or business to a for profit entity. This increased scrutiny may increase the difficulty of completing or prevent the completion of acquisitions in some states in the future.

As with our past acquisitions, we may face difficulties integrating businesses that we may acquire in the future. Our efforts to acquire other businesses may be unsuccessful, involve significant cash expenditures or expose us to unforeseen liabilities.

Our 1998 acquisitions, which were closed nearly simultaneously and increased our patient census approximately five-fold, presented significant integration difficulties. Due to the size and complexity of these transactions, immediately following the transactions our resources available for integration efforts were limited. In time, as we were able to focus on the integration of the acquired businesses, we spent substantial resources on projects such as:

	•		implementing consistent billing and payroll systems across a large number of new programs;

	•		instituting standard procedures for ordering pharmaceuticals, medical equipment and supplies; and

	•		re-training staff from the acquired businesses to complete properly our standard claim documentation and to conform to our service philosophy and internal compliance procedures.

Our future acquisitions could require that we spend significant resources on some of the same types of projects. In addition, our future acquisitions could present other challenges such as:

	•		potential loss of key employees or referral sources of acquired businesses;

	•		potential difficulties in obtaining required regulatory approvals; and

	•		assumption of liabilities and exposure to unforeseen liabilities of acquired businesses, including liabilities for their failure to comply with healthcare regulations.

Our future acquisitions may also involve significant cash expenditures, debt incurrence and integration expenses that could have a material adverse effect on our financial condition and results of operations. Any acquisition may ultimately have a negative impact on our business and financial condition.

The loss of key senior management personnel could adversely affect our ability to remain competitive.

We believe that the success of our business strategy and our ability to operate profitably depends on the continued employment of our senior management team. If key members of our senior management team become unable or unwilling to continue in their present positions, our business and financial results could be materially adversely affected. In particular, we believe the continued employment of each of Richard R. Slager, our Chief Executive Officer, Mark E. Liebner, our Chief Financial Officer, and Carla Davis Hughes, our Senior Vice President of Operations, is important to our future growth and competitiveness. We have entered into management agreements with Messrs. Slager and Liebner and Ms. Hughes to provide them with incentives to remain employed by us. However, there can be no assurance that any of these individuals will continue to be employed by us.

If any of our hospice programs fail to comply with the Medicare conditions of participation, that hospice program could lose its Medicare certification, thereby adversely affecting our net patient revenue and profitability.

Each of our hospice programs must comply with the extensive conditions of participation to remain certified under Medicare guidelines. If any of our hospice programs fails to meet any of the Medicare conditions of participation, that hospice program may receive a notice of deficiency from a state surveyor designated by Medicare to measure the hospice program’s level of compliance. The notice may require the hospice program to prepare a plan of correction and undertake other steps to ensure future compliance with the conditions of participation. If a hospice program fails to correct the deficiencies or develop an adequate plan of correction, the hospice program may be required to suspend admissions or may have its Medicare or Medicaid provider agreement terminated. In June 2000, the Medicare provider agreement for our Odessa, Texas hospice program was terminated. In July 1999, our Las Vegas, Nevada hospice program received a Medicare termination notice asserting that the program was not in compliance with the Medicare conditions of participation. Following an internal review, we determined that it would not be cost-effective to protest the termination or to attempt to bring the program into compliance. Accordingly, the Medicare certification for that program was terminated in August 1999. We cannot assure you that we will not lose our Medicare certification at one or more of our other hospice programs in the future. Any such loss could adversely affect our net patient revenue and profitability as well as our reputation within the hospice care industry.

We may not be able to compete successfully against other hospice care providers, and competitive pressures may limit our ability to maintain or increase our market position and adversely affect our profitability.

Hospice care in the United States is competitive. In many areas in which we maintain hospice programs, we compete with a large number of organizations, including:

	•		community-based hospice providers;

	•		national and regional companies;

	•		hospital-based hospice and palliative care programs;

	•		nursing homes; and

	•		home health agencies.

Our largest competitors include Odyssey Healthcare, Inc., SouthernCare Hospice, Inc. and Vitas Healthcare Corporation.

Some of our current and potential competitors have or may obtain significantly greater financial and marketing resources than us. Various healthcare companies have diversified into the hospice market. Relatively few regulatory barriers to entry exist in our local markets. Accordingly, other companies, including hospitals and other healthcare organizations that are not currently providing hospice care, may expand their services to include hospice care. We may encounter increased competition in the future that could negatively impact patient referrals to us, limit our ability to maintain or increase our market position and adversely affect our profitability.

A significant reduction in the carrying value of our goodwill could have a material adverse effect on our profitability.

A substantial portion of our total assets consists of intangible assets, primarily goodwill. Goodwill, net of accumulated amortization, accounted for approximately 19.1% of our total assets as of June 30, 2003. Effective January 1, 2002, we adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets. As a result, we no longer amortize goodwill and indefinite lived intangible assets. Instead, we review them at least annually to determine whether they have become impaired. If they have become impaired, we charge the impairment as an expense in the period in which the impairment occurred. Any event which results in the significant impairment of our goodwill, such as closure of a hospice program or sustained operating losses, could have a material adverse effect on our profitability.

We are dependent on the proper functioning of our information systems to efficiently manage our business.

We are dependent on the proper functioning of our information systems in operating our business. Critical information systems used in daily operations perform billing and accounts receivable functions. Our information systems are vulnerable to fire, storm, flood, power loss, telecommunications failures, physical or software break-ins and similar events. If our information systems fail or are otherwise unavailable, these functions would have to be accomplished manually, which could impact our ability to identify business opportunities quickly, to maintain billing and clinical records reliably, to pay our staff in a timely fashion and to bill for services efficiently.

We may experience difficulties in transitioning to a new billing software system which may result in delays and errors in billing for our services.

We are in the process of replacing our billing software, which we believe to be inadequate to support our growth, with our proprietary software running on our CareNation operating platform. Accurate billing is crucial to reimbursement from third-party payors. If any unforeseen problems emerge in connection with our migration to the new billing software, billing delays and errors may occur, which could significantly increase the time that it takes for us to collect payments from payors and in some cases, our ability to collect at all. Any such increase in

collection time or inability to collect could have a material adverse effect on our cash flows or result in a financial loss.

A material write-off of our capitalized software development costs and costs and problems related to the implementation of new software applications could have a material adverse effect on our profitability.

As of June 30, 2003, our capitalized software development costs, net of amortization, was approximately $4.9 million, most of which amount related to the development of CareNation, our proprietary software platform, and related application modules. We anticipate that the development work on several application modules will be completed in the near term. If one or more of the application modules do not function as anticipated, we may be required to write off a significant amount of capitalized software development costs and we may experience significant disruptions in our operations, all of which could have a material adverse effect on our profitability. In addition, the costs associated with training our employees to use these new applications effectively and errors arising from being unfamiliar with the new applications could have a material adverse effect on our operations and profitability.

We may need to raise additional capital in the future to fund our operations and finance our growth, which may be unavailable or which may result in dilution to our stockholders and restrict our operations.

We may seek to sell additional equity or debt securities or obtain new credit facilities in order to finance our operations, which we may not be able to do on favorable terms or at all. If we are unable to obtain financing, we may be unable to continue with our strategy to increase same-store growth, develop new hospice programs and acquire existing hospice programs. The sale of additional equity or convertible debt securities could result in dilution to our stockholders. If additional funds are raised through the issuance of debt securities or preferred stock, these securities could have rights that are senior to the our common stock and any debt securities could contain covenants that would restrict our and our subsidiaries’ operations.

We operate in a regulated industry and changes in regulations or violations of regulations may result in increased costs or sanctions that could reduce our revenues and profitability.

The healthcare industry is subject to extensive and complex federal and state laws and regulations related to professional licensure, conduct of operations, payment for services and payment for referrals. If we fail to comply with the laws and regulations that are directly applicable to our business, we could suffer civil and/or criminal penalties, be subject to injunctions or cease and desist orders or become ineligible to receive government program payments.

In recent years, Congress and some state legislatures have introduced an increasing number of proposals to make significant changes in the United States healthcare system. Changes in law and regulatory interpretations could reduce our net patient revenue and profitability. Recently, there have been heightened coordinated civil and criminal enforcement efforts by both federal and state government agencies relating to the healthcare industry. There has also been an increase in the filing of actions by private individuals on behalf of the federal government against healthcare companies alleging the filing of false or fraudulent healthcare claims. This heightened enforcement activity increases our potential exposure to damaging lawsuits, investigations and other enforcement actions. Any such action could distract our management and adversely affect our business reputation and profitability.

In the future, different interpretations or enforcement of laws, rules and regulations governing the healthcare industry could subject our current business practices to allegations of impropriety or illegality or could require us to make changes in our operations and personnel and distract our management. If we fail to comply with these extensive laws and government regulations, we could become ineligible to receive government program payments, suffer civil and criminal penalties or be required to make significant changes to our operations. In addition, we could be forced to expend considerable resources responding to an investigation or other enforcement action under these laws or regulations.

A pending review of the hospice industry could result in decreased Medicare hospice reimbursements for nursing home patients, which could adversely affect our profitability.

The Office of the Inspector General for the Department of Health and Human Services has recently called for a review of the hospice sector. The review is expected to consider whether Medicare should decrease hospice reimbursements for patients in nursing homes on the theory that nursing homes provide some of the same services that hospice providers provide. Approximately 40% of our patients reside in nursing homes. If, as a result of this review, Medicare decreases hospice reimbursement rates for nursing home patients, our profitability could be adversely affected.

Many states have certificate of need laws or other regulatory provisions that may adversely impact our ability to expand into new markets and thereby limit our ability to grow and to increase our net patient revenue.

Many states have enacted certificate of need laws that require prior state approval to open new healthcare facilities or expand services at existing facilities. Currently, fourteen states have certificate of need laws that apply to hospice programs. Those laws require some form of state agency review or approval before a hospice may add new services or undertake significant capital expenditures. In addition, two states in which we do not currently operate, Florida and New York, have additional barriers to entry. Florida places restrictions on the ability of for-profit corporations to own and operate hospices, and New York places restrictions on the corporate ownership of hospices. Accordingly, our ability to operate in Florida and New York and the states with certificate of need laws is restricted. The laws in these states could affect our ability to expand into new markets and to expand our services and facilities in existing markets.

To comply with new laws and regulations regarding the confidentiality of patient medical information, we may be required to expend substantial sums on acquiring and implementing new information systems, which could negatively impact our profitability.

There are currently numerous legislative and regulatory initiatives at both the state and federal levels that address patient privacy concerns. In particular, the Health Insurance Portability and Accountability Act of 1996, or HIPAA, contains provisions that may require us to implement expensive new computer systems and business procedures designed to protect the privacy of each of our hospice patient’s individual health information. The United States Department of Health and Human Services published final regulations addressing patient privacy in December 2000. Those regulations subsequently were modified in March 2002 and again in August 2002. We have been subject to the privacy regulations since April 14, 2003. Final regulations addressing the security of patient health information were modified and published in final form on February 20, 2003. We must be in compliance with these regulations by April 21, 2005. We have not yet fully evaluated and cannot fully predict the total financial or other impact of these regulations on us. Compliance with these rules could require us to spend substantial sums, which could negatively impact our profitability.

Our net patient revenue and profitability may be constrained by cost containment initiatives undertaken by payors.

Initiatives undertaken by private insurers, managed care companies and federal and state governments to contain healthcare costs may affect the profitability of our hospice programs. We have a number of contractual arrangements with private insurers and managed care companies to provide hospice care for a fixed fee. These payors often attempt to control healthcare costs by contracting with hospices and other healthcare providers to obtain services on a discounted basis. We believe that this trend may continue and may limit payments for healthcare services, including hospice services in the future. In addition, there may be changes made to the Medicare program’s Medicare HMO component, which could result in managed care companies becoming financially responsible for providing hospice care. Currently, Medicare pays for hospice services outside of the Medicare HMO per-member per-month fee so that managed care companies do not absorb the cost of providing these services. If such changes were to occur, a greater percentage of our net patient revenue could come from managed care companies and these companies would be further incentivized to reduce hospice costs. As managed care companies attempt to control hospice-related costs, they could reduce payments to us for hospice services. In addition, states, many of which are operating under significant budgetary pressures, may seek to reduce hospice payments under their Medicaid programs or Medicaid managed care programs may opt not to continue providing hospice coverage. These developments could negatively impact our net patient revenue and profitability.

Professional and general liability claims may have an adverse effect on us either because our insurance coverage may be inadequate to cover the losses or because claims against us, regardless of merit or eventual outcome, may adversely affect our reputation, our ability to obtain patient referrals or our ability to expand our business.

In recent years, participants in the healthcare industry have become subject to an increasing number of lawsuits, including allegations of medical malpractice. Many of these lawsuits involve large claims and substantial defense costs. The medical malpractice claims we have faced relate to our patients in inpatient facilities where we were named as a defendant together with the operator of the inpatient facility.

We maintain general liability insurance coverage on an occurrence basis with limits of $1.0 million per occurrence and $3.0 million in the aggregate. We maintain healthcare professional liability insurance coverage on a claims-made basis with limits of $1.0 million per occurrence and $3.0 million in the aggregate. We also maintain umbrella coverage with a limit of $10.0 million excess over both general and healthcare professional liability coverage. Nevertheless, some risks and liabilities, including claims for punitive damages or claims based on the actions of third parties, may not be covered by insurance. In addition, we cannot assure you that our coverage will be adequate to cover potential losses. While we have generally been able to obtain liability insurance in the past, insurance can be expensive and may not be available in the future on terms acceptable to us, or at all. For example, our insurance relating to automobiles not owned by us but used by our employees and volunteers in connection with their employment recently expired. To date, we have not been able to secure replacement coverage except on prohibitively expensive terms. Moreover, claims, regardless of their merit or eventual outcome, may also adversely affect our reputation, our ability to obtain patient referrals or our ability to expand our business, as well as divert management resources from the operation of our business.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Market risk represents the risk of loss that may affect us due to adverse changes in financial market prices and rates. We have not entered into derivative or hedging transactions to manage any market risk. We do not believe that our exposure to market risk is material at this time.

Item 4. Controls and Procedures.

(a) As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s President and Chief Executive Officer, and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(3). Based upon the required evaluation, the Company’s President and Chief Executive Officer, and Chief Financial Officer, have concluded that the Company’s disclosure controls and procedures are effective.

(b) There have been no changes in the Company’s internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings.

As previously reported in our report on Form 10-K for 2002, we and one of our former employees are currently defendants in an action initiated on February 5, 2003 in the United States District Court in the District of Nevada. The action, Bradeen et al. v. Vista Hospice Care, Inc. and Edward Raymond Lowe, relates to a fatal motor vehicle accident involving a former employee. The plaintiffs in the action allege that the now former employee, while acting within the scope of his employment by us, negligently and recklessly caused a motor vehicle collision that resulted in the death of two people. The plaintiffs seek pecuniary and punitive damages in an unspecified amount. We maintained aggregate liability insurance of $4.0 million at the time of the accident.

Item 2. Changes in Securities and Use of Proceeds.

Use of Proceeds from Our Initial Public Offering

On December 23, 2002, we completed an initial public offering of shares of our Class A common stock. We sold 4.5 million shares and selling stockholders sold 2.4 million shares at an offering price of $12.00 per share. The shares were registered under the Securities Act on a registration statement on Form S-1 (Registration No. 333-98033). The registration statement was declared effective by the Securities and Exchange Commission on December 17, 2002. The managing underwriters for the offering were Lehman Brothers Inc., SG Cowen Securities Corporation, William Blair & Company, L.L.C. and Jefferies & Company, Inc. We incurred the following expenses in connection with the offering:


Underwriting discounts and commissions		$	3,780,000
Finders’ fees		$	0
Expenses paid to or for underwriters:		$	50,000
Other expenses:		$	2,028,000
	Total:	$	5,858,000

None of the foregoing payments represented direct or indirect payments to our directors, officers or holders of 10% or more of any class of our equity securities.

The net proceeds to VistaCare after deducting the total expenses described above amounted to $48.1 million.

Through June 30, 2003, of the net proceeds that we received from our initial public offering, we estimate that we used $4.2 million for working capital purposes. We did not use any of such proceeds to make any direct or indirect payments to our directors, officers or holders of 10% or more of any class of our equity securities during the quarter ended June 30, 2003.

Restrictions Upon the Payment of Dividends

We are prohibited under our credit facility from paying any cash dividends if there is a default under the facility or if the payment of any cash dividends would result in default.

Item 3. Defaults Upon Senior Securities.

None.

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

The Company’s annual meeting of shareholders was held on May 23, 2003. At the annual meeting, the shareholders voted on the following proposals:

To elect two directors of the Company to a term expiring in 2006. Each nominee for director was elected by a vote of the shareholders as follows:


	Affirmative Votes		Votes Withheld

David A. Freeman		14,879,692		35,008
Barry M. Smith		14,887,692		27,008

In addition, the terms of Messrs. Perry G. Fine, M.D., William J. McBride, Pete A. Klisares, Ronald A. Matricaria and Richard R. Slager as directors continued after the meeting

To ratify the selection of Ernst & Young LLP as the Company’s independent accountant for the year ending December 31, 2003. The proposal was approved by a vote of shareholders as follows:


For			13,966,483
Against			920,993
Abstain			27,224
Broker Non-Vote			0

Item 5. Other Information.

None.

Item 6. Exhibits and Reports on Form 8-K.

(a) Exhibits:

The exhibits listed in the Exhibit Index immediately preceding such exhibits are filed as part of this report.

(b) Reports on Form 8-K:

The registrant furnished the following Current Report on Form 8-K during the three months ended June 30, 2003:

The registrant furnished a report on Form 8-K with the Securities and Exchange Commission on April 29, 2003 furnishing, pursuant to item 12 of Form 8-K, a copy of the press release issued by the registrant on April 28, 2003 announcing its results of operations for the three months ended, and financial condition as of, March 31, 2003.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	VISTACARE, INC.

	By:	/s/ Richard R. Slager


Date: August 14, 2003	Richard R. Slager
	President and Chief Executive Officer
	(principal executive officer)

	By:	/s/ Mark E. Liebner


Date: August 14, 2003	Mark E. Liebner
	Chief Financial Officer
	(principal financial officer and chief accounting officer)

EXHIBIT INDEX


Exhibit
Number		Description

10.40*		Amendment to Employee Confidentiality and Non-Competition Agreement dated as of June 6, 2003 between VistaCare, Inc. and Barry M. Smith

31.1		Certification pursuant to Exchange Act Rules 13a-14 and 15d-14 of the Chief Executive Officer

31.2		Certification pursuant to Exchange Act Rules 13a-14 and 15d-14 of the Chief Financial Officer

32.1		Certification pursuant to 18 U.S.C. Section 1350 of the Chief Executive Officer

32.2		Certification pursuant to 18 U.S.C. Section 1350 of the Chief Financial Officer

Indicates management contract or compensatory plan, contract or arrangement.

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	8th grade Good

Vasta Platform Inactive 10-Q2003 Q2 Quarterly report

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