ODYSSEY HEALTHCARE INC - 10-Q Quarterly Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

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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, 2002

OR

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

FOR THE TRANSITION PERIOD FROM TO
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COMMISSION FILE NUMBER 000-33267

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ODYSSEY HEALTHCARE, INC.
(Exact name of registrant as specified in its charter)

Delaware 43-1723043
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)

717 N. Harwood, Suite 1500, Dallas, Texas 75201
(Address of principal executive offices) (Zip Code)

(214) 922-9711
(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 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes (X) No ( ) The Registrant has only
been subject to filing requirements of the Securities Exchange Act of 1934 since
October 30, 2001.

The number of outstanding shares of the issuer's class of capital stock as
of July 31, 2002 was as follows: 15,500,454 shares of Common Stock, $.001 par
value.

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FORM 10-Q
ODYSSEY HEALTHCARE, INC.
FOR THE QUARTER ENDED JUNE 30, 2002
TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS..................................... 3
ITEM 2. MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS................................ 10
ITEM 3. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK............................ 17
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS........................................ 18
ITEM 2. CHANGE IN SECURITIES AND USE OF PROCEEDS................. 18
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS.................................................. 18
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K......................... 18

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

ODYSSEY HEALTHCARE, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

See accompanying notes.

3

ODYSSEY HEALTHCARE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

See accompanying notes.

4

ODYSSEY HEALTHCARE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes.

5

ODYSSEY HEALTHCARE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

THREE AND SIX MONTHS ENDED JUNE 30, 2001 AND 2002

1. BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States 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 notes required by accounting principles generally
accepted in the United States for complete financial statements of Odyssey
HealthCare, Inc. (the Company). In the opinion of management, all adjustments
consisting only of normal recurring adjustments necessary for a fair
presentation have been included. Interim results are not necessarily indicative
of the results that may be expected for the year. The consolidated financial
statements should be read in conjunction with the consolidated financial
statements and notes thereto for the year ended December 31, 2001 included in
the Company's Form 10-K filed with the Securities and Exchange Commission on
March 20, 2002.

The balance sheet at December 31, 2001 has been derived from the audited
financial statements at that date but does not include all of the information
and notes required by accounting principles generally accepted in the United
States for complete financial statements.

Certain amounts have been reclassed to conform to current presentation.

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.

2. RECENT ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board (FASB) issued
Statements of Financial Accounting Standards (SFAS) No. 141, "Business
Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets,"
effective for 2002. Under the new rules, goodwill and intangible assets deemed
to have indefinite lives are no longer being amortized but are subject to
impairment tests, at least annually, in accordance with the new rules. Other
intangible assets continue to be amortized over their useful lives. The
amortization provisions of SFAS No. 142 apply immediately to goodwill and
intangible assets acquired after June 30, 2001. With respect to goodwill and
intangible assets acquired prior to July 1, 2001, SFAS No. 142 was effective
beginning in the first quarter of 2002. The Company has performed the required
impairment tests of goodwill and indefinite lived intangible assets and has
concluded that no basis for impairment of goodwill and indefinite lived
intangible assets exists at this time.

As required by SFAS 142, the results of operations for the three and six
months ended June 30, 2001 have not been restated for the change in goodwill
amortization. The following table discloses the effect on net income and
earnings per share of excluding goodwill amortization which was recognized in
the three and six months ended June 30, 2001.

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In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which addresses financial
accounting and reporting for the impairment or disposal of long-lived assets and
supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed Of," and the accounting and reporting
provisions of Accounting Principles Board (APB) Opinion No. 30, "Reporting the
Results of Operations for a Disposal of a Segment of a Business." The Company
adopted SFAS No. 144 as of January 1, 2002 and the adoption of the statement did
not have a significant impact on the Company's financial position or results of
operations.

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," which eliminates the requirements under FASB Statement No. 4,
"Reporting Gains and Losses from Extinguishment of Debt," to report gains and
losses from extinguishments of debt as extraordinary items in the income
statement. Similarly, FASB Statement No. 64, "Extinguishments of Debt Made to
Satisfy Sinking-Fund Requirements," has been rescinded. Accordingly, gains or
losses from extinguishments of debt for fiscal years beginning after May 15,
2002 shall not be reported as extraordinary items unless the extinguishment
qualifies as an extraordinary item under the provisions of APB Opinion No. 30,
"Reporting the Results of Operations - Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions." The Company has not determined the impact on the
results of operations or financial position from the adoption of SFAS 145 but
does not expect the impact to be material.

In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which is effective for exit or
disposal activities initiated after December 31, 2002, with earlier application
encouraged. SFAS No. 146 addresses the accounting for costs associated with
exit or disposal activities and nullifies Emerging Issues Task Force Issue No.
94-3 "Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in Restructuring)".
The Company does not anticipate a material impact on the results of operations
or financial position from the adoption of SFAS No. 146.

3. SECONDARY PUBLIC OFFERING

On April 15, 2002, the Company completed its secondary public offering at
$27.00 per share (the Offering). The selling stockholders sold 5.6 million
shares (including 0.7 million shares issued upon the exercise of the
underwriter's option to purchase such shares to cover overallotments). The
Company did not receive any of the proceeds from the Offering and has incurred
costs of $0.3 million related to the Offering.

4. ACQUISITIONS

In April 2002, the Company purchased all of the assets and business of
Heart of Ohio Community Health Services Corporation, a hospice located in
Columbus, Ohio. The purchase price, including transaction costs, totaled $0.6
million. Assets acquired include goodwill of $0.6 million.

In April 2002, the Company purchased three hospices of Hospice Care of
Louisiana, Inc., located in Baton Rouge, New Orleans and Shreveport, Louisiana.
The purchase price, including transaction costs, totaled $9.9 million. Assets
acquired include furniture and fixtures of $0.1 million and goodwill of $9.8
million.

In June 2002, the Company purchased all of the assets and business of
Centercal Management Services, LTD, a hospice located in Bakersfield,
California. The purchase price, including transaction costs, totaled $0.5
million. Assets acquired include goodwill of $0.5 million.

In July 2002, the Company purchased all of the assets and business of
Palliative Hospice Center, LLC, a hospice located in Wichita, Kansas. The
purchase price, including transaction costs, totaled $0.1 million. Assets
acquired include licenses of $0.1 million.

In August 2002, the Company purchased all of the assets and business of
HospiCare, Inc., a hospice located in Biloxi, Mississippi. The purchase price,
including transaction costs, totaled $1.0 million. Assets acquired include
licenses of $0.2 million and goodwill of $0.8 million.

In August 2002, the Company purchased all of the assets and business of
Delta Hospice, Inc., a hospice located in Albuquerque, New Mexico, including an
alternate delivery site located in Los Alamos, New Mexico. The purchase price,
including transaction costs, totaled $2.0 million. Assets acquired include
licenses of $0.2 million and goodwill of $1.8 million.

The Company has made acquisitions to expand its base of hospice locations.
All acquisitions were accounted for under the purchase method of accounting. The
results of operations have been included in the consolidated financial
statements of the Company from the dates of acquisition.

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Unaudited pro forma consolidated results of operations of the Company for
the six months ended June 30, 2001 and 2002 are presented below. Such pro forma
presentation has been prepared assuming that the acquisitions described above
have been made as of January 1 of the year preceding the year of acquisition:

5. DEFERRED COMPENSATION

During the three and six months ended June 30, 2001, the Company recorded
aggregate deferred compensation for employees of $1.4 million, representing the
difference between the exercise prices of stock options granted in fiscal year
2001 under the Stock Option Plan and the then deemed fair value of the common
stock. These amounts are being amortized as charges to operations, using the
graded method. Under the graded method, approximately 46%, 26%, 15%, 9% and 4%,
respectively, of each options compensation expense is recognized in each of the
five years following the date of the grant. For the three months ended June 30,
2001 and 2002, the Company amortized $0.2 million and $0.2 million of deferred
compensation, respectively. For the six months ended June 30, 2001 and 2002, the
Company amortized $0.6 million and $0.4 million of deferred compensation,
respectively.

6. NET INCOME PER COMMON SHARE

Basic net income per common share is computed by dividing net income less
the annual Series A, Series B and Series C Convertible Preferred Stock
dividends, where applicable, by the weighted average number of common shares
outstanding during the period. Diluted net income per common share is computed
by dividing the net income by the weighted average number of common shares
outstanding during the period plus the effect of dilutive securities, giving
effect to the conversion of the convertible preferred stock (using the
if-converted method), where applicable, and employee stock options and
outstanding warrants (using the treasury stock method and considering the effect
of unrecognized deferred compensation charges).

The following table presents the calculation of basic and diluted net
income per common share and pro forma basic and diluted net income per common
share:

8

Series B Preferred Stock Warrants
convertible to common stock ............................ 110 42 50 42
Common stock warrants .................................... 970 -- 970 --
---------- ---------- ---------- ----------
Denominator for diluted net income per share - adjusted
weighted average shares and assumed conversions .......... 11,992 16,362 11,929 16,281
========== ========== ========== ==========
Net income per common share:
Basic .................................................... $ 1.27 $ 0.31 $ 2.14 $ 0.57
Diluted .................................................. 0.24 0.29 0.41 0.54

7. INCOME TAXES

The Company expects that its effective tax rate will be approximately 37.5%
during 2002 as there are no remaining net operating loss carryforwards or
remaining valuation allowances.

Income taxes of $6.9 million were paid thus far in 2002.

8. CONTINGENCIES

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

The Company's current general and professional liability policy does not
provide coverage for claims that arise from acts that occurred prior to the
policy's start date of April 12, 2000. From March 12, 1999 to April 12, 2000,
Reliance National Insurance Company provided the Company's insurance coverage.
Since April 12, 2000, Lexington Insurance Company, a subsidiary of American
International Group, Inc., has provided the Company's insurance coverage. During
the fourth quarter of 2001, the Insurance Commissioner of the Commonwealth of
Pennsylvania placed Reliance National Insurance Company in liquidation. As of
June 30, 2002, the Company's reserves of $0.6 million included amounts to cover
potential losses resulting from current and future litigation claims covered by
Reliance National Insurance Company to the extent its assets are not sufficient
to pay such claims. Although the Company believes that the amount reserved is
adequate to cover its potential losses, the Company cannot assure that its
losses will not exceed the amount reserved. The Company's profitability will be
negatively impacted to the extent its actual losses exceed the amount reserved.
The Company could potentially recover from any losses through state funds and/or
bankruptcy rulings; however these amounts are undeterminable.

9. RELATED PARTY TRANSACTIONS

A member of the Company's board of directors is a partner of the limited
liability partnership from which the Company had obtained senior subordinated
notes. Interest paid on these notes was approximately $0.4 million and $1.1
million for the three and six months ended June 30, 2001, respectively. These
notes were paid in full with proceeds from the initial public offering in
October 2001.

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

The following discussion of our financial condition and results of
operations should be read in conjunction with our unaudited consolidated
financial statements and the related notes thereto included in Item 1 of this
Quarterly Report on Form 10-Q.

OVERVIEW

We are one of the largest providers of hospice care in the United States in
terms of both average daily census and number of locations. As a hospice care
provider, our goal is to improve the quality of life of terminally ill patients
and their families. We believe that our overriding focus on the delivery of
quality, responsive service differentiates us from other hospice care providers.
We have grown rapidly since we opened our first hospice location in January
1996. Through the development of new hospice locations and a series of
acquisitions, we now have 53 hospice locations to serve patients and their
families in 24 states. We operate all of these hospice locations through our
operating subsidiaries. During the three months ended June 30, 2002, our average
daily census was 4,289 patients, which represents a 47.4% increase over our
average daily census for the three months ended June 2001 of 2,909 patients.
During the six months ended June 30, 2002, our average daily census was 3,991
patients, which represents a 46.1% increase over our average daily census for
the six months ended June 2001 of 2,731 patients. Our net patient service
revenue of $46.6 million for the three months ended June 30, 2002 represents an
increase of 51.4% over our net patient service revenue of $30.8 million for the
three months ended June 30, 2001. Our net patient service revenue of $86.8
million for the six months ended June 30, 2002 represents an increase of 52.2%
over our net patient service revenue of $57.0 million for the six months ended
June 30, 2001. We reported net income of $4.7 million for the three months ended
June 30, 2002, and $2.9 million for the three months ended June 30, 2001,
respectively. We reported net income of $8.8 million for the six months ended
June 30, 2002, and $4.9 million for the six months ended June 30, 2001,
respectively.

DEVELOPED HOSPICES AND ACQUISITIONS

DEVELOPED HOSPICES

During the second quarter of 2002, our Austin, Texas and Montgomery,
Alabama hospices received Medicare certification. We are continuing development
of the Chicago (South), Illinois, Tulsa, Oklahoma, Cleveland, Ohio and St.
Louis, Missouri hospices.

ACQUISITIONS

During 2001, we acquired seven hospices for a combined purchase price of
$11.3 million. We financed our acquisitions in 2001 with $7.0 million in cash
obtained from borrowings under our credit agreement, $1.2 million in cash from
the proceeds of our initial public offering and promissory notes payable to the
sellers in the aggregate principal amount of $3.1 million.

During the second quarter of 2002, we acquired five hospices for a combined
purchase price of $11.0 million. We financed our acquisitions during the second
quarter with $11.0 million in cash proceeds from our initial public offering.

During the third quarter of 2002, we acquired three hospices for a combined
purchase price of $3.1 million. We financed our acquisitions during the third
quarter with $3.1 million in cash proceeds from our initial public offering.

We accounted for these acquisitions as purchases.

As part of our ongoing acquisition strategy, we are continually evaluating
other potential acquisition opportunities.

We have entered into a non-binding letter of intent to acquire a hospice
located in Omaha, Nebraska with a patient census of approximately five.
Completion of this acquisition is subject to various conditions, including our
ability to enter into a definitive agreement to acquire this hospice. We cannot
assure you that a definitive agreement will be entered into or that this
acquisition will be completed.

Goodwill from our hospice acquisitions, net of accumulated amortization,
was $26.7 million as of December 31, 2001 and $37.7 million as of June 30, 2002.
Goodwill, net of accumulated amortization, was 34.4% of common stockholders'
equity and 27.2% of total assets as of December 31, 2001 and 43.2% of common
stockholders' equity and 35.0% of total assets as of June 30, 2002. During

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fiscal 2001 and prior years, we amortized our goodwill over 20 years for
acquisitions completed through June 30, 2001 and did not amortize goodwill for
acquisitions subsequent to June 30, 2001. Under new rules issued by the FASB,
effective for fiscal 2002, goodwill and intangible assets deemed to have
indefinite lives are no longer amortized but are subject to annual impairment
tests in accordance with the new rules. Other intangible assets with definite
lives continue to be amortized over their useful lives. We applied the new rules
on accounting for goodwill and other intangible assets beginning in the first
quarter of 2002. We have completed the required impairment tests of goodwill and
indefinite lived intangible assets and have concluded that no basis for
impairment of our goodwill and indefinite lived intangible assets exists at this
time.

NET PATIENT SERVICE REVENUE

Net patient service revenue is the estimated net realizable revenue from
patients, Medicare, Medicaid, commercial insurance, managed care payors and
others for services rendered. Payors may determine that the services provided
are not covered and do not qualify for a payment or, for commercial payors, that
the payments are subject to usual and customary rates. To determine net patient
service revenue, we adjust gross patient service revenue for estimated payment
denials and contractual adjustments based on historical experience. We recognize
net patient service revenue in the month in which our services are delivered.
Services provided under the Medicare program represented approximately 93.8% and
94.7% of our net patient service revenue for the three months ended June 30,
2001 and 2002, respectively, and 93.6 % and 94.6% of our net patient service
revenue for the six months ended June 30, 2001 and 2002, respectively. Services
provided under Medicaid programs represented approximately 3.1% and 2.8% of our
net patient service revenue for the three months ended June 30, 2001 and 2002,
respectively, and 3.2% and 2.9% of our net patient service revenue for the six
months ended June 30, 2001 and 2002, respectively. The payments we receive from
the Medicare and Medicaid programs are calculated using daily or hourly rates
for each of the four levels of care we deliver and are adjusted based on
geographic location.

Routine home care is the largest component of our gross patient service
revenue, representing 89.2% and 89.9% of gross patient service revenue for the
three months ended June 30, 2001 and 2002, respectively, and 88.0% and 89.5% of
gross patient service revenue for the six months ended June 30, 2001 and 2002,
respectively. Inpatient care represented 8.8% and 8.1% of gross patient service
revenue for the three months ended June 30, 2001 and 2002, respectively, and
9.5% and 8.5% of gross patient service revenue for the six months ended June 30,
2001 and 2002, respectively. Continuous care and respite care, combined,
represented most of the remaining gross patient service revenue for these
periods.

The principal factors that impact net patient service revenue are our
average daily census, levels of care provided to our patients and changes in
Medicare and Medicaid payment rates due to adjustments for inflation. Average
daily census is affected by the number of patients referred by new and existing
referral sources, and admitted into our hospice program, and average length of
stay of those patients once admitted. Average length of stay is impacted by
patients' decisions of when to enroll in hospice care after diagnoses of
terminal illnesses and, once enrolled, the length of the terminal illnesses. Our
average hospice length of stay has increased from 57 days for the quarter ended
June 30, 2001 to 63 days for the quarter ended June 30, 2002 and has increased
from 56 days for the six months ended June 30, 2001 to 63 days for the six
months ended June 30, 2002.

Payment rates under the Medicare and Medicaid programs are currently
indexed for inflation annually; however, the increases have historically been
less than actual inflation. Effective April 1, 2001, however, the base Medicare
daily payment rates for hospice care increased by five percent over the base
rates then in effect, which has favorably impacted our profitability. On October
1, 2001, the base Medicare payment rates for hospice care increased by
approximately 3.2% over the base rates previously in effect. The Centers for
Medicare and Medicaid Services recently announced a net 3.4% increase in
Medicare hospice reimbursement rates effective October 1, 2002. These rates are
further adjusted by the hospice wage index. In the future, reductions in the
Medicare and Medicaid payment rates or the rate of increase in Medicare and
Medicaid payments may have an adverse impact on our net patient service revenue.

EXPENSES

Because we generally receive fixed payments for our hospice services, our
profitability is largely dependent on our ability to manage the expenses of
providing hospice services. We recognize expenses as incurred and classify
expenses as either direct hospice care expenses or general and administrative
expenses. Direct hospice care expenses primarily include direct patient care
salaries and payroll taxes, pharmaceuticals, medical equipment and supplies, and
inpatient costs. Length of stay impacts our direct hospice care expenses as a
percentage of net patient service revenue because, if lengths of stay decline,
direct hospice care expenses, which are often highest during the latter days of
care for a patient, are spread against fewer days of care. Expenses are normally
higher during the latter days of care, because patients generally require
greater hospice services, including drugs, medical equipment and nursing care at
that time due to their deteriorating medical condition. These increased expenses
reduce our profitability because we generally receive fixed payments for our
hospice services. In addition, cost pressures resulting from the use of more
expensive forms of palliative care, including drugs and drug delivery systems,
could negatively impact our profitability.

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For our patients receiving nursing home care under a state Medicaid program
whom elect hospice care under Medicare or Medicaid, we contract with nursing
homes for the nursing homes' provision to patients of room and board services.
The state must pay us, 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. Under our standard nursing home contracts, we pay the nursing home
for these room and board services at the Medicaid daily nursing home rate. We
refer to these costs, net of Medicaid payments, as "nursing home costs, net."

General and administrative expenses primarily include non-patient care
salaries, employee benefits and office leases.

The following table sets forth the percentage of net patient service
revenue represented by the items included in direct hospice care expenses and
general and administrative expenses (exclusive of $0.2 million and $0.2 million
for the three months ended June 30, 2001 and 2002, respectively, and exclusive
of $0.6 million and $0.4 million for the six months ended June 30, 2001 and
2002, respectively, reported separately as stock-based compensation) for the
periods indicated:

STOCK-BASED AND OTHER COMPENSATION CHARGES

Stock-based compensation charges represent the difference between the
exercise price of stock options granted and the deemed fair value of our common
stock on the date of grant determined in accordance with APB No. 25 and its
related interpretations. We recognize compensation charges over the vesting
periods of the stock options using a graded amortization methodology in
accordance with FASB Interpretation No. 28. For purposes of the period-to-period
comparisons included in our results of operations, general and administrative
expenses exclude these stock-based compensation charges, which are reflected as
a separate line item.

We have recorded deferred stock-based compensation charges related to stock
options granted to employees and directors during 2000 and 2001. Based on the
number of outstanding stock options granted during 2000 and 2001, we expect to
amortize approximately $1.4 million of deferred stock-based compensation during
2002 and in future periods. We expect to amortize this deferred stock-based
compensation in the following approximate amounts:

o $0.7 million during 2002 (of which $0.4 million has been amortized as
of June 30, 2002);

o $0.4 million during 2003;

o $0.2 million during 2004; and

o $0.1 million during 2005 and 2006.

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PROVISION FOR INCOME TAXES

Our provision for income taxes consists of current and deferred federal and
state income tax expenses. We estimate that our effective tax rate will be
approximately 37.5% during 2002 as there are no remaining net operating loss
carryforwards or remaining valuation allowances. For fiscal 2001, we fully
utilized our net operating loss carryforwards of $9.5 million that existed at
December 31, 2000 and were fully reserved by a valuation allowance. Accordingly,
our effective tax rate was 19.0% during 2001, after considering the reversal of
the valuation allowance on our deferred tax assets.

RESULTS OF OPERATIONS

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

THREE MONTHS ENDED JUNE 30, 2001 COMPARED TO THREE MONTHS ENDED JUNE 30, 2002

Net Patient Service Revenue

Net patient service revenue increased $15.8 million, or 51.4%, from $30.8
million for the three months ended June 30, 2001 to $46.6 million for the three
months ended June 30, 2002 due primarily to an increase in average daily census
of 1,380, or 47.4%, from 2,909 in 2001 to 4,289 in 2002. Increases in patient
referrals from existing and new referral sources, resulting in increased
billable days, and, to a lesser extent, increases in payment rates, provided
approximately $10.6 million, or 67.1%, of this increase in net patient service
revenue. The remaining increase of $5.2 million, or 32.9%, in net patient
service revenue was due to the inclusion of net patient service revenue from
hospices acquired and developed in 2001 and 2002. Net patient service revenue
per day of care was $116.38 and $119.48 for the three months ended June 30, 2001
and 2002, respectively. This increase was primarily due to overall increases in
Medicare payment rates for our hospice services. Medicare and Medicaid payments
represented 96.9% and 97.5% of our net patient service revenue for the three
months ended June 30, 2001 and 2002, respectively.

Direct Hospice Care Expenses

Direct hospice care expenses increased $7.9 million, or 53.1%, from $14.8
million for the three months ended June 30, 2001 to $22.6 million for the three
months ended June 30, 2002. This increase was primarily due to the growth of our
operations at our existing hospices and, to a lesser extent, to direct hospice
care expenses of hospices acquired in 2001 and 2002. As a percentage of net
patient service revenue, direct hospice care expenses increased from 48.0% to
48.5% for the three months ended June 30, 2001 and 2002, respectively, primarily
due to the growth of our operations through developed hospices.

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

General and administrative expenses increased $5.6 million, or 57.6%, from
$9.7 million for the three months ended June 30, 2001 to $15.3 million for the
three months ended June 30, 2002. This increase was due to the growth of our
operations at our hospice locations. As a percentage of net patient service
revenue, general and administrative expenses increased from 31.5% to 32.8% for
the three months ended June 30, 2001 and 2002, respectively, due primarily to
the growth of our operations at our hospice locations.

Stock-Based Compensation Charges

Stock-based compensation charges were $0.2 million for both the three
months ended June 30, 2001 and 2002. These charges related to amortization of
deferred compensation for stock options granted to management prior to our
initial public offering with exercise prices below the deemed fair value of our
common stock.

Provision for Uncollectible Accounts

Our provision for uncollectible accounts decreased $0.1 million, or 7.2%,
from $0.7 million to $0.6 million for the three months ended June 30, 2001 and
2002, respectively. As a percentage of net patient service revenue, our
provision for uncollectible accounts decreased from 2.3% to 1.4% for the three
months ended June 30, 2001 and 2002, respectively.

Depreciation and Amortization Expense

Depreciation and amortization expense decreased $0.3 million, or 42.7%,
from $0.6 million for the three months ended June 30, 2001 to $0.3 million for
the three months ended June 30, 2002. The decrease was due to the adoption of
SFAS 142 in which goodwill is no longer amortized but assessed for impairment at
least annually. As a percentage of net patient service revenue, depreciation and
amortization expense decreased from 1.9% to 0.7% for the three months ended June
30, 2001 and 2002, respectively.

Other Income (Expense)

Other income (expense) increased $0.9 million from an expense of $0.8
million for the three months ended June 30, 2001 to income of $0.1 million for
the three months ended June 30, 2002, due primarily to a decrease in interest
expense as a result of paying off our line of credit and certain seller notes
with proceeds received from our initial public offering, and by an increase in
interest income received from investment of the proceeds of our initial public
offering.

Provision for Income Taxes

Our provision for income taxes was $1.1 million and $2.9 million for the
three months ended June 30, 2001 and 2002, respectively.

Net Income

Net income increased $1.9 million, from a net income of $2.9 million for
the three months ended June 30, 2001 to a net income of $4.7 million for the
three months ended June 30, 2002.

SIX MONTHS ENDED JUNE 30, 2001 COMPARED TO SIX MONTHS ENDED JUNE 30, 2002

Net Patient Service Revenue

Net patient service revenue increased $29.7 million, or 52.2%, from $57.0
million for the six months ended June 30, 2001 to $86.8 million for the six
months ended June 30, 2002 due primarily to an increase in average daily census
of 1,260, or 46.1%, from 2,731 in 2001 to 3,991 in 2002. Increases in patient
referrals from existing and new referral sources, resulting in increased
billable days, and, to a lesser extent, increases in payment rates, provided
approximately $22.3 million, or 75.3%, of this increase in net patient service
revenue. The remaining increase of $7.4 million, or 24.7%, in net patient
service revenue was due to the inclusion of net patient service revenue from
hospices acquired and developed in 2001 and 2002. Net patient service revenue
per day of care was $115.35 and $120.12 for the six months ended June 30, 2001
and 2002, respectively. This increase was primarily due to overall increases in
Medicare payment rates for our hospice services. Medicare and Medicaid payments
represented 96.8% and 97.5% of our net patient service revenue for the six
months ended June 30, 2001 and 2002, respectively.

14

Direct Hospice Care Expenses

Direct hospice care expenses increased $14.1 million, or 50.8%, from $27.8
million for the six months ended June 30, 2001 to $42.0 million for the six
months ended June 30, 2002. This increase was primarily due to the growth of our
operations at our existing hospices. As a percentage of net patient service
revenue, direct hospice care expenses decreased from 48.8% to 48.4% for the six
months ended June 30, 2001 and 2002, respectively, due primarily to efficiencies
in staffing and, to a lesser extent, overall increases in Medicare payment
rates.

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

General and administrative expenses increased $10.0 million, or 53.6%, from
$18.7 million for the six months ended June 30, 2001 to $28.7 million for the
six months ended June 30, 2002. This increase was due to the growth of our
operations at our hospice locations. As a percentage of net patient service
revenue, general and administrative expenses increased from 32.7% to 33.0% for
the six months ended June 30, 2001 and 2002, respectively, due primarily to the
growth of our operations at our hospice locations.

Stock-Based Compensation Charges

Stock-based compensation charges were $0.6 million and $0.4 million for the
six months ended June 30, 2001 and 2002, respectively. These charges related to
amortization of deferred compensation for stock options granted to management
prior to our initial public offering with exercise prices below the deemed fair
value of our common stock.

Provision for Uncollectible Accounts

Our provision for uncollectible accounts increased $0.2 million, or 15.5%,
from $1.1 million to $1.3 million for the six months ended June 30, 2001 and
2002, respectively, due primarily to our increased net patient service revenue.
As a percentage of net patient service revenue, our provision for uncollectible
accounts decreased from 2.0% to 1.5% for the six months ended June 30, 2001 and
2002, respectively.

Depreciation and Amortization Expense

Depreciation and amortization expense decreased $0.4 million, or 38.6%,
from $1.1 million for the six months ended June 30, 2001 to $0.7 million for the
six months ended June 30, 2002. The decrease was due to the adoption of SFAS 142
in which goodwill is no longer amortized but assessed for impairment at least
annually. As a percentage of net patient service revenue, depreciation and
amortization expense decreased from 1.9% to 0.7% for the six months ended June
30, 2001 and 2002, respectively.

Other Income (Expense)

Other income (expense) increased $1.6 million from an expense of $1.5
million for the six months ended June 30, 2001 to income of $0.2 million for the
six months ended June 30, 2002, due primarily to a decrease in interest expense
as a result of paying off our line of credit and certain seller notes with
proceeds received from our initial public offering, and by an increase in
interest income received from investment of the proceeds of our initial public
offering.

Provision for Income Taxes

Our provision for income taxes was $1.4 million and $5.3 million for the
six months ended June 30, 2001 and 2002, respectively. We had an effective
income tax rate of 21.8% and 37.5% for the six months ended June 30, 2001 and
2002, respectively. Our effective tax rate in 2001 was lower than the statutory
rate due to our net operating loss carryforwards.

Net Income

Net income increased $3.8 million, from a net income of $4.9 million for
the six months ended June 30, 2001 to a net income of $8.8 million for the six
months ended June 30, 2002.

15

LIQUIDITY AND CAPITAL RESOURCES

Our principal liquidity requirements have historically been for debt
service, hospice acquisition and development plans, working capital and other
capital expenditures. Since our initial public offering, we have financed these
requirements primarily with borrowings under our credit facility, proceeds from
the issuance of common stock and debt, seller financing of hospice acquisitions,
operating and capital leases, normal trade credit terms, and cash flows from
operations. At June 30, 2002, we had cash and cash equivalents of $7.9 million
and working capital of $47.8 million. We also had short-term investments of
$27.2 million and an available borrowing capacity of $20.0 million under our
credit agreement.

Cash provided by operating activities was $5.7 million and $6.8 million for
the six months ended June 30, 2001 and 2002, respectively. The increase in cash
provided by operating activities from the prior year was primarily attributable
to the increase in net income, partially offset by increases in non-cash working
capital requirements due to the growth of our business.

Investing activities, consisting primarily of cash paid to purchase
hospices and purchase property and equipment and to acquire short-term
investments, used cash of $6.4 million and $18.0 million for the six months
ended June 30, 2001 and 2002, respectively.

Net cash provided by (used in) financing activities was $1.1 million and
$(1.1) million for the six months ended June 30, 2001 and 2002, respectively,
and represented net borrowings under our credit agreement and proceeds from the
sale of capital stock, warrants and, in 2001, our 12% senior subordinated notes.

In connection with our acquisition of seven hospice programs in 2001, we
paid an aggregate of $8.2 million in cash and issued the following promissory
notes payable to the sellers:

o A promissory note in the principal amount of $0.2 million. We repaid in
full the principal balance of this note and all accrued and unpaid
interest in the aggregate amount of $0.3 million in February 2002;

o A promissory note in the principal amount of $0.3 million. The
promissory note bears interest at the rate of 8% per annum and is
payable in two installments, with $0.2 million of the principal amount,
plus accrued and unpaid interest, paid on April 1, 2002 and the
remaining principal amount, plus accrued and unpaid interest, due and
payable on April 19, 2003;

o A promissory note in the principal amount of $1.0 million. The
promissory note bears interest at the rate of 7% per annum and is
payable in two installments, with $0.5 million of the principal amount,
plus accrued and unpaid interest, paid on April 1, 2002 and the
remaining principal amount, plus accrued and unpaid interest, due and
payable on April 2, 2003;

o A promissory note in the principal amount of $0.5 million. We repaid in
full the principal balance of this note and all accrued and unpaid
interest in the aggregate amount of $0.5 million on May 31, 2002;

o A promissory note in the principal amount of $0.6 million. We repaid in
full the principal balance of this note and all accrued and unpaid
interest in the aggregate amount of $0.6 million on June 30, 2002 and
July 29, 2003; and

o A promissory note in the principal amount of $0.5 million. The
promissory note bears interest at the rate of 8% per annum and is
payable in two installments, with $0.3 million of the principal amount,
plus accrued and unpaid interest, due and payable on December 6, 2002
and the remaining principal amount, plus accrued and unpaid interest,
due and payable on December 6, 2003.

In connection with our acquisition of eight hospices thus far in 2002, we
paid $14.1 million in cash from the proceeds of our initial public offering.

Our credit agreement with Heller Healthcare Finance, Inc. provides us with
a $20 million revolving line of credit for working capital, acquisitions and
general corporate purposes. Borrowings outstanding under our revolving line of
credit bear interest at fluctuating rates equal to 1.0% above the prime rate of
interest designated by Citibank, with a floor of 10% per annum. Our revolving
line of credit will mature on October 2, 2003. As of June 30, 2002, we had no
outstanding borrowings under our credit agreement or accrued and unpaid
interest. Our revolving line of credit is secured by all of our accounts
receivable and any other right to payment for goods sold or leased or services
rendered by us and all other property in our possession or under our control. We
and our subsidiaries are subject to affirmative and negative covenants,
including:

o limitations on indebtedness, mergers, acquisitions and dispositions of
assets, dividends, investments and liens;

o license maintenance covenants; and

o financial maintenance covenants.

16

We were in full compliance with our financial and other covenants as of
June 30, 2002. We may in the future refinance our credit agreement with a new
credit agreement with our existing lender or new lenders.

We expect that our principal liquidity requirements will be for working
capital, development plans, anticipated hospice acquisitions, debt service and
other anticipated 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 12
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 locations and acquisitions.

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
service revenue and profits.

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 cost control measures designed to curb
increases in operating expenses. We have, to date, offset increases in operating
costs by increasing patient census. However, we cannot predict our ability to
cover or offset future cost increases.

FORWARD-LOOKING STATEMENTS

Certain statements used in the preceding discussion and elsewhere in this
Quarterly Report on Form 10-Q, including statements regarding our future
financial position and results of operations, business strategy and plans and
objectives of management for future operations and statements containing the
words "believe", "may", "will", "estimate", "continue", "anticipate", "intend",
"expect" and similar expressions, as they relate to us, are forward-looking
statements within the meaning of the federal securities laws. These
forward-looking statements are subject to known and unknown risks, uncertainties
and assumptions which may cause our actual results, performance or achievements
to differ materially from those anticipated or implied by the forward-looking
statements. Such risks, uncertainties and assumptions include, but are not
limited to (i) the effect of reductions in amounts paid to the us by the
Medicare and Medicaid programs, (ii) the effect of changes in healthcare
licensure, regulation and payment methods, (iii) our dependence on patient
referrals, (iv) our ability to develop new hospice locations in new markets or
markets that we currently serve, (v) our ability to identify suitable hospices
to acquire on favorable terms and to integrate effectively the operations of
acquired hospices, (vi) our ability to attract and retain key personnel and
skilled employees, and (vii) our ability to obtain additional capital to finance
growth. Given these uncertainties, readers are cautioned not to place undue
reliance on such forward-looking statements, which reflect management's view
only as of the date of this Quarterly Report on Form 10-Q. We undertake no
obligation to update any such statements or publicly announce any updates or
revisions to any of the forward-looking statements contained herein to reflect
any change in our expectations with regard thereto or any change in events,
conditions, circumstances or assumptions underlying such statements. Reference
is hereby made to the disclosure contained under the heading "Risk Factors" in
our Form 10-K filed with the Securities and Exchange Commission on March 20,
2002.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Changes in interest rates would affect the fair market value of our fixed
rate debt instruments but would not have an impact on our earnings or cash
flows. Fluctuations in interest rates on any future variable rate debt
instruments, which are tied to the prime rate, would affect our earnings and
cash flows but would not affect the fair market value of the variable rate debt.

17

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

From time to time, we may be involved in litigation relating to claims
arising out of our operations in the normal course of our business. We are not
aware of any legal proceedings pending or threatened that we expect would have a
material adverse effect on us.

ITEM 2. CHANGE IN SECURITIES AND USE OF PROCEEDS

During the quarter ended June 30, 2002, we utilized approximately $3.3
million of the proceeds received by us in our initial public offering in
November 2001 for general corporate purposes. We also utilized $11.0 million of
the proceeds received by us in our initial public offering to complete the
acquisitions of hospices located in California, Ohio and Louisiana. We have
utilized $3.1 million of the proceeds received by us in our initial public
offering to complete the acquisitions of hospices located in Mississippi, New
Mexico and Kansas in the third quarter of 2002. The remainder of the net
proceeds will be used to finance potential acquisitions of hospices, for the
development of new hospice locations and for other general corporate purposes.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

At our Annual Meeting of Stockholders held on May 31, 2002, the following
proposals were submitted to stockholders with the following results:

1. Election of Mark A. Wan to serve as our Class I Director until our
annual Meeting of Stockholders in 2005 and until his successor is
elected and qualified or until his earlier death, resignation or
removal from office. 13,604,540 shares of common stock were voted for
the election of Mr. Wan and 109,015 shares of our common stock were
withheld from voting thereon.

The following individual is also a Class I Director, whose term
expires at our Annual Meeting of Stockholders in 2005: Paul Feldstein.
The following individuals are our Class II Directors, whose terms
expire at our Annual Meeting of Stockholders in 2003: John K. Carlyle,
David W. Cross and David L. Steffy. The following individuals are our
Class III Directors, whose terms expire at our Annual Meeting of
Stockholders in 2004: Martin S. Rash, Richard R. Burnham and David C.
Gasmire.

2. Ratification of the selection of Ernst & Young LLP as independent
accountants of the Company for the fiscal year ending December 31,
2002.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits:

3.1 Fifth Amended and Restated Certificate of Incorporation
(incorporated by reference to Exhibit 3.1 to the Company's
Amendment No. 2 to Registration Statement on Form S-1
(Registration No. 333-51522) as filed with the Commission on
September 13, 2001)

3.2 Second Amended and Restated Bylaws (incorporated by
reference to Exhibit 3.2 to the Company's Registration
Statement on Form S-1 (Registration No. 333-51522) as filed
with the Commission on December 8, 2000)

4.1 Form of Common Stock Certificate (incorporated by reference
to Exhibit 4.1 to the Company's Amendment No. 1 to
Registration Statement on Form S-1 (Registration No.
333-51522) as filed with the Commission on August 2, 2001)

4.2 Second Amended and Restated Registration Rights Agreement,
dated July 1, 1998, by and among Odyssey HealthCare, Inc. and
the security holders named therein (incorporated by reference
to Exhibit 4.3 to the Company's Registration Statement on Form
S-1 (Registration No. 333-51522) as filed with the Commission
on December 8, 2000)

18

4.3 Rights Agreement (the "Rights Agreement") dated November 5,
2001, between Odyssey HealthCare, Inc. and Rights Agent
(incorporated by reference to Exhibit 4.1 to the Company's
Registration Statement on Form 8-A as filed with the
Commission on December 8, 2001)

4.4 Form of Certificate of Designation of Series A Junior
Participating Preferred Stock (included as Exhibit A to the
Rights Agreement (Exhibit 4.3 hereto))

(b) Reports on Form 8-K:

None.

19

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, in the City of Dallas, State of Texas,
on the 13th day of August, 2002.

ODYSSEY HEALTHCARE, INC.

By: /s/ Richard R. Burnham
----------------------
Richard R. Burnham
Chief Executive Officer and Chairman of the Board
(Duly authorized to sign this report on behalf of Registrant)

By: /s/ Douglas B. Cannon
---------------------
Douglas B. Cannon
Senior Vice President, Chief Financial Officer, Secretary and Treasurer
(Principal Financial and Accounting Officer)

20

EXHIBIT INDEX