UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

FOR THE TRANSITION PERIOD FROM            TO

COMMISSION FILE NUMBER 000-33267

ODYSSEY HEALTHCARE, INC.

(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 þ      No o

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

     The number of outstanding shares of the issuer’s common stock as of May 5, 2005 was as follows: 34,496,588 shares of Common Stock, $0.001 par value per share.

FORM 10-Q

ODYSSEY HEALTHCARE, INC.
FOR THE QUARTER ENDED MARCH 31, 2005
TABLE OF CONTENTS

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

ODYSSEY HEALTHCARE, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these financial statements.

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ODYSSEY HEALTHCARE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

The accompanying notes are an integral part of these financial statements.

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ODYSSEY HEALTHCARE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of these financial statements.

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ODYSSEY HEALTHCARE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2004 AND 2005

1. BASIS OF PRESENTATION

     The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. 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 notes required by U.S. generally accepted accounting principles for complete financial statements of Odyssey HealthCare, Inc. and its subsidiaries (the “Company”). In the opinion of management, all adjustments consisting 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 unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2004 included in the Company’s Form 10-K filed with the Securities and Exchange Commission (the “SEC”) on March 15, 2005.

     The consolidated balance sheet at December 31, 2004 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 reclassified to conform to the current presentation.

USE OF ESTIMATES

     The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Management estimates include an allowance for uncollectible accounts and contractual allowances, accrued compensation, accrued nursing home costs, accrued Medicare cap, accrued workers’ compensation, accrued patient care costs, accrued taxes, accrued professional fees and goodwill impairment. Actual results could differ from those estimates.

2. STOCK BASED COMPENSATION

     On December 16, 2004, the Financial Accounting Standards Board (the “FASB”) issued FASB Statement 123R (revised 2004), “Share-Based Payment,” (“Statement 123R”) which is a revision of FASB Statement 123, “Accounting for Stock-Based Compensation, (“Statement 123”). Statement 123R supersedes Accounting Principles Board (the “APB”) Opinion No. 25 “Accounting for Stock Issued to Employees” (“APB 25”) and amends FASB Statement No. 95, “Statement of Cash Flows.” Generally, the approach in Statement 123R is similar to the approach described in Statement 123. However, Statement 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative.

     In April 2005, the SEC amended the compliance dates for the application of Statement 123R. Statement 123R must be adopted for fiscal years that begin after June 15, 2005. Early adoption will be permitted in periods in which financial statements have not yet been issued. The Company expects to adopt Statement 123R on January 1, 2006.

     Statement 123R permits public companies to adopt the requirements using one of two methods:

	1.	A “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of Statement 123R for all share-based payments granted after the effective date and (b) based on the requirement of Statement 123 for all awards granted to employees prior to the effective date of Statement 123R that remain unvested on the effective date.
	2.	A “modified retrospective” method which include the requirements of the modified prospective method described above, but also permits companies to restate based on the amounts previously recognized under

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Statement 123 for purposes of pro forma disclosures either (a) all prior periods presented or (b) prior interim periods of the year of adoption.

The Company has not yet determined which method it will use.

     As permitted in Statement 123, the Company currently accounts for share-based payments to employees using APB 25 which uses the intrinsic value method and, as such, generally recognizes no compensation cost for employee stock options. Accordingly, the adoption of Statement 123R’s fair value method will have a significant impact on the Company’s results of operations, although it will have no impact on the Company’s overall financial position or liquidity. The impact of adoption of Statement 123R cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had the Company adopted Statement 123R in prior periods, the impact of that standard would have approximated the impact of Statement 123 as described in the disclosure of pro forma net income and earnings per share which is included in the table below. Statement 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current accounting literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. While the Company cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options), the amount of operating cash flows recognized in prior periods for such excess tax deductions were $0.1 million and $0.4 million for the three months ended March 31, 2004 and 2005, respectively.

     The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS 123 to all stock-based compensation.

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3. NET INCOME PER COMMON SHARE

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

     For the three months ended March 31, 2004 and 2005, options outstanding of 661,170 and 2,279,561, respectively, were not included in the computation of diluted earnings per share because the exercise prices of the options were greater than the average market price of the common stock and thus the inclusion would have been antidilutive.

4. REPURCHASE OF COMMON STOCK

     On November 1, 2004, the Company announced the adoption of an open market stock repurchase program to repurchase up to $30.0 million of the Company’s common stock over a six-month period. The timing and the amount of any repurchase of shares during the six-month period was determined by management based on its evaluation of market conditions and other factors. As of March 31, 2005, the Company had repurchased 2,515,434 shares of the Company’s common stock at a cost of $30.0 million (average cost of $11.93 per share) and had completed its stock repurchase program. Stock repurchases were funded from the Company’s working capital.

5. OTHER ACCRUED EXPENSES

     Other accrued expenses are as follows:

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6. REVOLVING LINE OF CREDIT

     On May 14, 2004, the Company entered into a new revolving line of credit with General Electric Capital Corporation (as amended, the “Credit Agreement”) that provides the Company with a $40 million revolving line of credit, subject to three separate $10 million increase options. The revolving line of credit will be used, if necessary, to fund future acquisitions, working capital, capital expenditures, and general corporate purposes. Borrowings outstanding under the revolving line of credit will bear interest at LIBOR plus 2.5% or the higher of the prime rate or 50 basis points over the federal funds rate. The revolving line of credit expires May 14, 2007. The revolving line of credit has an unused facility fee of 0.375% per annum and an annual monitoring fee of $30,000. No amounts have been drawn on the revolving line of credit as of March 31, 2005. The revolving line of credit is secured by substantially all of the Company’s and its subsidiaries’ existing and after-acquired personal property assets and all after-acquired real property assets. The Company and its subsidiaries are subject to affirmative and negative covenants under the Credit Agreement. The Company is currently in compliance with all covenants under the Credit Agreement.

     In September 2004, the Company was informed by the Civil Division of the U.S. Department of Justice (the “DOJ”) that it had begun an investigation of the Company under the authority of the False Claims Act. On November 1, 2004, the Company entered into an amendment to the Credit Agreement which, among other things, amended the definition of “Indebtedness” in the Credit Agreement such that (i) the assessment of any fines, penalties and damages, if any, arising from the DOJ investigations will result in a default under the Credit Agreement, meaning that the Company will be prohibited from using loan proceeds to pay for such fines, penalties and damages, and (ii) fines, penalties and damages, if any, arising from the DOJ investigations will be included for purposes of calculating financial covenants. Accordingly, if the Company is assessed any fines, penalties and damages by the DOJ, the Company could be forced to use other sources of capital to pay the amounts of such fines, penalties and damages.

7. CONTINGENCIES

     The Company and its current and former Chief Executive Officers and its current Chief Financial Officer are defendants in a lawsuit originally filed on April 21, 2004 in the United States District Court for the Northern District of Texas, Dallas Division, by plaintiff Francis Layher, Individually and On Behalf of All Others Similarly Situated, purportedly on behalf of all persons who purchased or otherwise acquired our publicly traded securities between May 5, 2003 and February 23, 2004. The complaint alleges violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. The plaintiff seeks an order determining that the action may proceed as a class action, awarding compensatory damages in favor of the plaintiff and the other class members in an unspecified amount, and reasonable costs and expenses incurred in the action, including counsel fees and expert fees. Six similar lawsuits were also filed in May and June of 2004 in the United States District Court for the Northern District of Texas, Dallas Division, by plaintiffs Kenneth L. Friedman, Trudy J. Nomm, Eva S. Caldarola, Michael Schaufuss, Duane Liffrig and G.A. Allsmiller on behalf of the same plaintiff class, making substantially similar allegations and seeking substantially similar damages. As of the date of this Form 10-Q, all of these lawsuits have been transferred to a single judge and consolidated into a single action. Lead plaintiffs and lead counsel have been appointed and the consolidated complaint was filed on December 20, 2004 which, among other things, extended the putative class period to October 18, 2004. The Company has filed a motion to dismiss the lawsuit which is currently pending. While the Company cannot predict the outcome of these matters, it believes that the plaintiffs’ claims are without merit, it denies the allegations in the complaints, and it intends to vigorously defend the lawsuits.

     On July 9, 2004, in the District Court, Dallas County, Texas, John Connolly brought a shareholders’ derivative action, for the benefit of the Company, as nominal defendant, against the current and former Chief Executive Officers and current Chief Financial Officer, Chief Operating Officer, Senior Vice President of Human Resources and Senior Vice President of Clinical and Regulatory Affairs of the Company and each of the current members of the board of directors of the Company and two former members of the board of directors of the Company. The complaint alleges breach of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets and unjust enrichment on the part of each of the named executive officers, current members of the board of directors and two former members of the board of directors. The complaint seeks unspecified amounts of compensatory damages,

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as well as interest and costs, including legal fees from the named executive officers, current members of the board of directors and two former members of the board of directors. No damages are sought from the Company. A similar derivative lawsuit was also filed on July 9, 2004, in the District Court, Dallas County, Texas, by Anne Molinari, for the benefit of the Company, as nominal defendant against the same defendants, making substantially similar allegations and seeking substantially similar damages and has been consolidated with above lawsuit filed by Mr. Connolly. The consolidated lawsuit has been abated by the District Court until July 8, 2005, unless sooner lifted pursuant to a court order. While the Company cannot predict the outcome of these matters, the Company believes that the plaintiffs’ claims are without merit.

     In September 2004, the Company was informed by the Civil Division of the U.S. Department of Justice (“DOJ”) that it had begun a civil investigation of the Company. The DOJ’s investigation appears to be principally focused on patient admissions, retention and discharges from January 2001 through October of 2004. The Company is cooperating with the investigation, which is still ongoing and may take a considerable amount of time to resolve. To date, the DOJ has not made any allegations of impropriety or asserted monetary demands against the Company. As such, the Company is unable to predict, what, if any, action (which could include the imposition of civil or criminal penalties, fines and/or exclusion of one or more of the Company’s hospice programs from participation in the Medicare, Medicaid and other federally-funded healthcare programs) the DOJ might take as a result of its investigation, or the impact, if any, that such action, if any, may have on the Company’s business, operations, liquidity or capital resources.

     On December 30, 2004, in the United States District Court for the Northern District of Texas, Dallas Division, John O. Hanson brought a shareholders’ derivative action, for the benefit of the Company, as nominal defendant, against the current and former Chief Executive Officers, current Chief Financial Officer and each of the current members of the board of directors of the Company and a former member of the board of directors of the Company. The complaint alleges breach of fiduciary duty, abuse of control, aiding and abetting breach of fiduciary duty and gross mismanagement, waste of corporate assets and unjust enrichment on the part of each of the named executive officers, current members of the board of directors and former member of the board of directors. The complaint seeks unspecified amounts of compensatory damages, as well as interest and costs, including legal fees from the named executive officers, current members of the board of directors and former member of the board of directors. No damages are sought from the Company. The lawsuit has been voluntarily stayed by the parties until a final determination on the motion to dismiss that is currently pending in the class action securities litigation previously filed in the United States District Court for the Northern District of Texas, Dallas Division. While the Company cannot predict the outcome of this matter, the Company believes that plaintiff’s claims are without merit.

     If any of these matters were successfully asserted against the Company, there could be a material adverse effect on the Company. From time to time, the Company may be involved in other litigation matters relating to claims that arise in the ordinary course of its business. Although the ultimate liability for these matters cannot be determined, based on the information currently available to the Company, the Company does not believe that the resolution of these other litigation matters to which the Company is currently a party will have a material adverse effect on the Company.

8. SEGMENT REPORTING

     The Company currently evaluates performance and allocates resources primarily on the basis of cost per day of care and income from operations. The hospice programs that are included in each region may change from time to time, but regions are presented for all periods here in a comparative format. During the three months ended March 31, 2005, the Company divided the Texas region into two distinct regions and named these new regions as East Texas and West Texas. Prior periods have been restated to reflect the two new regions. The distribution by regions of the Company’s net patient service revenue, direct hospice care expenses, income (loss) from operations (which is used by management for operating performance review) and average daily census are summarized in the following tables:

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

FORWARD-LOOKING STATEMENTS

     Certain statements used in the following 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 the following:

	•	general market conditions;
	•	adverse changes in reimbursement levels under Medicare and Medicaid programs;
	•	increases in inflation including inflationary increases in patient care costs;
	•	adverse changes in the Medicare payment cap limits and increases in our Medicare payment cap accrual;
	•	decline in patient census growth;
	•	challenges inherent in and potential changes in our growth and expansion strategy;
	•	our ability to attract and retain healthcare professionals;
	•	our dependence on patient referral sources and potential adverse changes in patient referral practices of those referral sources;
	•	changes in state or federal income, franchise or similar tax laws and regulations;
	•	adverse changes in the state and federal licensure and certification laws and regulations;
	•	adverse results of regulatory surveys;
	•	delays in licensure and/or certification;
	•	government and private party legal proceedings and investigations;
	•	adverse changes in the competitive environment in which we operate; and
	•	our ability to implement a new integrated billing and clinical management and electronic medical records system.

     In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this Quarterly Report on Form 10-Q may not occur and actual results could differ materially from those anticipated or implied in the forward-looking statements. Many of these factors are beyond our ability to control or predict. Given these uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements, which reflect management’s views only as of the date hereof. We undertake no obligation to revise or update any of the forward-looking 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 disclosures contained under the headings “Government Regulation and Payment Structure,” “Overview of Government Payments,” “Other Healthcare Regulations” and “Regulations Governing the Privacy and Transmission of Healthcare Information” in “Item 1. Business” and the disclosures contained under the heading “Some Risks Related to Our Business” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K filed with the SEC on March 15, 2005.

     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 patient census and number of hospice programs serving communities. Through the development of new hospice programs and a series of acquisitions, we now have 74 Medicare-certified hospice programs to serve patients and their

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families in 30 states. We operate all of our hospice programs through our operating subsidiaries. During the three months ended March 31, 2005, our average daily census was 7,609 patients, which represents a 3.8% increase over our average daily census for the three months ended March 31, 2004 of 7,330 patients. Our net patient service revenue of $87.8 million for the three months ended March 31, 2005 represents an increase of 3.7% over our net patient service revenue of $84.7 million for the three months ended March 31, 2004. We reported net income of $5.3 million for the three months ended March 31, 2005, which represents a decrease of 32.4% below our net income of $7.9 million for the three months ended March 31, 2004.

     On November 1, 2004, we announced the adoption of an open market stock repurchase program to repurchase up to $30.0 million of our common stock over a six-month period. The timing and the amount of any repurchase of shares during the six-month period was determined by management based on its evaluation of market conditions and other factors. As of March 31, 2005, we had repurchased 2,515,434 shares of our common stock at a cost of $30.0 million (average cost of $11.93 per share) and had completed our stock repurchase program. Stock repurchases were funded out of our working capital.

DEVELOPED HOSPICES

     In the first quarter of 2004, our Arlington, Virginia hospice program became Medicare certified and we continued the development of hospice programs in Athens, Georgia; Allentown, Pennsylvania; Jackson, Mississippi; Providence, Rhode Island; and Savannah, Georgia. All of these hospice programs received Medicare certification in 2004.

     In the first quarter of 2005, our Daytona Beach, Florida hospice program operated by our wholly-owned not-for-profit subsidiary, Hospice of the Palm Coast, Inc., became Medicare certified. We are continuing the development of hospice programs in Harrisburg, Pennsylvania; Corpus Christi, Texas; and Columbia, South Carolina.

     Once a hospice becomes Medicare certified, the process is started to obtain Medicaid certification. This process takes approximately six months and varies from state to state. Medicaid is a state-administered program to provide medical assistance to the indigent and certain other eligible individuals. Medicaid represents approximately 5.0% of our net patient service revenue for the three months ended March 31, 2005.

ACQUISITIONS

     In January 2004, we purchased substantially all the assets and business of Crown of Texas, Ltd., a hospice program with operations located in Amarillo and Conroe, Texas. The purchase price, including transaction costs, totaled $22.5 million. Assets acquired include licenses of $0.6 million, a non-compete agreement of $0.5 million, and furniture and fixtures and goodwill of $21.4 million.

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

     Goodwill from our hospice acquisitions was $93.9 million as of March 31, 2005. During 2001 and prior years, we amortized goodwill over 20 years for acquisitions completed through June 30, 2001. We do not amortize goodwill for acquisitions subsequent to June 30, 2001 based on the provisions of Statement of Financial Accounting Standard No. 142 “Goodwill and Other Intangible Assets” (“SFAS 142”). Under SFAS 142, goodwill and intangible assets deemed to have indefinite lives are not amortized but are reviewed for impairment annually (during the fourth quarter) or more frequently if indicators arise. As of March 31, 2005, no impairment charges have been recorded. Other intangible assets continue to be amortized over their useful lives.

NET PATIENT SERVICE REVENUE

     Net patient service revenue is the estimated net realizable revenue from Medicare, Medicaid, commercial insurance, managed care payors, patients and others for services rendered to our patients. To determine net patient service revenue, we adjust gross patient service revenue for estimated contractual adjustments based on historical experience and estimated Medicare cap assessments. Net patient service revenue does not include charity care or the Medicaid room and board payments. We recognize net patient service revenue in the month in which our services

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are delivered. Services provided under the Medicare program represented approximately 92.5% and 92.2% of our net patient service revenue for the three months ended March 31, 2004 and 2005, respectively. Services provided under Medicaid programs represented approximately 4.1% and 5.0% of our net patient service revenue for the three months ended March 31, 2004 and 2005, respectively. The payments we receive from Medicare and Medicaid are calculated using daily or hourly rates for each of the four levels of care we deliver and are adjusted based on geographic location.

     The four main levels of care we provide are routine home care, general inpatient care, continuous home care and inpatient respite care. We also receive reimbursement for physician services, self-pay and non-governmental room and board. Routine home care is the largest component of our gross patient service revenue, representing 89.6% and 90.8% of gross patient service revenue for the three months ended March 31, 2004 and 2005, respectively. General inpatient care represented 8.3% and 6.9% of gross patient service revenue for the three months ended March 31, 2004 and 2005, respectively. Continuous home care and inpatient respite care and reimbursement for physician services, self-pay and non-governmental room and board represents the remaining 2.1% and 2.3% of gross patient service revenue for the three months ended March 31, 2004 and 2005, respectively.

     The principal factors that impact net patient service revenue are our average daily census, levels of care, annual changes in Medicare and Medicaid payment rates due to adjustments for inflation and estimated Medicare cap assessments. Average daily census is affected by the number of patients referred and admitted into our hospice programs 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 75 days for the three months ended March 31, 2004 to 85 days for the three months ended March 31, 2005. This increase is in part related to a change in the patient diagnosis mix and to increased admissions of non-cancer patients, whose lengths of stay are typically higher than those with cancer related illnesses.

     Payment rates under the Medicare and Medicaid programs are indexed for inflation annually; however, the increases have historically been less than actual inflation. On October 1, 2003 and 2004, the base Medicare payment rates for hospice care increased by approximately 3.4% and 3.3%, respectively, over the base rates previously in effect. These rates were further adjusted geographically by the hospice wage index. In the future, reductions in, or reductions in the rate of increase of Medicare and Medicaid payments may have an adverse impact on our net patient service revenue and profitability.

MEDICARE REGULATION

     We are subject to two limitations on Medicare payments for services. With one limitation, if the number of general inpatient days of care that any of our hospice programs provide to Medicare beneficiaries exceeds 20% of the total days of care that program provides to all patients for an annual period beginning on November 1st, the days in excess of the 20% figure may be reimbursed only at the routine home care rate. None of our hospice programs exceeded the payment limits on general inpatient care services for the three months ended March 31, 2004 and 2005.

     With the other limitation, overall payments made by Medicare to us on a per hospice program basis are subject to a cap amount calculated by the Medicare fiscal intermediary at the end of the hospice cap period. The hospice cap period runs from November 1st of each year through October 31st of the following year. Total Medicare payments to us during this period are compared to the cap amount for this period. Payments in excess of the cap amount must be returned by us to Medicare. The Medicare cap amount is calculated by multiplying the number of Medicare beneficiaries electing hospice care during the period by a statutory amount (“multiplier”) that is indexed for inflation. The multipliers for the twelve-month periods ended October 31, 2003 and 2004 are $18,661 and $19,636, respectively. The Medicare cap amount is further adjusted for transfers of patients to or from other hospices. We only receive partial benefit of the multiplier for Medicare beneficiaries who transfer into our hospice from another hospice or who transfer out of our hospice to another hospice. The 2004 cap amount is applied to all services performed from November 1, 2003 to October 31, 2004. The 2005 multiplier for the Medicare cap year ending October 31, 2005 has not been established. Once established, the new multiplier will become effective retroactively for all services performed since November 1, 2004. The hospice cap amount is computed on a hospice-by-hospice basis.

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     The following table shows the amounts accrued and paid for the Medicare cap for the Medicare cap years ended October 31, 2003, 2004 and 2005.

Medicare Cap Accrual as of March 31, 2005

     For the Medicare cap years ended October 31, 2003 and 2004, the cap accruals noted above in the table are for three and four hospice programs, respectively, that exceeded the Medicare cap for the respective Medicare cap year. For the Medicare cap year ended October 31, 2005, $3.4 million has been accrued for eight hospice programs exceeding the cap as of March 31, 2005. We will continue to review the adequacy of our 2005 accrual on a quarterly basis. We cannot assure you that additional hospice programs will not exceed the Medicare cap in the future or that our accrual for existing programs subject to the Medicare cap will not increase.

EXPENSES

     Because payments for hospice services are primarily paid on a per diem basis, 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, payroll taxes, employee benefits, 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 earliest and latter days of care for a patient, are spread against fewer days of care. Expenses are normally higher during the last 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. In addition, cost pressures resulting from the use of more expensive forms of palliative care, including drugs and drug delivery systems, and increases in direct patient care salaries and employee benefits, could negatively impact our profitability.

     For our patients receiving nursing home care under a state Medicaid program who elect hospice care under Medicare or Medicaid, we contract with nursing homes for 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 100% of the Medicaid daily nursing home rate. We refer to these costs, net of Medicaid payments, as “nursing home costs, net.”

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     General and administrative expenses primarily include non-patient care salaries, payroll taxes, employee benefits, office leases, professional fees and other operating costs.

     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 for the three months ended March 31, 2004 and 2005, respectively:

PROVISION FOR INCOME TAXES

     Our provision for income taxes consists of current and deferred federal and state income tax expenses. Our effective tax rate for the three months ended March 31, 2004 was approximately 39%. We estimate that our effective tax rate for 2005 will remain at approximately 39%.

RESULTS OF OPERATIONS

     The following table sets forth selected consolidated financial information as a percentage of net patient service revenue for the three months ended March 31, 2004 and 2005, respectively.

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THREE MONTHS ENDED MARCH 31, 2004 COMPARED TO THREE MONTHS ENDED MARCH 31, 2005

     The following table summarizes and compares our results of operations for the three months ended March 31, 2004 and 2005, respectively:

Net Patient Service Revenue

     Net patient service revenue increased $3.1 million, or 3.7%, from $84.7 million for the three months ended March 31, 2004 to $87.8 million for the three months ended March 31, 2005, due primarily to an increase in average daily patient census of 279, or 3.8%, from 7,330 patients in 2004 to 7,609 patients in 2005. 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 the increase in net patient service revenue. The increase in net patient service revenue was offset by the Medicare cap accrual which was $2.2 million for the three months ended March 31, 2005 compared to $0.1 million for the three months ended March 31, 2004. Net patient service revenue per day of care was $126.96 and $128.24 for the three months ended March 31, 2004 and 2005, respectively. This increase was primarily due to overall increases in Medicare payment rates for our hospice services. Medicare revenues represented 92.5% and 92.2% of our net patient service revenue for the three months ended March 31, 2004 and 2005, respectively. Medicaid revenues represented 4.1% and 5.0% of our net patient service revenue for the three months ended March 31, 2004 and 2005, respectively.

Direct Hospice Care Expenses

     Direct hospice care expenses increased $1.1 million, or 2.3%, from $47.3 million for the three months ended March 31, 2004 to $48.4 million for the three months ended March 31, 2005. Salaries, benefits and payroll tax expense increased $2.7 million, or 9.6%, from $27.9 million for the three months ended March 31, 2004 to $30.6 million for the three months ended March 31, 2005. This increase is primarily due to average salary increases of 4% and total full-time employees increasing approximately 9% compared to the three months ended March 31, 2004 to accommodate additional census growth at our hospice programs. As a percentage of net patient service revenue, salaries, benefits and payroll tax expense increased from 33.0% to 34.8% for the three months ended March 31, 2004 and 2005, respectively. Pharmacy expense decreased $1.5 million, or 22.7%, from $6.6 million for the three months ended March 31, 2004 to $5.1 million for the three months ended March 31, 2005 as a result of our new electronic data collection and claims adjudication system which allows us to track pharmacy utilization in our hospice programs and manage our pharmacy costs more efficiently. As a percentage of net patient service revenue, pharmacy expenses decreased from 7.8% to 5.8% for the three months ended March 31, 2004 and 2005, respectively. As a percentage of net patient service revenue, total direct hospice care expenses decreased from 55.9% to 55.1% for the three months ended March 31, 2004 and 2005, respectively, due primarily to the reasons noted above.

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General and Administrative Expenses

     General and administrative expenses increased $4.8 million, or 21.8%, from $22.3 million for the three months ended March 31, 2004 to $27.1 million for the three months ended March 31, 2005. Salaries, benefits and payroll tax expense increased $3.1 million, or 24.5%, from $12.8 million for the three months ended March 31, 2004 to $15.9 million for the three months ended March 31, 2005. This increase is primarily due to average salary increases of 4%, the hiring of additional billing coordinators and community education representatives at the hospice program level and a non-recurring severance charge related to the termination of employment of a sales and marketing executive. As a percentage of net patient service revenue, salaries, benefits and payroll tax expense increased from 15.1% to 18.1% for the three months ended March 31, 2004 and 2005, respectively. Legal and accounting fees increased $1.3 million, or 396.6%, from $0.3 million for the three months ended March 31, 2004 to $1.6 million for the three months ended March 31, 2005 due primarily to legal costs incurred related to the DOJ investigation and the class action securities litigation and shareholder derivative litigation. See Note 7 related to the Consolidated Financial Statements. As a percentage of net patient service revenue, total general and administrative expenses increased from 26.3% to 30.9% for the three months ended March 31, 2004 and 2005, respectively, due primarily to the increase in salaries, benefits and payroll tax expense and an increase in legal fees.

Provision for Uncollectible Accounts

     Our provision for uncollectible accounts increased $1.3 million, or 94.5%, from $1.3 million to $2.6 million for the three months ended March 31, 2004 and 2005, respectively, due primarily to additional reserves for uncollectible accounts receivable related to Medicaid room and board services and, to a lesser extent, for additional reserves related to uncollectible accounts receivable related to Medicare resulting from additional development requests from the Medicare fiscal intermediaries, which have increased industry-wide. As a percentage of net patient service revenue, our provision for uncollectible accounts increased from 1.6% to 2.9% for the three months ended March 31, 2004 and 2005, respectively.

Depreciation and Amortization Expense

     Depreciation and amortization expense increased slightly by $0.1 million, or 13.5%, from $0.9 million to $1.0 million for the three months ended March 31, 2004 and 2005, respectively. The increase was related to depreciation of acquired fixed assets during 2004. As a percentage of net patient service revenue, depreciation and amortization expense increased from 1.1% to 1.2% for the three months ended March 31, 2004 and 2005, respectively.

Other Income (Expense)

     Other income increased $77,000, or 167.4%, from $46,000 to $123,000 for the three months ended March 31, 2004 and 2005, respectively. Interest income increased $122,000, or 259.6%, from $47,000 to $169,000 for the three months ended March 31, 2004 and 2005, respectively, due to the average amount invested increasing by approximately $23.6 million for the three months ended March 31, 2005 compared to the three months ended March 31, 2004. Interest expense increased from $0 to $46,000 for the three months ended March 31, 2004 and 2005, respectively. Interest expense is primarily associated with the unused facility fee and amortization of deferred costs related to our revolving line of credit. See Note 6 related to the Consolidated Financial Statements.

Provision for Income Taxes

     Our provision for income taxes was $5.0 million and $3.4 million for the three months ended March 31, 2004 and 2005, respectively. We had an effective income tax rate of approximately 39% for the three months ended March 31, 2004 and 2005.

LIQUIDITY AND CAPITAL RESOURCES

     Our principal liquidity requirements are for the acquisition and implementation of a new integrated billing and clinical management and electronic medical records system, working capital, development plans, hospice acquisitions, debt service and other capital expenditures. We finance these requirements primarily with existing funds, cash flows from operations, operating leases, and normal trade credit terms. As of March 31, 2005, we had cash and cash equivalents of $22.9 million and working capital of $60.8 million. At such date, we also had short-term investments of $14.4 million.

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     Cash provided by operating activities was $6.1 million and $14.3 million for the three months ended March 31, 2004 and 2005, respectively, and represented net income generated, non-cash charges related to depreciation, amortization and taxes and increases and decreases in working capital.

     Investing activities, consisting primarily of cash paid to purchase hospices and property and equipment and to establish short-term investments, used cash of $24.0 million and $6.6 million for the three months ended March 31, 2004 and 2005, respectively.

     Net cash provided by (used in) financing activities was $0.3 million and $(9.6) million for the three months ended March 31, 2004 and 2005, respectively, and represented proceeds from the issuance of common stock and payments related to our stock repurchase program.

     On May 14, 2004, we entered into a new revolving line of credit with General Electric Capital Corporation (as amended, the “Credit Agreement”) that provides us with a $40 million revolving line of credit, subject to three separate $10 million increase options. The revolving line of credit will be used, if necessary, to fund future acquisitions, working capital, capital expenditures and general corporate purposes. Borrowings outstanding under the revolving line of credit will bear interest at LIBOR plus 2.5% or the higher of the prime rate or 50 basis points over the federal funds rate. The revolving line of credit expires May 14, 2007. The revolving line of credit has an unused facility fee of 0.375% per annum and an annual monitoring fee of $30,000. No amounts have been drawn on the revolving line of credit as of March 31, 2005. The revolving line of credit is secured by substantially all of our and our subsidiaries’ existing and after-acquired personal property assets and all after-acquired real property assets. We and our subsidiaries are subject to affirmative and negative covenants under the Credit Agreement. We are currently in compliance with all covenants under the Credit Agreement.

     As discussed under Part II, “Item 1. Legal Proceedings,” in September 2004, we were informed by the Civil Division of the U.S. Department of Justice (the “DOJ”) that it has begun an investigation of us under the authority of the False Claims Act. On November 1, 2004, we entered into an amendment to the Credit Agreement which, among other things, amended the definition of “Indebtedness” in the Credit Agreement such that (i) the assessment of any fines, penalties and damages, if any, arising from the DOJ investigations will result in a default under the Credit Agreement, meaning that we will be prohibited from using loan proceeds to pay for such fines, penalties and damages, and (ii) fines, penalties and damages, if any, arising from the DOJ investigations will be included for purposes of calculating financial covenants. Accordingly, if we are assessed any fines, penalties and damages by the DOJ, we could be forced to use other sources of capital to pay the amounts of such fines, penalties and damages.

     We expect that our principal liquidity requirements will be for the acquisition and implementation of a new integrated billing, clinical management and electronic medical records system, working capital, development plans, hospice acquisitions, debt service and other anticipated capital expenditures. We expect that our existing funds, cash flows from operations, operating leases, normal trade credit terms and our revolving line of credit under the Credit Agreement will be sufficient to fund our principal liquidity requirements for at least 12 months following the date of this Quarterly Report on Form 10-Q. Our future liquidity requirements and the adequacy of our available funds will depend on many factors, including payment for our services, changes in the Medicare per beneficiary cap amount, changes in Medicare payment rates, regulatory changes and compliance with new regulations, expense levels, capital expenditures, development of new hospices and acquisitions and government and private party legal proceedings and investigations.

OFF-BALANCE SHEET ARRANGEMENTS

     As of March 31, 2005, we do not have any off-balance sheet arrangements.

RECENT ACCOUNTING PRONOUNCEMENT

     On December 16, 2004, the Financial Accounting Standards Board (the “FASB”) issued FASB Statement 123R (revised 2004), “Share-Based Payment,” which is a revision of FASB Statement 123, “Accounting for Stock-Based Compensation.” Statement 123R supersedes APB Opinion No. 25 “Accounting for Stock Issued to Employees” (“APB 25”) and amends FASB Statement No. 95, “Statement of Cash Flows.” Generally, the approach in Statement

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123R is similar to the approach described in Statement 123. However, Statement 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative.

     In April 2005, the SEC amended the compliance dates for the application of Statement 123R. Statement 123R must be adopted for fiscal years that begin after June 15, 2005. Early adoption will be permitted in periods in which financial statements have not yet been issued. We expect to adopt Statement 123R on January 1, 2006.

     Statement 123R permits public companies to adopt the requirements using one of two methods:

	1.	A “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of Statement 123R for all share-based payments granted after the effective date and (b) based on the requirement of Statement 123 for all awards granted to employees prior to the effective date of Statement 123R that remain unvested on the effective date.
	2.	A “modified retrospective” method which include the requirements of the modified prospective method described above, but also permits companies to restate based on the amounts previously recognized under Statement 123 for purposes of pro forma disclosures either (a) all prior periods presented or (b) prior interim periods of the year of adoption.

We have not yet determined which method we will use.

     As permitted in Statement 123, we currently account for share-based payments to employees using APB 25 which uses the intrinsic value method and, as such, generally recognizes no compensation cost for employee stock options. Accordingly, the adoption of Statement 123R’s fair value method will have a significant impact on our results of operations, although it will have no impact on our overall financial position or liquidity. The impact of adoption of Statement 123R cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had we adopted Statement 123R in prior periods, the impact of that standard would have approximated the impact of Statement 123 as described in the disclosure of pro forma net income and earnings per share in the table set forth in Note 2 to the consolidated financial statements. Statement 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current accounting literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. While we cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options), the amount of operating cash flows recognized in prior periods for such excess tax deductions were $0.1 million and $0.4 million for the three months ended March 31, 2004 and 2005, respectively.

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 profitability. For the three months ended March 31, 2005, Medicare and Medicaid services constituted 92.2% and 5.0% of our net patient service revenue, respectively.

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 cannot predict our ability to cover or offset future cost increases.

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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 flow. We do not currently have any variable rate debt instruments. 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.

ITEM 4. CONTROLS AND PROCEDURES

     Our Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of March 31, 2005, and based on such evaluation have concluded that the design and operation of such disclosure controls and procedures are effective in ensuring that material information that is required to be disclosed in the periodic reports we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) that occurred during the quarter ended March 31, 2005, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

     We, our current and former Chief Executive Officers and our current Chief Financial Officer are defendants in a lawsuit originally filed on April 21, 2004 in the United States District Court for the Northern District of Texas, Dallas Division, by plaintiff Francis Layher, Individually and On Behalf of All Others Similarly Situated, purportedly on behalf of all persons who purchased or otherwise acquired our publicly traded securities between May 5, 2003 and February 23, 2004. The complaint alleges violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. The plaintiff seeks an order determining that the action may proceed as a class action, awarding compensatory damages in favor of the plaintiff and the other class members in an unspecified amount, and reasonable costs and expenses incurred in the action, including counsel fees and expert fees. Six similar lawsuits were also filed in May and June of 2004 in the United States District Court for the Northern District of Texas, Dallas Division, by plaintiffs Kenneth L. Friedman, Trudy J. Nomm, Eva S. Caldarola, Michael Schaufuss, Duane Liffrig and G.A. Allsmiller on behalf of the same plaintiff class, making substantially similar allegations and seeking substantially similar damages. As of the date of this Form 10-Q, all of these lawsuits have been transferred to a single judge and consolidated into a single action. Lead plaintiffs and lead counsel have been appointed and the consolidated complaint was filed on December 20, 2004, which, among other things, extended the class period to October 18, 2005. We have filed a motion to dismiss the lawsuit, which is currently pending. While we cannot predict the outcome of these matters, we believe that the plaintiffs’ claims are without merit, we deny the allegations in the complaints, and we intend to vigorously defend the lawsuits. If any of these matters were successfully asserted against us, there could be a material adverse effect on us.

     On July 9, 2004, in the District Court, Dallas County, Texas, John Connolly brought a shareholders’ derivative action, for the benefit of us, as nominal defendant, against our current and former Chief Executive Officers and our current Chief Financial Officer, Chief Operating Officer, Senior Vice President of Human Resources and Senior Vice President of Clinical and Regulatory Affairs of the Company and each of the current members of our board of directors and two former members of our board of directors. The complaint alleges breach of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets and unjust enrichment on the part of each of the named executive officers, current members of the board of directors and two former members of the board of directors. The complaint seeks unspecified amounts of compensatory damages, as well as interest and costs, including legal fees from the named executive officers, current members of the board of directors and two former members of the board of directors. No damages are sought from the Company. A similar derivative lawsuit was also filed on July 9, 2004, in the District Court, Dallas County, Texas, by Anne Molinari, for the benefit of the Company, as nominal defendant against the same defendants, making substantially similar allegations and seeking substantially similar damages and has been consolidated with above lawsuit filed by Mr. Connolly. The consolidated lawsuit has been

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abated by the District Court until July 8, 2005, unless sooner lifted pursuant to a court order. While we cannot predict the outcome of these matters, we believe that the plaintiffs’ claims are without merit.

     In September 2004, we were informed by the Civil Division of the U.S. Department of Justice (“DOJ”) that it had begun a civil investigation of the Company. The DOJ’s investigation appears to be principally focused on patient admissions, retention and discharges from January 2001 through October of 2004. We are cooperating with the investigation, which is still ongoing and may take a considerable amount of time to resolve. To date, the DOJ has not made any allegations of impropriety or asserted monetary demands against the Company. As such, we are unable to predict, what, if any, action (which could include the imposition of civil or criminal penalties, fines and/or exclusion of one or more of our hospice programs from participation in the Medicare, Medicaid and other federally-funded healthcare programs) the DOJ might take as a result of its investigation, or the impact, if any, that such action, may have on our business, operations, liquidity or capital resources.

     On December 30, 2004, in the United States District Court for the Northern District of Texas, Dallas Division, John O. Hanson brought a shareholders’ derivative action, for the benefit of us, as nominal defendant, against our current and former Chief Executive Officers, our current Chief Financial Officer and each of the current members of our board of directors and a former member of the board of directors. The complaint alleges breach of fiduciary duty, abuse of control, aiding and abetting breach of fiduciary duty and gross mismanagement, waste of corporate assets and unjust enrichment on the part of each of the named executive officers, current members of the board of directors and former member of the board of directors. The complaint seeks unspecified amounts of compensatory damages, as well as interest and costs, including legal fees from the named executive officers, current members of the board of directors and former member of the board of directors. No damages are sought from the Company. The lawsuit has been voluntarily stayed by the parties until a final determination on the motion to dismiss that is currently pending in the class action securities litigation previously filed in the United States District Court for the Northern District of Texas, Dallas Division. While we cannot predict the outcome of this matter, we believe that the plaintiff’s claims are without merit.

     From time to time, we may be involved in other litigation matters relating to claims that arise in the ordinary course of our business. Although the ultimate liability for these matters cannot be determined, based on the information currently available to us, we do not believe that the resolution of these other litigation matters to which we are currently a party will have a material adverse effect on us.

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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

     On November 1, 2004, we announced the adoption of an open market stock repurchase program to repurchase up to $30.0 million of our common stock over a six-month period. The timing and the amount of any repurchase of shares during the six-month period was determined by management based on its evaluation of market conditions and other factors. As of March 31, 2005, we completed our open market stock repurchase program and had repurchased 2,515,434 shares of our common stock at a cost of $30.0 million (average cost of $11.93 per share). Stock repurchases were funded out of our working capital. The following table sets forth the repurchase data for each of the three months during the first quarter ended March 31, 2005:

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ITEM 6. EXHIBITS

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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.

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EXHIBIT INDEX

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