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SECURITIES AND EXCHANGE COMMISSION

Form 10-K

Commission File No. 000-50118

VistaCare, Inc.

(480) 648-4545

Securities Registered Pursuant to Section 12(b) of the Act:

Securities Registered Pursuant to Section 12(g) of the Act:

          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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in the definitive proxy statement incorporated by reference into Part III of this Form 10-K.     o

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

          The aggregate market value of the Registrant’s Class A Common Stock, held by non-affiliates, based on the closing price (as reported by Nasdaq) of such Class A Common Stock on the last business day of the Registrant’s most recently completed second fiscal quarter (June 30, 2004) was approximately $298,874,076.

          As of November 30, 2004, there were outstanding 16,210,932 shares of the Registrant’s Class A Common Stock, $0.01 par value per share.

DOCUMENTS INCORPORATED BY REFERENCE

          Portions of the Proxy Statement for the Registrant’s 2005 Annual Meeting of Stockholders are incorporated herein by reference in Item 5 of Part II and in Part III of this Form 10-K to the extend stated herein.

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PART I

      On August 10, 2004, VistaCare’s Board of Directors changed the Company’s fiscal year end from December 31 to September 30. The nine-month results now being reported by the Company relate to the transitional fiscal period ended September 30, 2004.

Overview of Our Business

      We are a leading provider of hospice services in the United States. Through interdisciplinary teams of physicians, nurses, home health aides, social workers, spiritual and other counselors and volunteers, we provide care primarily designed to reduce pain and enhance the quality of life of terminally ill patients, most commonly in their home or other residence of choice. Our mission is to provide superior and financially responsible care for the physical, spiritual and emotional needs of our patients and their families, while maintaining a supportive environment for our employees.

      We have grown rapidly since commencing operations in 1995. By the end of 1997, our operations consisted of seven programs in four states. In 1998, we completed two significant acquisitions that increased our census from approximately 350 patients to approximately 1,750 patients. Since then, we have more than tripled our patient census primarily through same-store growth. As of September 30, 2004, we had 45 hospice programs serving patients in 14 states with a census of approximately 5,300 patients.

      Our operations are built around a mission-oriented philosophy that emphasizes superior care and open access to our services. We believe our high care standards, distinctive service philosophy and expertise in cost-effective care management help us develop strong relationships with the medical and consumer communities we serve and give us a competitive advantage in obtaining patient referrals.

Availability of SEC Reports and Our Code of Ethics

      We maintain a website with the address www.vistacare.com. We are not including the information contained on our website as a part of, or incorporating it by reference into, this Transition Report on Form 10-K. We make available free of charge through our website our Transition Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after we electronically file such material with, or furnish such material to, the Securities and Exchange Commission. Information relating to our corporate governance, including our Code of Conduct for our employees, officers and directors and information concerning Board Committees, including Committee Charters, is also available on our Website at www.vistacare.com under the “Investor Relations — Corporate Governance” captions. We will provide any of the foregoing information free of charge upon written request to Investor Relations, VistaCare, Inc., 4800 North Scottsdale Road, Suite 5000, Scottsdale, Arizona 85251. Reports of our executive officers, directors and any other persons required to file securities ownership reports under Section 16(a) of the Securities Exchange Act of 1934 are also available through our web site under the “Investor Relations — Corporate Governance — Click Here for Section 16 Filings” captions.

Overview of the Hospice Care Industry

      Over the past century, care for terminally ill patients in the United States focused primarily on curative treatment, with only secondary regard for patient comfort and immediate quality of life concerns. The 1960s and 1970s saw the emergence of a grass roots movement in the United States that advocated a shift in attitude from strictly providing curative care for terminally ill patients to providing a greater degree of physical, emotional and spiritual comfort and care for patients and their families at the end-of-life. Hospice programs provide these services. According to the National Hospice and Palliative Care Organization (NHPCO) since the 1970s, hospice care in the United States has grown into a multi-billion dollar industry that served

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      Today, Medicare is the largest payor for hospice services. To receive Medicare payment for hospice services, the hospice medical director and, if the patient has one, the patient’s attending physician, must certify that the patient has a life expectancy of six months or less if the illness runs its normal course. Hospice care is also covered by most private insurance plans, and 45 states and the District of Columbia provide hospice coverage to their Medicaid beneficiaries. The NHPCO reports that in 2003, at the time of admission, approximately 81% of hospice patients claimed Medicare as their payment source, 11% private insurance, 5% Medicaid, 3% alternative sources and 1% self-pay.

      Medicare has provided benefits for hospice care since 1983. According to the Centers for Medicare and Medicaid Services (formerly the Health Care Financing Administration), or CMS, between 1984 and 2003, the number of hospice programs certified by Medicare increased from 31 to 2,454. In addition, CMS estimates that Medicare hospice expenditures will reach $5.9 billion in 2003.

      The Medicare hospice benefit covers four distinct levels of care, each of which is subject to a different per diem reimbursement rate. The table below sets forth a brief description of each of the four levels of care and the base Medicare per diem reimbursement rates in effect for the periods indicated:

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      These reimbursement rates are Medicare’s base rates and vary from region to region depending on local salary levels. In 2003, routine home care services accounted for 95.5% of all Medicare hospice days while general inpatient care services, continuous home care services and respite inpatient care services accounted for 3.4%, 0.9%, and 0.2% of Medicare hospice days, respectively. Effective each October 1, and occasionally at other times, Medicare establishes new base hospice care reimbursement rates. The table below sets forth the Medicare hospice base rate increases since October 1, 1999:

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

Market Opportunity

      We believe the hospice care industry is poised for substantial growth over the next several years due to the following factors:

      Awareness and Acceptance of Hospice Care Services is Expanding. Over the past several years, there has been expanding awareness and acceptance of hospice care evidenced by:

	•	according to the NHPCO, between 1992 and 2003 the number of patients receiving hospice care increased from approximately 246,000 to approximately 950,000 annually;
	•	according to CMS’s Office of the Actuary, projected spending will grow from $3.5 billion in 2001 to $5.9 billion in 2003, a 30 percent annual increase;
	•	although hospice care has been traditionally associated with end-stage cancer patients, Medicare records from 1992 to 1998 show a 338% increase in the number of Medicare beneficiaries using the Medicare hospice benefit for conditions other than cancer;
	•	according to CMS, the number of Medicare certified hospice programs increased by 93% between 1992 and 2003; and
	•	a significant percentage of commercial insurers now provide coverage for hospice care services.

      Hospice Care Provides Significant Cost Savings Over Traditional Care. Recent estimates by CMS have concluded that the cost of care for hospice patients is substantially less than the cost of care for similarly situated patients receiving traditional medical services, often in high acuity settings such as hospitals. Reasons for those cost savings include:

	•	hospice care patients in long-term care facilities are hospitalized fewer days in their last month of life than long-term care facility residents not enrolled in hospice programs, according to a March 2000 report commissioned by the United States Department of Health and Human Services (HHS).
	•	hospice care patients are often transitioned from expensive treatments, such as chemotherapy and radiation, to less expensive forms of palliative care; and
	•	hospice care patients generally require less emergency care, which typically involves costly transportation, paramedics, emergency room and other charges.

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      We believe that government and other payors will continue to encourage the use of hospice care because of such cost savings.

      The American Population is Aging. In 2003, 82.4% of our patients were over the age of 65 at the time of admission. Data from the United States Census Bureau indicate that this segment of the American population is expected to grow at a rate three times greater than the rate of the general population between 2002 and 2022. According to the United States Census Bureau, the number of Americans over the age of 65 will increase from 35 million in 2000 to 54 million in 2020. We expect that as this segment of the population grows, the demand for end-of-life services, including hospice care, will increase accordingly.

      Hospice Services Are Underutilized. Although the number of hospice patients has increased rapidly in recent years, we believe that a significant number of hospice-eligible patients do not take advantage of hospice care. The NHPCO estimates that only 25% of decedents in 2000 received hospice care. A 1999 study by The National Hospice Foundation concluded that 75% of Americans were not aware that hospice care can be provided in the home and 90% did not know that hospice care is covered by Medicare. We believe that the following factors contribute to the current underutilization of hospice care:

	•	resistance to or misunderstanding of the benefits of hospice care; and
	•	restrictive eligibility criteria on the part of some hospice care providers, including denying enrollment to patients who wish to continue to maintain certain forms of aggressive treatment or patients who do not have a principal caregiver.

      We believe that as awareness and acceptance of hospice care grows and hospice programs develop a reputation for consistent, high quality care, utilization of hospice services will increase.

Industry Consolidation and Government Initiatives

      In addition to favorable industry growth conditions, we believe that consolidation in the hospice care industry will provide opportunities for us to grow our business. Based on industry data published in the MedPAC (Medicare Payment Advisory Commission) June 2004 report to Congress, approximately 56% of existing hospice in 2003 were local, not-for-profit hospice programs. For-profit ownership was 36%, totaling 883 hospice facilities, an increase of approximately 25% since 2001. Demanding market conditions are making it difficult for smaller providers to offer cost-effective, quality care. We believe that the fragmented hospice care industry is poised for consolidation and that large, well-managed hospice providers are best positioned to affiliate with or acquire smaller hospice care providers.

      Notwithstanding the recent increase in awareness and acceptance of hospice care, we believe that most Americans still lack a basic understanding of the benefits that hospice care offers and are unaware that Medicare, Medicaid and private insurers provide coverage for hospice care. In an effort to increase awareness and acceptance, medical societies, patient advocacy groups, private foundations and the hospice care industry have all undertaken campaigns in recent years to educate physicians and the public about the benefits of hospice care. In March 2003, CMS published an article urging physicians to raise awareness of hospice care among their patients and to recommend hospice care to qualified beneficiaries.

Our Competitive Strengths

      We believe a number of factors differentiate us from our competitors and provide us with important competitive advantages.

      We Benefit from Being One of the Nation’s Largest Hospice Care Providers. As a result of having a patient census among the highest of any hospice provider in the United States, we are able to negotiate volume discounts on the purchase of pharmaceuticals, durable medical equipment and medical supplies, to enter into favorable contracts with private insurers and pharmacy benefit managers and to spread certain fixed costs, particularly corporate overhead, information technology and marketing spending, over a large patient population. In addition, the geographic scope of our operations gives us a competitive advantage in developing referral relationships with national and regional nursing home and assisted living companies who, we believe,

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      We Have Implemented a Highly Effective Pharmacy Cost Control System. Pharmaceuticals represent our second largest category of patient care expenses. To manage those expenses, we have developed and implemented a comprehensive pharmacy cost management system. Using this system, in 2003 and 2004 we were able to achieve an average daily pharmacy cost per patient that is significantly lower than the industry average. Our pharmacy cost management system involves:

	•	a flexible, proprietary, disease and symptom-specific drug formulary that emphasizes the use of generic drugs, if as effective as the brand-name alternative;
	•	the use of our proprietary software applications to streamline the enrollment of our patients in a nationwide network of pharmacies;
	•	the commitment of our clinical staff to reducing our patients’ use of treatments that are needlessly expensive or clinically ineffective; and
	•	an education program for our physicians and nurses that emphasizes both clinical and cost effectiveness.

      We Have Developed an Advanced, Proprietary Technology Infrastructure. We have developed a proprietary technology infrastructure consisting of a highly-scalable, Linux-based operating platform we call CareNation and a variety of hospice specific applications. Because we own our core technology, we believe we will be able to minimize our payment of third-party licensing or maintenance and support fees that would likely increase as we grow. We believe that our web-based platform provides a level of secure, rapid and remote access from a wide variety of sources that is not currently available from third-party vendors. In addition, as we deploy additional applications, we anticipate improvements in our operating efficiency and ability to deliver a consistently high level of care across our organization. Our systems currently enable us to:

	•	track patient admission and certification;
	•	enroll our patients in a nationwide network of pharmacies;
	•	monitor patient census and length of stay data; and
	•	automate our bereavement communications.

      In addition to ongoing efforts to refine our existing applications, we are in the process of developing additional applications. During the quarter ended December 31, 2003, we introduced a new HIPAA compliant billing program for Medicare and commercial Claims processing, installed an Oracle human resource administration software system and upgraded our Oracle financial software to Version 11i. In the quarter ended September 30, 2004, we incorporated a Medicaid claims processing component to the billing program. We expect to be able to deploy our existing and new technologies rapidly in hospice programs that we develop or acquire in the future. We intend to continue to invest in our technology infrastructure to streamline our decision making and drive efficiencies in our operations, while providing further support and functionality to our care providers. In the future, we may consider commercializing these technologies.

      We Provide “Open Access” to Hospice-Eligible Patients. Our service philosophy is to provide hospice care to all adult patients who are eligible to receive hospice care under Medicare guidelines, regardless of the complexity of their illness. We call this philosophy “open access”. In a May 2002 report to Congress, MedPAC concluded that many patients who meet Medicare hospice eligibility requirements currently have problems accessing hospice care because of restrictive admission criteria on the part of some hospice care providers. Operating with an open access philosophy enables us to remove these barriers to hospice care access and to achieve important competitive advantages, including:

	•	Strong relationships with our referral sources. We believe that our open access service philosophy helps us build strong relationships with our referral sources because we will accept all hospice-eligible adult patients they refer to us.

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	•	Greater utilization of our services, resulting in lower direct care costs. Patient care expenses are generally higher during the initial and latter days of care. In the initial days of care, expenses tend to be higher because of the initial purchases of pharmaceuticals, medical equipment and supplies and the administrative costs of determining the patient’s hospice eligibility, registering the patient and organizing the plan of care. In the latter days of care, expenses tend to be higher because patients generally require more services, especially pharmaceuticals and nursing care, due to their deteriorating medical condition. Therefore, when we increase the number of days a patient stays in our care, we increase the number of lower cost days over which our costs are spread. Our open access philosophy involves a commitment on the part of all our staff to encourage patients to use our services, and referral sources to refer patients, at the earliest stage of hospice eligibility. We believe this philosophy has contributed to our transitional nine month period 2004 average length of stay of approximately 118 days per patient, which we believe to be above the industry average.

      We Have an Experienced Management Team. We have assembled a management team at both the corporate and program level with the financial, regulatory and operating experience to grow our company. Our corporate executive officers, most of whom have been with us since January 1, 2001, have significant experience operating publicly traded healthcare companies and growing businesses both organically and through acquisitions.

Our Business Strategy

      We intend to enhance our position as a market leader in the hospice care industry by pursuing the following strategies:

      An important aspect of our growth strategy involves increasing patient census within our existing programs. Since the end of 1998, following the completion of our last material acquisition, through September 30, 2004, we grew our “same-store” patient census by approximately 231%, from 1,579 to 5,219 patients. We intend to continue to increase our same-store growth by:

	•	Continuing to provide superior quality of care. We have driven our same-store growth to date largely through “word of mouth” recommendations based on the quality of our care. Consistent with our mission, we will continue to focus our efforts on providing superior care to our patients and their families.
	•	Building relationships that enhance our presence in local markets. We intend to increase our presence in local markets by fostering relationships with physicians, discharge planners, local faith-based and other community organizations and their leaders, and by providing educational workshops on hospice care and other end-of-life issues.
	•	Focusing on our formal marketing initiatives. We continue to focus on our company-wide marketing program on expanding awareness and acceptance of hospice care and increasing our market share. Our same-store census has grown 132%, from 2,245 patients as of September 1, 2000 to 5,219 patients as of September 30, 2004. We believe that a continued commitment to these initiatives will help us to continue growing.
	•	Building relationships with national and regional nursing homes, assisted living facilities and managed care organizations. By building relationships with nursing home chains, assisted living providers, and managed care organizations, we hope to develop steady referral sources, that have the ability to provide multiple referrals on an on-going basis.

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      We intend to expand our services in existing and new markets. Factors we consider when examining expansion opportunities include the following:

	•	hospice utilization and the number of eligible beneficiaries in the community who are not receiving hospice care;
	•	proximity to our existing programs and our ability to leverage our local resources through regional density;
	•	existing competition;
	•	the potential profitability of the target hospice program; and
	•	the regulatory environment.

      After we identify a market that fits our criteria for expansion, we may choose to develop or acquire a new hospice program or enter into a strategic alliance with an existing hospice program. If a potential new market is located within the geographical coverage area of an existing program’s Medicare provider certification, we may begin a “LeapFrog” site. Because small, non-urban, not-for-profit hospice providers dominate the United States hospice care industry, and because demanding market conditions have made it more difficult for small providers to offer cost-effective quality care, we believe that there will be opportunities for us to acquire or enter into strategic alliances with existing programs. We believe that because of the quality of our care, our management capabilities and our dedication to open access, smaller hospice programs, including not-for-profit providers, may look favorably on combining their operations with ours.

      In markets where there are no suitable acquisition or strategic alliance opportunities, we may develop a new program. When we develop a new program, we first deploy a small staff and acquire necessary office space, contracts and begin to develop referral sources. We acquire appropriate licensure, admit a small number of patients and request a Medicare certification survey. Following Medicare certification, we employ recruiting, training, community education and marketing efforts to build census.

      Hospice care usage by Medicare beneficiaries in non-urban areas has increased dramatically in recent years. A significant portion of our current business involves providing care in these areas. We plan to continue to focus on building market share in both the urban and the non-urban markets in which we currently operate and in new non-urban markets on the outskirts of major metropolitan areas. We find these markets particularly attractive because:

	•	we tend to encounter less competition from larger healthcare institutions devoted to aggressive curative care; and
	•	we are able to develop a dominant market share by quickly building relationships and brand identity with local referral sources.
	•	we can begin to develop a regional market presence to better service similarly located multi-site referral services such as, hospital, nursing home and assisted living companies.

      We are committed to maintaining a superior work environment consisting of competitive compensation, proper staffing, useful management tools and extensive internal training. All of our full-time employees participate in a performance-based cash bonus program that rewards them based on a combination of factors including quality of care, compliance, profitability and census growth. We analyze current data from each of our programs in order to adjust staffing levels in response to or in anticipation of fluctuations in patient census so that we can minimize staff turnover. We have also initiated the development of technology tools designed to reduce administrative paperwork and enable our clinical staff to focus on patient care. As a result of these

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Effectively Manage Our Medicare Cap Exposure

      In recent years, the Medicare Cap on reimbursement has negatively impacted our revenue and operating results. We are committed to reducing and making more predictable our exposure to Medicare Cap liabilities by:

	•	Focusing on patient mix at Cap affected sites by marketing to referral sources, such as hospitals, that are more likely to refer patients with shorter lengths of stay;
	•	managing the certification and recertification processes;
	•	establishing alternative delivery sites linked to programs with Medicare Cap exposure to increase first-time admission rates; and
	•	exploring possible ways to enhance the forecasting to ascertain future admission and discharge trends by patient mix categories and the pro-ration of beneficiary service days between providers.

Our Services

      We provide a full range of hospice services, from pain and symptom control to emotional and spiritual support, tailored to the individual needs of our patients and their families. Each patient who enrolls in one of our programs is assigned an interdisciplinary care team consisting of, depending on the patient’s needs, a physician, a nurse, a home health aide, a social worker, occupational and speech pathology therapists, a spiritual counselor, a dietary counselor, a volunteer, a homemaker and a bereavement coordinator. Below is a list of the key services we provide:

	•	pain and symptom management;
	•	emotional and spiritual support;
	•	special palliative modalities such as radiation therapy, chemotherapy and infusion therapy;
	•	diagnostic testing;
	•	inpatient and respite care;
	•	physician visits;
	•	nursing care;
	•	personal care by home health aides;
	•	homemaker services;
	•	social worker visits;
	•	spiritual counseling;
	•	bereavement counseling for up to 13 months after the patient’s death;
	•	dietary counseling;
	•	physical, occupational and speech therapy;
	•	medical equipment and supplies; and
	•	medications.

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      Our services are available twenty-four hours a day, seven days a week and can be provided in a patient’s home or other residence of choice, such as a nursing home or assisted living facility, or in a hospital or other inpatient facility. We currently operate one inpatient facility, a 12-bed unit in a skilled nursing facility.

Marketing and Referral Relationships

      The primary focus of our marketing activities is on increasing patient referrals from existing referral sources and establishing new referral sources. Our referral sources include:

	•	hospitals;
	•	physicians;
	•	nursing homes;
	•	assisted living facilities;
	•	home health care organizations;
	•	managed care companies;
	•	community social service organizations;
	•	religious organizations; and
	•	patient families

      Historically, we have dedicated relatively few resources to formal marketing activities. Most of our referrals have been the result of “word of mouth” among referral sources about the high quality of our care. Beginning in 2002, we implemented a standardized marketing strategy. A key element of our current marketing strategy is training our professional relations representatives and providing them with the tools to communicate effectively to a variety of different types of referral sources, including referral sources with which an individual professional relations representative may not have had significant prior experience.

      Each of our hospice care programs has a marketing team led by the site’s executive director who is assisted by at least one director of professional relations. A program typically employs between three and five professional relations representatives. At September 30, 2004, we employed 147 professional relations representatives company-wide. Consistent with our belief that marketing is a team effort, each program’s marketing team is supported by other program employees, including admissions coordinators, patient care managers, medical directors, chaplains, social workers, counselors and nurses. Each professional relations representative seeks to develop patient referral sources located in the representative’s territory by regularly calling on those referral sources and educating them regarding our services and hospice care generally. Our professional relations representatives provide feedback to those sources regarding the status of referred patients as appropriate. Our marketing efforts also include educational seminars for physicians and hospital personnel and community-based events.

Information Technology

      We believe that information technology can significantly enhance our financial, operational, clinical, and compliance performance, and that by building our own information technology infrastructure and software, we can achieve important cost efficiencies as we grow. We employ an in-house software development team of experienced professionals capable of developing solutions in a complex data environment. We believe that by building our own information technology solutions, we can reduce or eliminate outside training costs, expensive third-party applications, and many third-party license or other fees which typically increase when the number of transactions processed or number of users increases.

      In addition to the proprietary applications already in place, we are in the process of developing applications we believe will improve the effectiveness of our business leaders, reduce travel and conference call expenses, and provide fast deployment of accurate business intelligence. Our newly deployed virtual private network software will provide VistaCare employees with secure and timely access to the data with which they

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Compliance

      We have a strong commitment to operating our business in a manner that adheres to all regulatory requirements, internal company policies and procedures and our corporate philosophy. We have adopted a proactive approach to compliance that includes:

	•	developing information systems that allow us to continuously monitor our performance in key areas;
	•	performing internal compliance audits;
	•	enhancing a continuous quality improvement process designed to ensure regulatory compliance and improve patient care; and
	•	developing a priority index that enables us to shift compliance resources to those hospice programs more likely to experience compliance-related issues before they arise.

Education and Training

      We have devoted substantial time and resources to the development of a comprehensive education and training program. We continue to utilize company specific multimedia health care content previously contracted from a national provider of healthcare educational resources and are beginning to leverage in-house developed e-learning components which focus on our established best practices. We believe these resources will help us deliver consistently high quality service and increase employee confidence, satisfaction and retention, while increasing the cost effectiveness of our training efforts.

Competition

      Hospice care in the United States is competitive. The hospice care industry is highly fragmented and we compete with a large number of organizations, some of which may have significantly greater financial and marketing resources than we have and we compete with not-for-profit hospice programs that have strong ties to local medical communities. Based on industry data published in the MedPAC June 2004 report to Congress, approximately 56% of existing hospice programs in 2003 were local, not-for-profit hospice programs. For-profit ownership was 36%, totaling 883 hospice facilities, an increase of approximately 25% since 2001. We also compete with other multi-program hospice companies including Odyssey Healthcare Inc., SouthernCare Hospice, Inc. and Chemed Corporation.

      In addition, we compete with a number of hospitals, nursing homes, home health agencies and other health care providers that offer home care to patients who are terminally ill, or market palliative care and “hospice-like” programs. In addition, various health care companies have diversified into the hospice market, including Beverly Enterprises, Inc. and Manor Care, Inc.

      Relatively few barriers to entry exist in the markets we serve. Accordingly, other companies that are not currently providing hospice care may enter these markets and expand the variety of services they offer.

Insurance

      VistaCare is covered by a general liability insurance policy on an occurrence basis with limits of $1.0 million per occurrence and $3.0 million in the aggregate. VistaCare is also covered by a healthcare professional liability insurance policy on a claims-made basis with limits of $1.0 million for each medical incident and $3.0 million in the aggregate. VistaCare maintains workers compensation coverage at the statutory limits and an employer’s liability policy with a $1 million limit, both with a $250,000 deductible per occurrence. We also maintain a policy insuring hired and non-owned automobiles with a $1.0 million limit of

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      VistaCare had retrospective workers compensation insurance policies for the 2002 and 2003 policy periods and as of September 30, 2004 has recorded a $621,000 reserve for future losses associated with these periods. For the 2004 policy period, VistaCare has a high deductible plan that required VistaCare to fund $2.4 million to a depleting cash fund during 2004. As of September 30, 2004, VistaCare has recorded a long-term asset associated with the depleting cash fund balance of $813,000. In addition, VistaCare has recorded approximately $2 million in prepaid expenses and a $536,000 accrual for future losses associated with the 2004 policy year.

Government Regulation

      As a provider of healthcare services, we are subject to extensive federal, state and local statutes and regulations. These laws and regulations significantly affect the way in which we operate various aspects of our business. For example, we must comply with federal, state and local laws relating to hospice care eligibility, the development and maintenance of plans of care, and the coordination of services with nursing homes or assisting living facilities where many of our patients live. In addition, each state in which we operate has its own licensing requirements with which we must comply.

      We also must comply with regulations and conditions of participation to be eligible to receive payments from various federal and state government-sponsored healthcare programs, such as Medicare and Medicaid. Medicare is a federally funded and administered health insurance program, primarily for individuals entitled to Social Security benefits who are 65 years of age or older or who are disabled. Medicaid is a medical assistance program, jointly funded by the states and the federal government that provides certain medical and psychiatric care services to qualifying low-income persons. States are not required to provide Medicaid coverage for hospice services, but 45 states and the District of Columbia currently do so. All fourteen states in which we currently provide services offer coverage for Medicaid hospice services. Those states in which we operate that do provide a Medicaid benefit may limit the days for which hospice service will be covered, establish pre-authorization processes that can deny or delay access to hospice care, or establish Medicaid managed care programs that include only limited forms of hospice care coverage.

      In the future, we may choose to provide hospice care services in one of the few states that do not provide Medicaid coverage for hospice services. All of our current hospice programs have been certified as Medicare providers and are eligible to receive payments from applicable state Medicaid programs.

      Federal regulations established as part of the Medicare program require that every hospice program continue to satisfy various conditions of participation to be certified and receive payment for the services it provides. Compliance with the conditions of participation is monitored by state survey agencies designated by the Medicare program. In some cases, failure to comply with the conditions may result in payment denials, the imposition of fines or penalties, or the implementation of a corrective action plan. In extreme cases or cases where there is a history of repeat violations, a state survey agency may recommend a suspension of new admissions to the program or termination of the program in its entirety.

      The Medicare conditions of participation for hospice programs include the following:

	•	Governing Body. Each hospice must have a governing body that assumes full responsibility for the policies and the overall operation of the hospice and for ensuring that all services are provided in a manner consistent with accepted standards of practice. The governing body must designate one individual who is responsible for the day-to-day administrative operations of the hospice.

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	•	Direct Provision of Core Services. Medicare limits those services for which the hospice may use individual independent contractors or contract agencies to provide care to patients. Specifically, substantially all nursing, social work, and counseling services must be provided directly by hospice employees meeting specific educational and professional standards. During periods of peak patient loads or under extraordinary circumstances, the hospice may be permitted to use contract workers, but the hospice must agree in writing to maintain professional, financial and administrative responsibility for the services provided by those individuals or entities.
	•	Medical Director. Each hospice must have a medical director who is a physician and who assumes responsibility for overseeing the medical component of the hospice’s patient care program.
	•	Professional Management of Non-Core Services. A hospice may arrange to have non-core services such as therapy services, home health aide services, medical supplies or drugs provided by a non-employee or outside entity. If the hospice elects to use an independent contractor to provide non-core services, however, the hospice must retain professional management responsibility for the arranged services and ensure that the services are furnished in a safe and effective manner by qualified personnel, and in accordance with the patient’s plan of care.
	•	Plan of Care. The patient’s attending physician, the medical director or designated hospice physician, and the interdisciplinary team must establish an individualized written plan of care prior to providing care to any hospice patient. The plan must assess the patient’s needs and identify services to be provided to meet those needs and must be reviewed and updated at specified intervals.
	•	Continuation of Care. A hospice may not discontinue or reduce care provided to a Medicare beneficiary if the individual becomes unable to pay for that care.
	•	Informed Consent. The hospice must obtain the informed consent of the hospice patient, or the patient’s representative, that specifies the type of care services that may be provided as hospice care.
	•	Training. A hospice must provide ongoing training for its employees.
	•	Quality Assurance. A hospice must conduct ongoing and comprehensive self-assessments of the quality and appropriateness of care it provides and that its contractors provide under arrangements to hospice patients.
	•	Interdisciplinary Team. A hospice must designate an interdisciplinary team to provide or supervise hospice care services. The interdisciplinary team develops and updates plans of care, and establishes policies governing the day-to-day provision of hospice services. The team must include at least a physician, registered nurse, social worker and spiritual or other counselor. A registered nurse must be designated to coordinate the plan of care.
	•	Volunteers. Hospice programs are required to recruit and train volunteers to provide patient care services or administrative services. Volunteer services must be provided in an amount equal to at least five percent of the total patient care hours provided by all paid hospice employees and contract staff.
	•	Licensure. Each hospice and all hospice personnel must be licensed, certified or registered in accordance with applicable federal, state and local laws and regulations.
	•	Central Clinical Records. Hospice programs must maintain clinical records for each hospice patient that are organized in such a way that they may be easily retrieved. The clinical records must be complete and accurate and protected against loss, destruction, and unauthorized use.

      In addition to the conditions of participation governing hospice services generally, Medicare regulations also establish conditions of participation related to the provision of various services and supplies that many hospice patients receive from us. These services include therapy services (physical therapy, occupational therapy, speech-language pathology), home health aide and homemaker services, pharmaceuticals, medical supplies, short-term inpatient care and respite inpatient care, among other services.

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Surveys and Audits

      Hospice programs are subject to periodic survey by federal and state governmental authorities to ensure compliance with various licensing and certification requirements. Regulators conduct periodic surveys of hospice programs and provide reports containing statements of deficiencies for alleged failure to comply with various regulatory requirements. Survey reports and statements of deficiencies are common in the healthcare industry. In most cases, the hospice program and reviewing agency will agree upon the steps to be taken to bring the hospice into compliance with applicable regulatory requirements. In some cases, however, a state or federal agency may take a number of adverse actions against a facility, including:

	•	the imposition of fines;
	•	temporary suspension of admission of new patients to the hospice’s service;
	•	in extreme circumstances, de-certification from participation in the Medicaid or Medicare programs; or
	•	in extreme circumstances, revocation of the hospice’s license.

      Billing Audits/ Claims Reviews. Medicare fiscal intermediaries and other payors periodically conduct pre-payment or post-payment medical reviews or other audits of our claims. In order to conduct these reviews, the payor requests documentation from us and then reviews that documentation to determine compliance with applicable rules and regulations, including the eligibility of patients to receive hospice benefits, the appropriateness of the care provided to those patients, and the documentation of that care. Historically we have had a certain number of claims denied as a result in these reviews.

      Certificate/ Determination of Need Laws and Other Restrictions.  Approximately 14 states continue to have certificate/ determination of need laws that seek to limit the number or size of hospice care providers. These states require some form of state agency review or approval before a hospice may add new services or undertake significant capital expenditures. Approval under these certificate of need laws is generally conditioned on the showing of a demonstrable need for services in the community. In the future we may seek to develop or acquire hospice programs in states having certificate of need laws. To the extent that state agencies require us to obtain a certificate of need or other similar approvals to expand services at our existing hospice programs or to make acquisitions or develop hospice programs in new or existing geographic markets, our plans could be adversely affected by a failure to obtain a certificate or approval.

      Limitations on For-Profit Ownership. A few states have laws that restrict the development and expansion of for-profit hospice programs. For example, Florida does not permit the operation of a hospice by a for-profit corporation unless it was operated in that capacity on or before July 1, 1978, although the law might permit us to purchase a grandfathered for-profit hospice and continue to operate it. New York law states that a hospice cannot be owned by a corporation that has another corporation as a stockholder. These types of additional state law restrictions could affect our ability to expand into New York or Florida, or other locations with similar restrictions.

      Limits on the Acquisition or Conversion of Non-Profit Health Care Corporations. An increasing number of states require government review, public hearings, and/or government approval of transactions in which a for-profit entity proposes to purchase or otherwise assume the operations of a non-profit healthcare facility or insurer. Heightened scrutiny of these transactions may significantly increase the costs associated with future acquisitions of non-profit hospice programs in some states, otherwise increase the difficulty in completing those acquisitions, or prevent them entirely. We cannot assure you that we will not encounter regulatory or governmental obstacles in connection with our acquisition of non-profit hospice programs in the future.

      Professional Licensure and Participation Agreements. Many of our employees are subject to federal and state laws and regulations governing the ethics and practice of their chosen profession, including physicians, physical, speech and occupational therapists, social workers, home health aides, pharmacists, and nurses. In addition, those professionals who are eligible to participate in the Medicare, Medicaid or other federal health care programs as individuals must not have been excluded from participation in those programs at any time.

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      Payments from Medicare and Medicaid are subject to legislative and regulatory changes as well as susceptible to budgetary pressures. Our revenues and profitability are therefore subject to the effect of those changes and to possible reductions in coverage or payment rates by private third-party payors. For the year ended December 31, 2003 and the nine month fiscal period ended September 30, 2004, 96.8% and 97.2%, respectively, of our net patient revenue was attributable to Medicare and Medicaid payments. As a result, any changes in the regulatory, payment or enforcement landscape may significantly affect our operations.

      Medicare Eligibility Criteria. To receive Medicare payment for hospice services, the hospice medical director and, if the patient has one, the patient’s attending physician, must certify that the patient has a life expectancy of six months or less if the illness runs its normal course. This determination is made based on the physician’s clinical judgment. Due to the uncertainty of such prognoses, however, it is likely that some percentage of our patients will not die within six months of entering the hospice program. The Medicare program (among other third-party payors) recognizes that terminal illnesses often do not follow an entirely predictable course, and therefore the hospice benefit remains available to beneficiaries so long as the hospice physician or the patient’s attending physician continues to certify that the patient’s life expectancy remains six months or less. Specifically, the Medicare hospice benefit provides for two initial 90-day benefit periods followed by an unlimited number of 60-day periods. A Medicare beneficiary may revoke his or her election of the Medicare hospice benefit at any time and resume receiving regular Medicare benefits. The patient may elect the hospice benefit again at a later date so long as he or she remains eligible.

      Levels of Care. Medicare pays for hospice services on a prospective payment system basis under which we receive an established payment for each day that we provide hospice services to a Medicare beneficiary, depending upon the level of service provided. These rates are then subject to annual adjustments for inflation and may also be adjusted based upon the location where the services are provided due to variability in labor costs — the greatest single expense for hospice programs. The rate we receive will vary depending on which of the following four levels of care is being provided to the beneficiary:

	•	Routine Home Care. We are paid the routine home care rate for each day that a patient is in our program and is not receiving one of the other categories of hospice care or when a patient is receiving hospital care for a condition that is not related to his or her terminal illness. We are paid the same daily rate regardless of the volume or intensity of the services provided to the patient and his or her family or caregivers.
	•	General Inpatient Care. General inpatient care is provided when a patient requires inpatient services for a short period for pain control or symptom management that typically cannot be provided in other settings. General inpatient care services must be provided in a Medicare or Medicaid certified hospital or long-term care facility or at a freestanding inpatient hospice facility with the required registered nurse staffing.
	•	Continuous Home Care. Continuous home care is provided only during periods of crisis when a hospice patient requires predominantly nursing care to achieve palliation or management of acute medical problems while at home. Medicare requires that at least eight hours of services be provided (licensed nursing care must be provided for at least half of the time) within a single day in order to qualify for reimbursement under the continuous home care provisions. While the Medicare published continuous home care rates are daily rates, Medicare actually pays for continuous home care services on an hourly basis. This hourly rate can be obtained by dividing the daily rate by 24.
	•	Respite Care. Respite care permits a hospice patient to receive services on an inpatient basis for a short period of time in order to relieve the patient’s family or other caregivers from the demands of caring for the patient. We can receive payment for respite care provided to a patient for up to five consecutive days at a time on an occasional basis. Any additional consecutive days of respite care will be reimbursed at the routine home care rate.

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      Program Limits on Hospice Care Payments. Medicare payments for hospice services are subject to two additional limits or “Caps,” both of which are assessed on a provider-wide basis. Within our business we have 35 separate provider numbers for Medicare Cap purposes, each of which include one or more of our 45 programs. The first of these two Caps is commonly known as the “80-20” rule and applies only to Medicare inpatient services. Specifically, the 80-20 rule states that if the number of inpatient care days at any of our hospice providers to Medicare beneficiaries exceeds 20.0% of the total days of hospice care it provides, those days in excess of the 20.0% figure may be reimbursed only at the routine home care rate. Compliance with the 80-20 rule is measured by examining all claims submitted by a hospice provider between November 1 and the following October 31.

      None of our hospice programs has exceeded the Cap on inpatient care services. However, we cannot assure you that one or more of our hospice programs will not exceed the inpatient Cap in the future.

      Overall Medicare payments to our hospice providers are also subject to an annual limitation or Cap. This Cap amount is revised annually to account for inflation. For the twelve-month period ended October 31, 2004, the annual hospice benefit Cap was $19,635.67 per beneficiary. Compliance with the Cap, however, is not determined on the basis of individual beneficiary experiences. Instead, compliance is measured by calculating the total Medicare payments received by a provider with respect to services provided to all Medicare hospice care beneficiaries between November 1 of each year and October 31 of the following year and comparing the result with the product of the Cap amount and the number of Medicare beneficiaries electing hospice care for the first time from that hospice provider during the relevant period. There is a further negative adjustment for the Cap calculation to the extent our first time beneficiaries are later admitted to another provider and also a positive adjustment for a second time beneficiary admitted into our provider, each on a pro-rated basis, based on days of service. If actual Medicare reimbursements to that provider exceed that amount, Medicare requires that we repay the difference to Medicare.

      Between 1999 and 2003, ten of our hospice programs exceeded the Medicare Cap amount. As a result, we were required to repay a portion of payments previously received from Medicare. We actively monitor the Cap amount at each of our programs and implement corrective measures if necessary. We maintain what we believe are adequate reserves in the event that we exceed the Cap in the future. We cannot assure you that one or more of our hospice programs will not exceed the Cap amount in the future.

      Medicare Managed Care Programs. The Medicare program has entered into contracts with managed care companies to provide a managed care benefit to those Medicare beneficiaries who wish to participate in managed care programs, commonly referred to as Medicare HMOs, Medicare + Choice or Medicare risk products. We provide hospice care to Medicare beneficiaries who participate in these managed care programs. Our payments for services provided to Medicare beneficiaries enrolled in Medicare HMO programs are processed in the same way and at the same rates as those of Medicare beneficiaries who are not in Medicare HMOs. Under current Medicare policy, Medicare pays the hospice directly for services provided to Medicare HMO, Medicare + Choice or risk product patients and then reduces the standard per member per month payment that the managed care program receives.

      Adjustments to Payment Rates and Payment Methodology. In the last several years there have been a number of adjustments to the base rates paid by Medicare for all four levels of hospice services. Specifically, the Balanced Budget Act of 1997 (“BBA of 1997”), Balanced Budget Refinement Act of 1999 (“BBRA of 1999”), and Medicare, Medicaid and SCHIP Benefits Improvement and Protection Act of 2000 (“BIPA 2000”), have all modified hospice payment rates in recent fiscal years. The Medicare fiscal year begins on October 1 of each year and runs through September 30 of the following year. Most recently, the base Medicare payment rates were increased an additional 3.4%, effective October 1, 2003, and 3.3% effective October 1, 2004.

      It is possible that there will be further modifications to the rate structure under which Medicare certified hospice programs are currently paid. In a May 2002 report to Congress, MedPAC recommended that the Secretary for the Department of Health and Human Services review the adequacy of hospice payment rates to ensure that the rates are adequate given the realities of the costs associated with providing hospice services in today’s market, and further recommended that the Secretary consider the possibility of moving to a case-mix

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      Sequential Billing. The Center for Medicare and Medicaid Services has implemented a process known as sequential billing that prevents hospice programs from billing a period of service for a patient before the prior billed period has been reimbursed. This billing process can negatively impact a hospice program’s cash flow when pre-payment audits or medical reviews are ongoing, or lost or incorrect bills are encountered.

      Medicaid Coverage and Reimbursement. State Medicaid programs are another source of our net patient revenue. Medicaid is a state-administered program financed by state funds and matching federal funds to provide medical assistance to the indigent and certain other eligible persons For those states that elect to provide a hospice benefit, the care must be provided by a Medicare-certified hospice, and the scope of hospice services available must include at least all of the services provided under the Medicare hospice benefit. Most of those states providing a Medicaid hospice benefit pay us at rates equal to or greater than the rates provided under Medicare and those rates are calculated using the same methodology as Medicare. States maintain flexibility to establish their own hospice election procedures and to limit the number and duration of benefit periods for which they will pay for hospice services.

      Nursing Home Residents. For our patients who receive nursing home care under state Medicaid programs in states other than Arizona, Oklahoma, Pennsylvania and South Carolina, the applicable Medicaid program pays us an amount equal to no more than 95.0% of the Medicaid per diem nursing home rate for “room and board” services furnished to the patient by the nursing home in addition to the applicable Medicare or Medicaid hospice per diem payment. Then, pursuant to our standard agreements with nursing homes, we pay the nursing home for these “room and board” services at a rate between 95.0% and 100.0% of the full Medicaid per diem room and board.

      Federal and State Anti-Kickback Laws and Safe Harbor Provisions. The federal anti-kickback law makes it a felony to knowingly and willfully offer, pay, solicit or receive any form of remuneration in exchange for referring, recommending, arranging, purchasing, leasing or ordering items or services covered by a federal health care program including Medicare or Medicaid. The anti-kickback prohibitions apply regardless of whether the remuneration is provided directly or indirectly, in cash or in kind. Although the anti-kickback statute does not prohibit all financial transactions or relationships that providers of healthcare items or services may have with each other, interpretations of the law have been very broad. Under current law, courts and federal regulatory authorities have stated that this law is violated if even one purpose (as opposed to the sole or primary purpose) of the arrangement is to induce referrals.

      Violations of the anti-kickback law carry potentially severe penalties including imprisonment of up to five years, criminal fines of up to $25,000 per act, civil money penalties of up to $50,000 per act, and additional damages of up to three times the amounts claimed or remuneration offered or paid. Federal law also authorizes exclusion from the Medicare and Medicaid programs for violations of the anti-kickback statute.

      Statutory and regulatory safe harbors protect various practices and relationships such as bona fide employment relationships, contracts for the rental of space or equipment, personal service arrangements, and management contracts, from enforcement action, when certain conditions are met. The safe harbor regulations, however, do not comprehensively describe all lawful relationships between healthcare providers and referral sources, and the failure of an arrangement to satisfy all of the requirements of a particular safe harbor does not mean that the arrangement is unlawful. Many states, including some states where we do business, have adopted similar prohibitions against payments that are intended to induce referrals of patients, regardless of the source of payment. Some of these state laws lack explicit “safe harbors” that may be available under federal law. Sanctions under these state anti-remuneration laws may include civil money penalties, license

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      We contract with a significant number of healthcare providers practitioners, and vendors such as physicians, hospitals, nursing homes, and pharmacies, and arrange for these individuals or entities to provide services to our patients. Some of these individuals or entities may refer, or be in a position to refer, patients to us, and we may refer, or be in a position to refer, patients to these individuals or entities. We believe that our contracts and arrangements with providers, practitioners and suppliers are not in violation of applicable anti-kickback or related laws. We cannot assure you, however, that these laws will ultimately be interpreted in a manner consistent with our practices.

      HIPAA Anti-Fraud Provisions. Portions of the HIPAA (Health Insurance Portability and Accountability Act of 1996) permit the imposition of civil monetary penalties in cases involving violations of the anti-kickback statute or contracting with excluded providers. In addition, HIPAA created new statutes making it a federal felony to engage in fraud, theft, embezzlement, or the making of false statements with respect to healthcare benefit programs, which include private, as well as government programs. In addition, for the first time, federal enforcement officials have the ability to exclude from the Medicare and Medicaid programs any investors, officers and managing employees associated with business entities that have committed healthcare fraud, even if the investor, officer or employee had no actual knowledge of the fraud.

      OIG Fraud Alerts, Advisory Opinions and Other Program Guidance. Congress established the OIG (Office of Inspector General) to, among other things, identify and eliminate fraud, abuse and waste in HHS programs. To identify and resolve such problems, the OIG conducts audits, investigations and inspections across the country and issues public pronouncements identifying practices that may be subject to heightened scrutiny. On occasion, the OIG has issued audit reports, fraud alerts, and advisory opinions regarding hospice practices which might be susceptible to fraud or abuse. The OIG also issued a voluntary Compliance Program Guidance for Hospices in September 1999. We cannot predict what, if any changes may be implemented in coverage, reimbursement, or enforcement policies as a result of these OIG reviews and recommendations.

      Federal False Claims Acts. The federal law includes several criminal and civil false claims provisions, which provide that knowingly submitting claims for items or services that were not provided as represented may result in the imposition of multiple damages, administrative civil money penalties, criminal fines, imprisonment, and/or exclusion from participation in federally funded healthcare programs, including Medicare and Medicaid. In addition, the OIG may impose extensive and costly corporate integrity requirements upon a healthcare provider that is the subject of a false claims judgment or settlement. These requirements may include the creation of a formal compliance program, the appointment of a government monitor, and the imposition of the annual reporting requirements and audits conducted by an independent review organization to monitor compliance with the terms of the agreement and relevant laws and regulations.

      The Civil False Claims Act prohibits the known filing of a false claim or the known use of false statements to obtain payments. Penalties for violations include fines ranging from $5,500 to $11,000, plus treble damages, for each claim filed. Provisions in the Civil False Claims Act also permit individuals to bring actions against individuals or businesses in the name of the government as so called “qui tam” relators. If a qui tam relator’s claim is successful, he or she is entitled to share in the government’s recovery.

      State False Claims Laws. At least 10 states and the District of Columbia, including Massachusetts, Nevada and Texas where we currently do business, have adopted state false claims laws that mirror to some degree the federal false claims laws. While these statutes vary in scope and effect, the penalties for violating these false claims laws include administrative, civil and/or criminal fines and penalties, imprisonment, and the imposition of multiple damages.

      The Stark Law and State Physician Self-Referral Laws. Section 1877 of the Social Security Act, commonly known as the “Stark Law,” prohibits physicians from referring Medicare or Medicaid patients for “designated health services” to entities in which they hold an ownership or investment interest or with whom

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	•	denial of payment;
	•	civil monetary penalties of $15,000 per referral or $1,000,000 for “circumvention schemes;”
	•	assessments equal to 200.0% of the dollar value of each such service provided; and
	•	exclusion from the Medicare and Medicaid programs.

      Hospice care itself is not specifically listed as a designated health service, however, a number of the services that we provide including physical therapy, pharmacy services and certain infusion therapies are among the services identified as designated health services for purposes of the self-referral laws. We cannot assure you that future regulatory changes will not result in hospice services becoming subject to the Stark Law’s ownership, investment or compensation prohibitions in the future.

      Many states where we operate have laws similar to the Stark Law, but with broader effect because they apply regardless of the source of payment for care. Penalties similar to those listed above as well the loss of state licensure may be imposed in the event of a violation of these state self-referral laws. Little precedent exists regarding the interpretation or enforcement of these statutes.

      Civil Monetary Penalties. The Civil Monetary Penalties Statute provides that civil penalties ranging between $10,000 and $50,000 per claim or act may be imposed on any person or entity that knowingly submits improperly filed claims for federal health benefits, or makes payments to induce a beneficiary or provider to reduce or limit the use of health care services or to use a particular provider or supplier. Civil monetary penalties may be imposed for violations of the anti-kickback statute and for the failure to return known overpayments, among other things.

      Prohibition on Employing or Contracting with Excluded Providers. Federal regulations prohibit Medicare providers, including hospice programs, from submitting claims for items or services or their related costs if an individual or entity that has been excluded or debarred from participation in federal health care programs furnished those items or services. The OIG and the GSA (General Services Administration) maintain lists of excluded persons and entities. Nonetheless, it is possible that we might unknowingly bill for services provided by an excluded person or entity with whom we contract. The penalty for contracting with an excluded provider may range from civil monetary penalties of $50,000 and damages of up to three times the amount of payment that was inappropriately received.

      Corporate Practice of Medicine and Fee Splitting. Most states have laws that restrict or prohibit anyone other than a licensed physician, including business entities such as corporations, from employing physicians and/or prohibit payments or fee-splitting arrangements between physicians and corporations or unlicensed individuals. While the laws vary from state to state, penalties for violating such laws may include civil or criminal penalties, the forced restructuring or termination of business arrangements or in rare cases the loss of the physician’s license to practice medicine. These laws have been subject to only limited interpretation by the courts or regulatory bodies.

      We employ or contract with physicians to provide medical direction and patient care services to our patients. We have made efforts to structure those arrangements in compliance with the applicable laws and regulations. Despite these efforts, however, we cannot assure you that agency officials charged with enforcing these laws will not interpret our physician contracts as violating the relevant laws or regulations. Future determinations or interpretations by individual states with corporate practice of medicine or fee splitting restrictions may force us to restructure our arrangements with physicians in those locations.

      Health Information Practices. Portions of HIPAA were enacted to develop national standards for the electronic exchange of health information. To accomplish this, the U.S. Department of Health & Human Services (“DHHS”) was directed to develop rules for standardizing electronic transmission of health care information and to protect its security and privacy. The privacy and security rules now apply to health information, regardless of the form in which it is maintained (e.g., electronic, paper, oral). Under these rules,

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Our Employees

      As of September 30, 2004, we had 2,355 full time employees and 469 part-time employees. None of our employees are covered by collective bargaining agreements. We believe that our relations with our employees are good.

      Our principal executive office is located in a 49,700 square foot leased facility located in Scottsdale, Arizona. The lease for this facility expires in 2010 and does not have an option to extend for additional years.

      As of September 30, 2004, we operated 45 hospice care programs and one inpatient facility, serving patients in 14 states from leased program offices. We believe that our properties are adequate for our current business needs. In addition, we believe that additional or alternative space will be available as needed in the future on commercially reasonable terms. With the exception of our principal executive office lease, we have no material operating leases.

      The action of Bradeen et al. v. Vista Hospice Care, Inc. and Edward Raymond Lowe, which was previously disclosed in our Form 10-K and 10-Q reports, was settled in November 2003. This action related to a fatal motor vehicle accident involving a former VistaCare employee. As part of the settlement, we were required to pay a sum of money, all of which was covered by insurance proceeds.

      Since August 2004, approximately five complaints have been filed individually and on behalf of all others similarly situated in the United States District Court for the District of Arizona against the Company and two of its officers alleging violations of the federal securities laws arising out of recent declines in the Company’s stock price. Specifically, the complaints allege claims in connection with various statements and purported omissions to the public and to the securities markets relating to the Company’s August 2004 announcement of its decision to accrue an increased amount for the quarter ended June 30, 2004 as a reserve for potential liability due to the Medicare per-beneficiary Cap on reimbursement for hospice services. The Company expects that the five lawsuits will be consolidated and intends to vigorously defend these lawsuits. No assurances can be made that the Company will be successful in defense of such claims. If the Company is not successful in defense of such claims, it could be forced to make significant payments to our stockholders and their lawyers, and such payments could have a material adverse effect on our business, financial condition and results of operations if not covered by our insurance carrier. Even if such claims are not successful, the litigation could result in substantial costs and divert management’s attention and resources, which could adversely affect our business, results of operations and financial position.

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      Since August 2004, two shareholders have filed separate derivative lawsuits purportedly on behalf of the Company against several present and former officers and members of the Board of Directors of the Company in the United States District Court for the District of Arizona. The two derivative complaints, which have been consolidated before Judge Broomfield, allege breaches of fiduciary duties, abuse of control, mismanagement, waste of corporate assets and unjust enrichment, as a result of the same activities alleged in the class action lawsuits discussed above. The derivative complaint seeks attorney fees and the payment of damages to the Company. As of the date of this report, these derivative actions are at the pleading stage. Defendants have not been required to answer or respond and no discovery has been served by plaintiffs.

      In the normal course of business, we are subject to various lawsuits, proceedings, claims and other matters asserted under laws and regulations. We believe the amounts provided in our consolidated financial statements, as prescribed by generally accepted accounting procedures in the United States (GAAP), are adequate in light of the probable and estimable contingencies. However, there can be no assurances that the actual amounts required to satisfy alleged liabilities from various legal proceedings, claims, and other matters discussed below, and to comply with applicable laws and regulations, will not exceed the amounts reflected in our consolidated financial statements. With respect to pending or threatened litigation facing the Company in the normal course of business, management does not believe the ultimate outcome of the matters either individually or in the aggregate will have a material adverse impact on the Company.

      During the third quarter of 2004, there were no matters submitted to a vote of security holders.

EXECUTIVE OFFICERS OF THE REGISTRANT

      Set forth below is information concerning our executive officers and including their ages as of September 30, 2004.

      Richard R. Slager has served as our President and Chief Executive Officer and as a member of our board of directors since May 2001. He became the Chairman of our board of directors in August 2003. From June 1999 until May 2001, he was Chairman of the board of directors and Chief Executive Officer of SilverAge LLC, an online monitoring and interactive technical company for seniors. In May 1989, Mr. Slager founded Karrington Health, Inc., an assisted living provider, and he served as Chairman of the board of directors and Chief Executive Officer of Karrington Health, Inc. until June 1999.

      Mark E. Liebner has served as our Chief Financial Officer since April 2002. From March 2000 until April 2002, he served as Managing Director of Searchlight Partners LLC, a corporate advisory services firm. From October 1991 until March 2000, Mr. Liebner served as Chief Financial Officer of Rural Metro Corporation, a publicly traded provider of healthcare transportation services. From July 1988 until September 1991, Mr. Liebner served as Vice President in the healthcare investment-banking group of Van Kampen Merritt, a financial services firm.

      Carla Davis Hughes has served as Executive Vice President since November 2004. From December 1998 until November 2004, Ms. Hughes held several senior operational positions at VistaCare including Program Director, Southeastern Area Director, Atlantic Coast Regional Director, Eastern Regional Vice President of Operations and Senior Vice President and Chief Operating Officer. From June 1996 until June 1998,

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      Stephen Lewis has served as one of our Senior Vice Presidents since May 2002 and as our General Counsel since November 2001. From December 1999 until November 2001, he served as Assistant Director, Office of General Services of the Ohio Department of Insurance. From August 1993 until June 1999, Mr. Lewis served as Vice President of Development and General Counsel for Karrington Health, Inc., a publicly traded assisted living provider. From August 1986 until December 1992, he served as Vice President and General Counsel of VOCA Corporation, a developer and operator of residential facilities for persons with mental retardation and developmental disabilities. From November 1974 until August 1986, Mr. Lewis was a practicing attorney with the law firm of Topper, Alloway, Goodman, Deleone & Duffy, which merged with Benesch, Friedlander, Coplan & Aronoff in January 1986.

      Kris Jamsa has served as our Executive Vice President of Education and Technology since April 2004. From July 1998 to April 2004, Dr. Jamsa served as President of the Jamsa Media Group, a company he founded, providing content for publishers such as McGraw-Hill, Microsoft Press, and John Wiley. In addition, he provided content and consultative services to over two-dozen online learning universities. From 1992 to 1997 Dr. Jamsa served as President and CEO of Jamsa Press, a publishing company he founded and which was acquired.

      Ronald F. Watson has served as our Executive Vice President of Corporate Development since November, 2003. From December 1999 to January 2003 Mr. Watson served in several executive capacities within United Health Group-including Senior Vice President Ovations; President Medicaid Operations; and Executive Vice President Evercare. These roles served Medicare, Medicaid, chronic care and elderly populations. From April 1997 to November 1999 he served as CEO and President of Constellation Senior Services, an operator and developer of senior housing facilities. From August 1989 to March 1997 Mr. Watson served as Vice President of Catholic Health Initiatives and a related company dedicated to serving the continuum of senior health services.

      There are no family relationships among any of our executive officers and directors.

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PART II

Market for Our Common Stock

      Our Class A Common Stock, $0.01 par value per share, which we refer to as our common stock, has been quoted on the Nasdaq National Market under the symbol “VSTA” since December 18, 2002. Prior to that time there was no public market for our common stock. At December 9, 2004, there were approximately 53 record holders of our common stock and the closing sale price of our common stock as reported on the Nasdaq National Market was $17.05 per share. The following table sets forth the high and low sales prices per share of our common stock for the period indicated, as reported on the Nasdaq National Market:

*	We changed our fiscal year end date to September 30, effective in 2004. Accordingly, our fiscal period ended September 30, 2004 was comprised of three fiscal quarters.

Dividends

      We have never declared or paid any cash dividends on our capital stock and do not anticipate paying cash dividends in the foreseeable future. We are prohibited under our credit facility from paying any dividends if there is a default under the facility or if the payment of any dividends would result in default. We currently intend to retain future earnings, if any, to fund the expansion of our business.

Recent Sales of Unregistered Securities

      VistaCare did not sell any of its equity securities in 2004 that were not registered under the Securities Act of 1933.

Repurchases of Common Stock

      VistaCare did not repurchase any shares of its common stock during the 2003.

Equity Compensation Plans

      The information pertaining to our equity compensation plans is incorporated by reference to our proxy statement under the heading “Securities Authorized for Issuance Under Equity Compensation Plans.”

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SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA

      The selected financial data set forth below should be read in conjunction with our consolidated financial statements and the notes to those statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, appearing elsewhere in this report. The consolidated statement of operations data for the years ended December 31, 2000 and 2001 and the consolidated balance sheet data as of December 31, 2000, 2001 and 2002 are derived from our audited financial statements not included in this report. The consolidated statement of operations data for the nine months ended September 30, 2004 and for the years ended December 31, 2002 and 2003 and the consolidated balance sheet data as of September 30, 2004 and December 31, 2003 are derived from our audited financial statements included elsewhere in this report. The historical results of operations are not necessarily indicative of the operating results to be expected in the future.

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(1)	Reflects accrued dividends on the Series B Preferred Stock, Series C Preferred Stock and the Series D Preferred Stock at the rate of 10% per annum, compounded semi- annually. The preferred stock converted into common stock upon the closing of our initial public offering, and the accrued preferred stock dividends, which were not payable in the event of a conversion into common stock, were reclassified as additional paid-in-capital. The preferred stock dividend is included in accumulated deficit.
(2)	Number of hospice programs at end of period.
(3)	Represents the total number of patients admitted into our hospice programs during the period.
(4)	Represents the total days of care provided to our patients during the period.
(5)	Represents the average number of patients for whom we provided hospice care each day during the period and is computed by dividing days of care by the number of days during the period.

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Overview

      Since completing an initial public offering of our common stock in December 2002 our business has continued to grow. As of September 30, 2004, we were operating 45 hospice programs serving approximately 5,304 patients in 14 states. For the nine months ended September 30, 2004, our net patient revenue was $150.4 million as compared to $138.1 million for the nine months ended September 30, 2003. Due to Medicare CAP estimated liabilities, net patient revenue for the nine months ended September 30, 2004 was reduced by $14.8 million as compared to $1.5 million in the nine months ended September 30, 2003. For the nine months ended September 30, 2004, we recorded a net loss of $4.2 million as compared to net income of $10.5 million in the nine months ended September 2003. This net loss was due primarily to the higher Medicare CAP charges, which covers unusually higher CAP obligations for nine of our Medicare provider numbers. Other costs that added to this loss included increases in patient care labor expenses, general and administrative expenses and new site development costs. Our business has benefited from regular increases in Medicare hospice reimbursement rates, including the two most recent increases effective October  1, 2002 and October 1, 2003, each being 3.4% over the base rates then in effect.

Change in Year End

      On August 19, 2004, VistaCare’s Board of Directors changed the Company’s fiscal year end from December 31 to September 30. The nine-month results now being reported by the Company relate to the transitional fiscal period end September 30, 2004.

Net Patient Revenue

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

	•	amounts we estimate we could be required to repay to Medicare, such as amounts that we would be required to repay if any of our programs exceed the annual CAP, as described below under “Critical Accounting Policies and Significant Estimates — Adjustments to Net Patient Revenue for Exceeding the Medicare CAP”; and
	•	estimated payment denials and contractual adjustments;
	•	patients who do not have insurance coverage and who are deemed financially in need of charity care;
	•	subsequent changes to initial level of care determinations.

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

      We derive net patient revenue from billings to Medicare, Medicaid, private insurers, managed care providers, patients and others. We operate under arrangements with those payors pursuant to which they reimburse us for services we provide to hospice eligible patients they cover, subject only to our submission of adequate and timely claim documentation. Our patient intake process screens patients for hospice eligibility and identifies whether their care will be covered by Medicare, Medicaid, private insurance, managed care or self-pay. Medicare reimbursements account for the majority of our net patient revenue. Our net patient revenue is determined primarily by the number of billable patient days, the level of care provided and reimbursement rates. The number of billable patient days is a function of the number of patients admitted to our programs and the number of days that those patients remain in our care (length of stay).

      Our average length of stay was approximately 118 days for the nine months ending September 30, 2004, which exceeds the industry average. We attribute our ability to exceed the industry average in terms of length

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      The table below sets forth the percentage of our net patient revenue in 2002, 2003 and 2004 derived from Medicare, Medicaid, private insurers and managed care payors.

      Medicare, Medicaid and most private insurers and managed care providers pay for hospice care at a daily or hourly rate that varies depending on the level of care provided. For a discussion of those levels of care established by Medicare and the current applicable Medicare reimbursement rates, see “Business — Overview of the Hospice Care Industry — Funding Hospice Care: Medicare, Medicaid and other Sources” and “Business — Government Regulation — Overview of Government Payments — Medicare.” The table below sets forth the percentage of our net patient revenue generated under each of the four Medicare levels of care for the periods indicated:

      Typically, each October, Medicare adjusts its base hospice care reimbursement rates for the following year based on inflation and other economic factors. Effective April 1, 2001, the Medicare base rates were increased 5.0% over the base rates then in effect. Such rates were further increased by 3.3% effective October 1, 2001, 3.4% effective October 1, 2002, 3.4% effective October 1 2003, and 3.3% effective October 1, 2004. These increases have favorably impacted our net patient revenue. Medicare’s base rates are subject to regional adjustments based on local wage levels. These regional adjustments are not necessarily proportional to adjustments in the base rates.

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

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

Expenses

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

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

      For our patients who receive nursing home care under state Medicaid programs in states other than Arizona, Oklahoma, Pennsylvania and South Carolina, the applicable Medicaid program pays us an amount equal to no more than 95% of the Medicaid per diem nursing home rate for room and board services furnished to the patient by the nursing home in addition to the Medicare or Medicaid routine home care per diem payment. We pay the nursing home for these room and board services at a rate between 90% and 100% of the full Medicaid per diem nursing home rate, depending on the terms of the contract between us and the nursing home. We include the difference between the amount we pay the nursing home and the amount we receive from Medicaid in patient care expenses. We refer to this difference as “nursing home costs, net”. Our nursing home costs, net, were $1.3 million in 2002, $4.8 million in 2003 and $3.4 million for the nine months ended September 30, 2004.

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

Stock-Based Compensation

      Certain employee stock options, which we granted in 2001, 2002 and 2003 have resulted in and will continue to result in stock-based compensation charges. In accordance with Accounting Principles Board Opinion No. 25 and related interpretations, if an employee stock option is granted or modified with an exercise price, which is less than the deemed fair value of the underlying stock, the difference is treated as a compensation charge that must be recognized ratably over the vesting period for the option. In addition, a stock option granted to our Chief Executive Officer in November 2002 was accelerated in full in February 2003, resulting in $1.1 million of compensation expense, which was recognized in the first quarter of 2003. In August of 2004, VistaCare granted 30,000 shares of restricted stock to two executive officers at no cost, which will cause the Company to recognize $480,000 in compensation expense ratably over the four-year vesting period. The stock agreements include accelerated vesting provisions, which may result in the Company having to accelerate the recognition of this deferred compensation expense. As of September 30, 2004, we had accrued a total of $1.2 million of deferred stock-based compensation relating to the foregoing options and grants.

Capitalized Software Development Costs

      We have capitalized certain internal costs related to the development of software used in our business. We capitalize all qualifying internal costs incurred during the application development stage. Costs incurred during the preliminary project stage and post-implementation/operation stage are expensed as incurred. For

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Goodwill

      Goodwill from our 1998 and 2002 acquisitions, net of accumulated amortization, was $20.6 million as of September 30, 2004. Prior to 2002, we were amortizing the goodwill from our 1998 acquisitions over 30 years. Rules issued by the Financial Accounting Standards Board, effective beginning in 2002, require that we no longer amortize goodwill. These rules require that we analyze our goodwill for impairment annually, or more often if events or circumstances arise that indicate that the carrying value of our goodwill exceeds its fair market value. We have concluded that no basis for impairment of our goodwill existed as of September 30, 2004.

Critical Accounting Policies and Significant Estimates

      To understand our financial position and results of operations, you should read carefully the description of our significant accounting policies set forth in “Part 3 — Item 8 Financial Statements and Supplementary Data — Notes To Consolidated Financial Statements — Note 1” of this report. You should also be aware that application of our significant accounting policies requires that we make certain judgments and estimates, which are subject to an inherent degree of uncertainty.

      Each of our hospice providers is subject to the annual Medicare Cap, as more fully described in Part I, Item 1 of this report under the caption entitled “Business — Government Regulation — Overview of Government Payments — Medicare”. Overall Medicare payments to our hospice providers are also subject to an annual limitation or Cap. This Cap amount is revised annually to account for inflation. For the twelve-month period ended October 31, 2004, the annual hospice benefit Cap was $19,635.67 per beneficiary. Compliance with the Cap, however, is not determined on the basis of individual beneficiary experiences. Instead, compliance is measured by calculating the total Medicare payments received by a provider with respect to services provided to all Medicare hospice care beneficiaries between November 1 of each year and October 31 of the following year and comparing the result with the product of the Cap amount and the number of Medicare beneficiaries electing hospice care for the first time from that hospice provider during the relevant period. There is a further negative adjustment for the Cap calculation to the extent our first time beneficiaries are later admitted to another provider and also a positive adjustment for a second time beneficiary admitted into our provider, each on a pro-rated basis, based on days of service. If actual Medicare reimbursements to that provider exceed that amount, Medicare requires that we repay the difference to Medicare.

      We actively monitor each of our programs to determine whether they are likely to exceed the Medicare Cap. If we determine that a program is likely to exceed the Cap, we attempt to institute corrective action, such as a change in patient mix. However, to the extent we believe our corrective action will not be successful, we estimate the amount that we could be required to repay to Medicare and accrue that amount as a reduction to net patient revenue. Throughout the year, we review our operating experience and adjust our estimate of potential Medicare Cap liability. The accuracy of our estimates is affected by factors, which include:

	•	the actual number of Medicare patient admissions and discharges and the dates of occurrence of each;
	•	the average length of stay at each program with those over 170 days most likely to generate Cap exposure;

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	•	our success in implementing corrective measures;
	•	possible enrollment of beneficiaries in our programs who, without our knowledge, may have previously elected Medicare hospice coverage through another hospice provider;
	•	the possible enrollment of beneficiaries in a third-party program who had been on previous hospice service within one of our own programs and whose per-beneficiary Cap amount is prorated for the days of service for the subsequent hospice admission;
	•	fiscal intermediary disallowances of certain beneficiaries;
	•	uncertainty surrounding length of patient stay in various patient groups, particularly with respect to non-oncology patients; and
	•	the fact that we are not advised of the actual per-beneficiary cap credit amount that will be used by Medicare until the last month of the Medicare fiscal year, requiring us to use an estimate of that amount throughout the year.

      While we endeavor to record an accurate estimate of cap liability, for the Medicare fiscal year ended October 2003, actual assessments differed from our recorded estimate. Actual assessments for the Medicare regulatory year ended October 2004 may also differ from the amount we have recorded as an estimate due to the factors listed above.

      We recorded reductions to net patient revenue of $14.8 million for the nine months ended September 30, 2004, $4.6 million for the year-ended December 31, 2003, and $1.0 million for the year ended December 31, 2002, for exceeding the Medicare Cap. As of the date of this report, we have received assessment letters totaling $7.5 million for all programs for the 2003 Medicare regulatory year and have not been assessed for exceeding the Medicare Cap for the Medicare regulatory year that began on November 1, 2003. We estimate that total future charges against revenue for Medicare Cap exposure for fiscal 2005 will be in the range of $6.0 to $8.0 million.

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

	•	our claim documentation is incomplete or contains incorrect patient information;
	•	the payor deems the patient ineligible for insurance coverage; or
	•	we have failed to provide timely written physician certifications as to patient eligibility.

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

	•	our experience of claim denials by payor class;
	•	the strength and reliability of our billing practices; and
	•	changes in the regulatory environment.

      We reflected reductions to net patient revenue (excluding room and board charges) for estimated claim denials of $3.8 million in for nine months ended September 30, 2004 and $4.0 million and $3.0 million for the years ended September 30, 2003 and 2002, respectively.

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Goodwill Impairment

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

	•	significant under-performance of our acquired businesses relative to historical or projected operating results;
	•	significant negative industry trends; or
	•	significant changes in regulations governing hospice reimbursements from Medicare and state Medicaid programs.

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

      In the event we determine that the value of our goodwill has become impaired, we are required to write down the value of the goodwill to its fair market value on our balance sheets and to reflect the extent of the impairment as an expense on our statements of operations. We have determined that no impairment of goodwill existed as of September 30, 2004.

Deferred Tax Assets

      In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. In order to fully realize the deferred tax asset, the Company will need to generate future taxable income prior to the reversal of its temporary differences. As of September 30, 2004, we had deferred tax assets of $10.7 million. In accordance with FAS 109, Accounting for Income Taxes, we have evaluated the recoverability of the deferred tax asset and have ascertained that it is more likely than not that the assets will be recovered.

Results of Operations

      On August 19, 2004, VistaCare’s Board of Directors changed the Company’s fiscal year end from December 31 to September 30. The nine-month results now being reported by the Company relate to the transitional fiscal period ended September 30, 2004.

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

(1)

      Net patient revenue increased $12.3 million, or 9.0%, to $150.4 million for the nine months ended September 30, 2004 from $138.1 million for the nine months ended September 30, 2003. These increases were due to:

	•	increases in patient service days, which increased by 15.5% to 1,431,766 for the nine months ended September 30, 2004 from 1,239,175 for the nine months ended September 30, 2003.
	•	the 3.4% Medicare reimbursement rate increase effective October 1, 2003,

      These increases were offset by increases in the Medicare Cap charge amount to $14.8 million for the nine months ended September 30, 2004 from $1.5 million for the nine months ended September 30, 2003, which had a 9.0% adverse impact on gross revenue. The $14.8 million reduction to revenue for Medicare CAP during the nine months ended September 30, 2004 includes:

	•	$1.6 million in actual assessment from letters received from our fiscal intermediary between June to October of 2004 for the 2003 Medicare regulatory year, related to pro-ration of service dates for

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		patients who received services from other hospice programs prior to or after their admission into a VistaCare program and technical disqualifications of cap credits. While pro-ration of patient service dates are a more significant issue in 2004, the assessments in 2003 were more significantly impacted by differences between technical disqualifications of Cap credits and payment data;
	•	$11.2 million for patient service dates during the 2004 Medicare regulatory year; and
	•	$2.0 million for pro-ration for patient service dates based on increased patient discharges and estimated services that these 2004 patients may receive from other hospice programs during the 2005 Medicare regulatory year.

      Net patient revenue per day of care decreased to approximately $105 for the nine months ended September 30, 2004 from approximately $111 for the nine months ended September 30, 2003. The decrease was primarily due to the increase in the Medicare Cap charge in the nine months ended September 30, 2004 and a lower mix of general inpatient care patients, partially offset by the October 1, 2003 Medicare reimbursement rate increase.

      Our average daily census of patients increased 15.1% to 5,225 for the nine months ended September 30, 2004 from 4,539 for the nine months ended September 30, 2003. This increase was attributable to an increase in the average length of stay to 118 days, for the nine months ended September 30, 2004 from 88 days for the nine months ended September 30, 2003. This was partially offset by a decline in patient admissions from 11,545 in the nine months ended September 30, 2004 as compared to 11,649 in the nine months ended September 30, 2003. At 118 days, our average length of stay is significantly higher than the industry average and is due in part to our relatively high mix of non-cancer patients, by hospice industry standards, though in line with total cancer deaths in the country. We believe that such patients generally have a higher average length of stay than cancer patients.

      Patient care expenses increased $17.7 million, or 21.5%, to $100.1 million for the nine months ended September 30, 2004, from $82.4 million for the nine months ended September 30, 2003 primarily as a result of average daily census increase. Of this increase, $13 million was attributable to increased salaries, benefits, payroll taxes and travel costs of hospice care providers, which increased as a result of the hiring of additional nurses, social workers and chaplains to accommodate actual and anticipated patient care growth, increased employee health insurance costs and the annual wage increase for all employees effective April 1, 2004 and new program costs. This increase in patient care expenses was also due to a $2 million increase in durable medical equipment expense and a $0.9 million increase in nursing homes costs, net.

      As a percentage of net patient revenue, patient care expenses increased to 66.5% for the nine months ended September 30, 2004 from 59.1% for the nine months ended September 30, 2003. These increases were primarily due to the increases in salaries, benefits and payroll cost of hospice care providers and, to a lesser extent, the increases in durable medical equipment and supplies expense and nursing homes costs, net. The increase to patient care expenses as a percent of net patient revenue was the result of the actual nominal increase in these expenses, combined with the significant reduction to net patient revenue due to the Medicare CAP charge.

      General and administrative expenses increased $13.8 million, or 34.4% to $53.9 million in the nine months ended September 30, 2004 from $40.1 million in the nine months ended September 30, 2003. As a percentage of net patient revenue, general and administrative expenses increased to 35.8% in the nine months ended September 30, 2004 from 29.0% in the nine months ended September 30, 2003. Of the overall increase in general and administrative expenses 45.8% was due to a $9.8 million increase in salaries, payroll taxes, and benefits including health care and workers compensation, primarily related to the addition of personnel, especially in the marketing area due to increased staffing, and a 4.5% wage increase that went into effect in April 2004. The remainder of the increase was primarily due to increases in insurance expenses, new office leases and lease termination expense, and legal expense.

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      Depreciation and amortization expense increased $1.7 million, or 131%, to $3.0 million in the nine months ended September 30, 2004 from $1.3 million in the nine months ended September 30, 2003. The increase was primarily due to additional equipment purchases placed into service and the amortization of $3.7 million of capitalized software development costs associated with our new billing system, which was released in the December quarter of 2003 and September quarter of 2004.

      Stock-based compensation was approximately $239,000 for the nine months ended September 30, 2004 and $1.2 million for the same period 2003. The 2003 figure included a $1.0 million compensation expense that resulted from the accelerated vesting of stock options in February 2003 to our Chief Executive Officer. Had the vesting not accelerated, a portion of the 2003 compensation expenses would have been recognized in 2004. The 2004 figure was also affected by our grant of 30,000 shares of restricted stock, for which $480,000 in compensation expenses will be recognized ratably over four years beginning in August 2004.

      Non-operating income for the nine months ended September 30, 2004 was $248,000, compared to non-operating income for nine months ended September 30, 2003 of $112,000. The increase was due primarily to higher interest income on available cash balances during 2004.

      In 2004, we recorded a taxable benefit of $2.3 million on our loss given that we believe it is more likely than not that we are able to recover our existing deferred tax assets. In 2003, we recorded $4.3 million in income tax expense, reflecting an effective tax rate of 22% for the year, and exhausted the balance of valuation allowances from prior years. In 2002, we had no federal income tax expense and $0.3 million of state income tax expense, due to our ability to utilize net operating tax loss carryforwards. Our effective tax rate in 2002 and 2003 was lower than the statutory rate due to utilization of valuation allowances.

      Net patient revenue increased $58.8 million, or 44.2%, from $132.9 million in 2002 to $191.7 million in 2003. This increase was due to an increase in billable patient days and the Medicare reimbursement rate increases effective October 1, 2002 and October 1, 2003. Substantially all of the increase in billable patient days was attributable to organic growth. Net patient revenue per day of care was approximately $108 in 2002 and $112 in 2003. This increase was due primarily to the Medicare rate increases and an increase in the percentage of patients receiving care in geographic regions where reimbursement rates are relatively high. Our average daily census of patients increased from 3,364 in 2002 to 4,705 in 2003.

      Patient care expenses increased $34.8 million, or 43.6%, from $$79.8 million in 2002 to $114.6 million in 2003. Of this increase, 69.3% was due to a $24.1 million increase in salaries, benefits and payroll taxes and travel costs of hospice care providers, including pay increases for our existing care providers and costs associated with additional personnel hired to provide care to our increased census of patients. The remainder of the increase was due to an increase in purchased services, durable medical equipment and medical supplies required to provide care to our increased census of patients and an increase in nursing home costs, net. As a percentage of net patient revenue, patient care expenses decreased from 60.0% in 2002 to 59.8% in 2003. This decrease was primarily due to the increase in net patient revenue per patient, per day in 2003, coupled with a decrease in the average cost of pharmaceuticals and durable medical equipment on a per patient, per day basis in 2003. Patient care expenses as a percentage of net patient revenue in 2003 was adversely impacted by the

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      General and administrative expenses increased $12.0 million, or 28.2%, from $42.5 million in 2002 to $54.5 million in 2003. As a percentage of net patient revenue, general and administrative expenses decreased from 32.0% in 2002 to 28.4% in 2003. Of the overall increase in general and administrative expenses 70.8% was due to a $8.5 million increase in salaries, payroll taxes, and benefits, primarily related to the addition of program-level personnel, and a 3.3% wage increase that went into effect in April 2003. The remainder of the increase was primarily due to increases in insurance expenses, facility leases and corporate-level personnel additions.

      Depreciation and amortization expense increased $0.7 million, or 45.5%, from $1.3 million in 2002 to $2.0 million in 2003. The increase was primarily due to additional equipment purchases placed into service and the amortization of $3.7 million of Capitalized software development costs associated with our new billing system which was completed in the fourth quarter of 2003.

      Stock-based compensation was approximately $427,000 in 2002 and $1,328,000 in 2003. Of the stock-based compensation in 2003, $1.0 million was recognized in the first quarter of 2003 and related to the acceleration of the vesting of a stock option.

      Non-operating income (expense) for 2003 was $0.2 million, compared to non-operating income (expense) for 2002 of $(1.0) million. The change was due to an increase in interest that we derived from our investment of a significant portion of the net proceeds from our initial public offering of common stock in December 2002 and a decrease in interest expense as a result of our repayment of outstanding indebtedness under our bank credit facility with proceeds from our initial public offering.

      In 2003 we recorded $4.3 million in income tax expense, reflecting an effective tax rate of 22% for the year, and exhausted the balance of valuation allowances from prior years. In 2002, we had no federal income tax expense and $0.3 million of state income tax expense due to our ability to utilize net operating tax loss carryforwards.

Liquidity and Capital Resources

      Our principal liquidity requirements have been for working capital and capital expenditures. We have financed these requirements primarily with cash flow from operations. In December 2002, we completed our initial public offering of common stock in which we raised net proceeds of $48.1 million. As of September 30, 2004, we had cash and cash equivalents of $28.7 million, working capital of $58.7 million and short-term investments of $33.2 million. Additionally we have the ability to borrow under our revolving credit facility described below.

      Net cash provided by operating activities for nine months ended September 30, 2004 was $17.4 million despite a net loss due to an increase in our accounts payable and accrued expenses and a decrease in our patient accounts receivable. The increase in accrued expenses was significantly impacted by an increase of $13.7 million in accrued Medicare Cap liability from December 31, 2003. This accrued expense accrual now stands at $19.6 and the balance is likely to be paid in fiscal 2005 and 2006.

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      Net cash used in investing activities was $4.3 million. This was due primarily to the investment in internally developed software and capital expenditures.

      Net cash provided by financing activities was $1.3 million for nine months ended September 30, 2004, which resulted from the exercise of the employee stock options.

      We currently maintain a revolving credit facility with Healthcare Business Credit Corporation, or HBCC, under which we may borrow, repay and re-borrow from time to time up to $30 million, based on 85% of the amount of our eligible accounts receivable. As of September 30, 2004, there were no borrowings under this facility.

      Advances under the HBCC revolving line of credit bear interest at an annual rate equal to, at our option, either the “prime rate” in effect from time to time, as reported in the “Money Rates” section of the Wall Street Journal, plus 1.5%, or the one-month London Interbank Borrowing Rate in effect from time to time, plus 3.0%. The applicable interest rate increases by 3.5% if there is an event of default. Accrued interest is due and payable weekly on advances under the revolving line of credit bearing interest at the prime rate. Accrued interest on advances bearing interest at the London Interbank Offering Rate is due and payable on the last business day of the month. The maturity date for the revolving line of credit is April 30, 2005. As of September 30, 2004, the effective interest rate for borrowings under this facility would have been 4.12% per annum.

      Our ability to borrow under the HBCC credit facility is predicated, in part, on our compliance with various conditions of the loan agreement, including financial covenants that require the company to maintain a minimum ratio of debt service coverage and minimum net worth ratio. Were we to default under the provisions of the loan agreement, the lender has the right to curtail further loan advances and exercise remedial rights. Due to the current period loss, we would have been out of compliance with the debt service coverage covenant however, the lender provided a waiver thru the maturity date of April 30, 2005.

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

      We expect that our principal liquidity requirements will be for working capital, including $19.6 million of accrued Medicare Cap liabilities, the development of new hospice programs, the acquisition of other hospice programs and capital expenditures. We expect that our existing funds and cash flows from operations will be sufficient to fund our principal liquidity requirements for at least the next twelve months. Our future liquidity requirements and the adequacy of our available funds will depend on many factors, including payment for our services, regulatory changes and compliance with new regulations, expense levels, capital expenditures, future development of new hospice programs and acquisitions.

Contractual Obligations

      The following table summarizes our significant contractual obligations at September 30, 2004, and the effect such obligations are expected to have on our liquidity and cash flows in future periods. The total excludes amounts already recorded on our balance sheet as current liabilities as of September 30, 2004 (in thousands):

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      The expected timing of payment of the obligations discussed above is estimated based on current information. Timing of payments and actual amounts may be different depending on the time of receipt of goods or services or charges to agreed-upon amounts for some obligations.

      For the purpose of this table, contracted obligations for purchase commitments relating to of goods and services are defined as agreements that are enforceable and legally binding on VistaCare and that specify all significant terms, including fixed or minimum quantities to purchase and approximate timing of the transaction.

Interest Rate and Foreign Exchange Risk

      We do not expect our cash flow to be affected to any significant degree by a sudden change in market interest rates. We have not implemented a strategy to manage interest rate market risk because we do not believe that our exposure to this risk is material at this time. We invest excess cash balances in money market accounts with average maturities of less than 90 days and our short-term investments generally are variable rate or contain interest reset features which causes their face value to be relatively stable.

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

Payment, Legislative and Regulatory Changes

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

Inflation

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

Recent Accounting Pronouncements

      In June of 2004, the Financial Accounting Standards Board issued a proposed statement, Fair Value Measurements. This proposed statement provides guidance for how to measure fair value. The statement would apply to financial and non-financial assets and liabilities measured at fair value under other accounting pronouncements. This proposed statement would define fair value as “the price at which an asset or liability would be changed in current transaction between knowledgeable parties. The proposed statement would be effective for financial statements issued for fiscal years beginning after June 2005. The adoption of this proposed statement is not expected to have a material effect on our financial position for results of operations.

      In March 2004, the FASB issued a Proposed Statement, Share Based Payments, an amendment of FASB Statements No. 123 and 95 on accounting for share-based payments, that would eliminate the ability to

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      In March 2004, the FASB issued EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, which provides new guidance for assessing impairment losses on debt and equity investments. Additionally, EITF Issue No. 03-1 includes new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the FASB delayed the accounting provisions of EITF Issue No. 03-1; however, the disclosure requirements remain effective and have been adopted for the Company’s fiscal year ended October 30, 2004. The Company will evaluate the effect, if any, of EITF Issue No. 03-1 when final guidance is released.

Forward-Looking Statements

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

Factors That May Affect Future Results

      Approximately 96.6%, 96.8% and 97.2 of our net patient revenue for the years ended December 31, 2002, 2003, and the nine months ended September 30, 2004, respectively, consisted of payments from Medicare and Medicaid programs. Because we generally receive fixed payments for our hospice care services based on the level of care provided to our hospice patients, we are at risk for the cost of services provided to our hospice patients. We cannot assure you that Medicare and Medicaid will continue to pay for hospice care in the same manner or in the same amount that they currently do. Reductions in amounts paid by government programs for our services or changes in methods or regulations governing payments, which would likely result in similar changes by private third-party payors, could adversely affect our net patient revenue and profitability.

      Medicare payments for hospice services are subject to an annual Cap, which for the twelve months ended October 31, 2004 was $19,635.67. Compliance with the Medicare Cap is measured by calculating the annual Medicare payments received by a hospice provider with respect to services provided to all Medicare hospice care beneficiaries and comparing the result with the product of the per-beneficiary Cap amount and the number of Medicare beneficiaries electing hospice care for the first time from that hospice provider during the relevant period. There is a further negative adjustment for the Cap calculation to the extent our first time beneficiaries are later admitted to another provider and also a positive adjustment for a second time

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

      For our patients receiving nursing home care under certain state Medicaid programs, the applicable Medicaid program pays us an amount equal to no more than 95% of the Medicaid per diem nursing home rate for “room and board” services furnished to the patient by the nursing home in addition to the applicable Medicare or Medicaid hospice per diem payment. We, in turn, are generally obligated to pay the nursing home for these room and board services at a rate between 90% and 100% of the full Medicaid per diem nursing home rate. In the past, we have experienced situations where both we and the Medicaid program have paid a nursing home for the same room and board service and the Medicaid program has imposed on us the burden of recovering the amount we previously paid to the nursing home. There can be no assurance these situations will not recur in the future or that if they do, we will be able to fully recover from the nursing home.

      In addition, many of our patients residing in nursing homes are eligible for both Medicare and Medicaid benefits. In these cases, the patients’ state Medicaid program pays their nursing home room and board charges and Medicare pays their hospice services benefit. Government audits conducted in the last several years have suggested that the reimbursement levels for these dual-eligible hospice patients as well as for Medicare-only patients living in nursing homes may be excessive. Specifically, the government has expressed concerns that hospice programs may provide fewer services to patients who reside in nursing homes than to patients living in

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

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

      We began operations in November 1995. For 1999, 2000 and 2001, we recorded net losses before accrued preferred stock dividends of $0.8 million, $0.4 million and $6.7 million, respectively. We recorded net income of $3.5 million and $15.2 million before accrued preferred stock dividends for the years ended December 31, 2002 and 2003 respectively and a net loss of $4.2 million for the nine months ended September 30, 2004. As of September 30, 2004, we have an accumulated deficit of $18.5 million. We cannot assure you that we will operate profitably in the future. In addition, we may experience significant quarter-to-quarter variations in operating results. We are pursuing a growth strategy focused primarily on same-store growth but also involving the development of new programs and acquisitions. Our growth strategy may involve, among other things, increased marketing expenses, significant cash expenditures, debt incurrence and other expenses that could negatively impact our profitability on a quarterly and an annual basis. Our net patient revenue could be adversely impacted by a number of factors, in particular, reductions in Medicare payment rates and patient lengths of stay, which may not be within our control.

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

      Our ability to attract and retain qualified nurses and other healthcare professionals depends on several factors, including our ability to provide attractive assignments and competitive benefits and wages. We cannot assure you that we will be successful in any of these areas. Because we operate in a fixed reimbursement

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

      Our success is heavily dependent on referrals from physicians, nursing homes, assisted living facilities, hospitals, managed care companies, insurance companies and other patient referral sources in the communities that our hospice programs serve. Because we and many of our referral sources are dependent upon Medicare, we are limited in our ability to engage in business practices that are commonplace among referring businesses in other industries such as referral fees, or bonuses and long-term exclusive contracts.

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