UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2004

or

     For the transition period from                                        to

Commission File No. 000-50118

VistaCare, Inc.

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

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes o No

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

     As of July 26, 2004, there were outstanding 16,192,666 shares of the issuer’s Class A Common Stock, $0.01 par value per share.

Table of Contents

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PART I — FINANCIAL INFORMATION

Item 1.	Financial Statements.

VISTACARE, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share information)

See accompanying notes to consolidated financial statements.

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VISTACARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except per share information)

See accompanying notes to consolidated financial statements.

2

VISTACARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)

See accompanying notes to consolidated financial statements.

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VISTACARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Description of Business

     VistaCare, Inc. (VistaCare), is a Delaware corporation providing medical care designed to address the physical, emotional, and spiritual needs of patients with a terminal illness and the support of their family members. Hospice services are provided predominately in the patient’s home; however, certain patients require inpatient services. VistaCare provides services in Alabama, Arizona, Colorado, Georgia, Indiana, Massachusetts, New Mexico, Nevada, Ohio, Oklahoma, Pennsylvania, South Carolina, Texas and Utah.

1. Significant Accounting Policies

Basis of Presentation

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

     The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments consisting of normal recurring accruals considered necessary for a fair presentation have been included. Operating results for the three- and six-month periods ended June 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004.

     The balance sheet at December 31, 2003 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in VistaCare Inc.’s annual report on Form 10-K for the year ended December 31, 2003.

Capitalized Software Development Costs

     VistaCare capitalizes certain internal salaries related to the development of computer software used in its operations. Such capitalized software development costs are being amortized over three years. Capitalized software development costs, net of amortization, included in other assets, amounted to $5.2 million at June 30, 2004 and $5.3 million at December 31, 2003. Costs incurred during the preliminary project stage and post implementation/operations stage are expensed as incurred.

Net Patient Revenue

     Net patient revenue is the amount VistaCare believes it is entitled to collect for its services, adjusted as described below. The amount VistaCare believes it is entitled to collect for its services varies depending on the level of care provided, the payor and the geographic area where services are rendered. Net patient revenue also includes adjustments for charity care and estimated payment denials (which VistaCare experiences from time to time for reasons such as its failure to submit complete and accurate

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VISTACARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
JUNE 30, 2004
(Unaudited)

claim documentation, its failure to provide timely written physician certifications as to patient eligibility, or the payor deems the patient ineligible for insurance coverage), subsequent changes to initial level of care determinations, contractual adjustments, and amounts VistaCare estimates it could be required to repay to Medicare, such as payments that VistaCare would be required to make in the event that any of its programs exceed the annual per-beneficiary cap. VistaCare adjusts its estimates from time to time based on its billing and collection experience and other factors. VistaCare recognizes net patient revenue once the patient’s coverage from a payment source has been verified and services have been provided to that patient.

     Approximately 97% and 96% of VistaCare’s net patient revenue was derived from the Medicare and Medicaid programs for the six-month periods ended June 30, 2004 and June 30, 2003, respectively. VistaCare operates under arrangements with Medicare, Medicaid and other third-party payors pursuant to which these payors reimburse VistaCare for services it provides to hospice-eligible patients these payors cover, subject only to VistaCare’s submission of adequate and timely claim documentation. VistaCare has a patient intake process that screens patients for hospice eligibility and identifies whether their care will be covered by Medicare, Medicaid, private insurance, managed care or self-pay. Whether Medicare or Medicaid continue to provide reimbursement for hospice care is dependent upon governmental policies.

Medicare and Medicaid Regulation

     VistaCare is subject to certain limitations on Medicare payments for services. Specifically, if the number of inpatient care days of care any hospice program provides to Medicare beneficiaries exceeds 20% of the total days of hospice care such program provides to all patients for an annual period beginning September 28, the days in excess of the 20% figure may be reimbursed only at the routine home care rate. None of VistaCare’s hospice programs exceeded the payment limits on inpatient services in the six-month periods ended June 30, 2004 or June 30, 2003.

     VistaCare is also subject to a Medicare annual per-beneficiary cap. Compliance with the Medicare per-beneficiary cap is measured by comparing the total Medicare payments received under a Medicare provider number with respect to services provided to all Medicare hospice care beneficiaries in the program or programs covered by that Medicare provider number with respect to services provided during the twelve-month period between November 1 of one year and October 31 of the following year, and the product of the per-beneficiary cap amount and the number of Medicare beneficiaries electing hospice care for the first time from that hospice program or programs during the relevant period. The company’s operations are conducted under 35 separate provider numbers, many of which have not experienced cap limitations. However, since cap regulations apply only at the provider number level, several of our operations under various provider numbers have been subject to cap limitations due to demographics of our patient base in such operations. VistaCare recorded reductions to net patient revenue of approximately $6.2 million for the three months ended June 30, 2004 and $0.6 million for the three months ended June 30, 2003 as estimates for exceeding the Medicare per-beneficiary cap. As of the date of this report, VistaCare had been assessed $0.4 million for exceeding the per-beneficiary cap for the assessment period that began on November 1, 2002 however, this is only a small portion of the locations where we believe we will receive an assessment. A determination as to this liability had not yet been made by the Medicare fiscal intermediary with respect to many of VistaCare’s programs. VistaCare management believes that as of June 30, 2004 adequate reserves had been established for this potential liability.

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

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VISTACARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
JUNE 30, 2004
(Unaudited)

     Laws and regulations governing the Medicare and Medicaid program are complex and subject to interpretation. VistaCare believes that it is in compliance with all applicable laws and regulations and is not aware of any pending or threatened investigations involving allegations of potential wrongdoing which would have a material impact on VistaCare’s consolidated financial condition or results of operations. Compliance with such laws and regulations can be subject to future government review and interpretation as well as significant regulatory action including fines, penalties, and exclusion from the Medicare and Medicaid programs.

Charity Care

     VistaCare provides care at no cost to patients who are not eligible for insurance coverage and meet certain financial need criteria established by VistaCare. Charity care totaled approximately $0.4 million and $0.7 million for the three-month periods ended June 30, 2004 and June 30, 2003, respectively. Because VistaCare does not pursue collection of amounts determined to qualify as charity care, these amounts are not recorded in net patient revenue. Costs VistaCare incurs in providing charity care are recorded as patient care expenses.

Nursing Home Costs

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

     Nursing home costs totaled approximately $11.8 million for the three months ended June 30, 2004 and $7.6 million for the three months ended June 30, 2003. Nursing home revenue totaled approximately $10.2 million for the three months ended June 30, 2004 and $7.1 million for the three months ended June 30, 2003. Revenues are less than 95% of costs due to provisions for estimated uncollectible amounts.

Income Taxes

     VistaCare accounts for income taxes under the liability method as required by Financial Accounting Standards Board Statement No. 109, Accounting for Income Taxes. Under the liability method, deferred taxes are determined based on temporary differences between financial statement and tax bases of assets and liabilities existing at each balance sheet date using enacted tax rates for years in which the related taxes are expected to be paid or recovered. No valuation allowances existed at June 30, 2004 due to VistaCare’s assessment that it is more likely than not that it will be able to recover all of its deferred tax assets.

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VISTACARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
JUNE 30, 2004
(Unaudited)

General and Professional Liability Insurance and Auto Insurance

     VistaCare is covered by claims made professional liability insurance coverage with limits of $1,000,000 per medical incident and $3,000,000 in the aggregate, and by occurrence-based general liability insurance with limits of $1,000,000 per occurrence and $3,000,000 in the aggregate, each with a $25,000 deductible. VistaCare also maintains a policy insuring hired and non-owned automobiles with a $1,000,000 limit of liability, with a $1,000,000 deductible. In addition, VistaCare maintains an umbrella policy of liability insurance with a $10,000,000 limit of liability over the underlying professional liability, general liability and hired and non-owned automobile liability policies.

Use of Estimates

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Stock-Based Compensation

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

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

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VISTACARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
JUNE 30, 2004
(Unaudited)

Earnings Per Share

     Basic net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of shares outstanding during the period plus the effect of dilutive securities, including employee stock options (using the treasury stock method). Diluted earnings per share for the quarter ended June 30, 2004 are equal to the primary earnings per share, since the inclusion of the 511,000 shares of common stock equivalents would be antidilutive.

Recent Accounting Pronouncements

     In January 2003, the Financial Accounting Standards Board issued FASB Interpretation No. 46, (“FIN 46”), Consolidation of Variable Interest Entities, Interpretation of ARB No. 51, which addresses consolidation by business enterprises of variable interest entities (“VIEs”) either: (1) that do not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (2) in which the equity investors lack an essential characteristic of a controlling financial interest. In December 2003, the FASB completed deliberations of proposed modifications to FIN 46 (“Revised Interpretations”) resulting in multiple effective dates based on the nature as well as the creation date of the VIE. VIEs created after January 31, 2003, but prior to January 1, 2004, may be accounted for either based on the original interpretation or the Revised Interpretations. For VIEs created or acquired prior to February 2, 2003, the provisions of FIN 46 must be applied for the first interim or annual period ending after December 15, 2003. Certain disclosures are effective immediately. VIEs created after January 1, 2004 must be accounted for under the Revised Interpretations. We currently have no contractual relationship or other business relationship with a variable interest entity and therefore the adoption of FIN No. 46 did not have a material effect on our consolidated financial position, results of operations or cash flows.

     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 account for share-based payments using Accounting Standards Board Opinion No. 25, Accounting for Stock Issued to Employees, and require all such transactions to be accounted for using a fair value based method. The Proposed Statement would become effective for awards granted, modified, or settled in years beginning after December 15, 2004 and would require the recognition of compensation expense for any portion of awards granted or modified after December 15, 1994 that are not vested as of the Proposed Statement’s effective date. VistaCare has not determined the effect of adopting the Proposed Statement on its consolidated financial position, results of operations or cash flows.

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VISTACARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
JUNE 30, 2004
(Unaudited)

2. Accrued Expenses

     A summary of accrued expenses follows (in thousands):

3. Income Taxes

     VistaCare’s provisions for income taxes for the six-month periods ended June 30, 2004 and June 30, 2003 reflect its estimates of the effective tax rate for the applicable full years. This estimate is re-evaluated by management each quarter based upon forecasts of income before taxes for the year. For the six-month period ended June 30, 2004, we recorded $1.8 million in income tax expense. The amount was comprised of tax at our estimated 39% effective rate expected for 2004 and an additional $0.3 million relating to taxes due in certain states in 2003 based upon a change in our assessment of the amounts due. Our effective rate of 39% differs from the statutory rate due primarily to state income taxes net of their federal income tax benefit. For the six-month period ended June 30, 2003, income tax expense was $1.3 million, which was below the statutory rate of $3.2 million due to the utilization of net operating loss carryforwards and corresponding reduction in the valuation reserve for deferred tax assets.

4. Long-Term Debt

     VistaCare has a $30.0 million revolving line of credit collateralized by substantially all of VistaCare’s assets including cash, accounts receivable and equipment. Loans under the revolving line of credit bear interest at an annual rate equal to, at VistaCare’s option, either the “prime rate” in effect from time to time, as reported in the “Money Rates” section of the Wall Street Journal, plus 1.5%, or the one-month London Interbank Borrowing Rate in effect from time to time, plus 3.0%. Accrued interest under the revolving line of credit is due (i) weekly, if VistaCare opts to pay interest at the prime rate, or (ii) on the last business day of the month, if VistaCare opts to pay interest at the London Interbank Borrowing Rate based rate.

     Under the revolving line of credit, VistaCare may borrow, repay and reborrow an amount equal to the lesser of: (i) $30.0 million or (ii) 85% of the estimated net value of eligible accounts receivable. As of June 30, 2004, approximately $20 million was available for borrowing under the revolving line of credit. The maturity date of the revolving line of credit is April 30, 2005. As of June 30, 2004, there was no balance outstanding on the revolving line of credit.

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VISTACARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
JUNE 30, 2004
(Unaudited)

     VistaCare’s revolving line of credit facility contains customary covenants including those that restrict the ability of VistaCare to incur additional indebtedness, pay dividends under certain circumstances, permit liens on property or assets, make capital expenditures, make certain investments, and prepay or redeem debt or amend certain agreements relating to outstanding indebtedness. As of June 30, 2004, VistaCare was in compliance with the terms of such covenants.

5. Dilutive Securities

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

6. Allowances for Denials

     The allowances for denials for patient care and room and board accounts receivable are as follows (in thousands):

7. Litigation

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

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

Overview

     Net patient revenue increased to $48.1 million for the three months ended June 30, 2004 from $46.1 million for the three months ended June 30, 2003. However, due to Medicare cap reserve, net patient revenue for the three months ended June 30, 2004 was less than net patient revenue for the three months ended March 31, 2004 of $53.6 million and net patient revenue for the three months ended December 31, 2003 of $53.6 million. The recent decline in patient admissions, coupled with our increasing average length of stay of patients, has increased significantly our liability exposure related to the Medicare per-beneficiary cap limitation. This required us to accrue $6.2 million in the three months ended June 30, 2004 for our Medicare cap reserve, which at June 30, 2004 totaled $12.9 million. We expect that we may be required to accrue up to a similar amount in the quarter ending September 30, 2004.

     We have undertaken a number of initiatives to reduce our Medicare cap exposure. These initiatives include restructuring our sales management, increasing the size of our sales force, accelerating the development of new programs and seeking shorter length of stay patients by targeting our marketing efforts on hospital referral sources. These initiatives, the implementation of which in some cases was delayed, have increased patient care and general and administrative expenses and impacted our bottom line. We incurred a net loss of $1.8 million for the quarter ended June 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:

	•		estimated payment denials (excluding payment denials related to Medicaid reimbursements for nursing home room and board charges) and contractual adjustments;
	•		amounts we estimate we could be required to repay to Medicare, such as amounts that we would be required to repay if any of our programs exceed the annual per-beneficiary cap, as described below under “Critical Accounting Policies and Significant Estimates — Potential Adjustments to Net Patient Revenue for Exceeding the Medicare Per-Beneficiary Cap”;
	•		patients who do not have insurance coverage and who are deemed financially in need of charity care; and
	•		subsequent changes to initial level of care determinations.

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

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

     Our average length of stay was approximately 114 days and our median length of stay was 33 days for the three months ended June 30, 2004, which we believe significantly exceed the industry averages. We attribute our ability to exceed the industry averages in terms of average and medium length of stay to several factors. First, by hospice industry standards, we have a relatively high percentage of non-cancer patients, who have a higher average length of stay than cancer patients. Second, we believe that our open access philosophy and our efforts to educate referral sources about hospice care encourages earlier transfers of patients to hospice care. Finally, a significant

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amount of our growth in recent periods has been in rural markets where access to intensive care hospitals or other alternative sites for hospice-eligible patients is more difficult.

     The table below sets forth the percentage of our net patient revenue for the three- and six-month periods ended June 30, 2004 and 2003 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. 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: