##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549




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Form 10-K

|           |  |                                                                                             
|---------- |  | --------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                             
|þ          |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934    
|          
|           |  | For the fiscal year ended December 31,
    2003                                             
|or        
|          
|o          |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR
    15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|          
|           |  | For the transition period
    from           to                                             

Commission file number 000-33267



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Odyssey HealthCare, Inc.

(Exact name of registrant as specified in its
charter)


|                                                                                         |  |                                     
|---------------------------------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                                                 |  | 43-1723043                          
|(State or other jurisdiction of
    incorporation or organization)                       |  | (IRS Employer Identification Number)
|                                                                                        
|717 N. Harwood, Suite 1500
    Dallas, Texas(Address of principal executive
    offices) |  | 75201(Zip Code)                     

(214) 922-9711

(Registrants telephone number, including
area code)


Securities registered pursuant to
Section 12(b) of the Act:

None


Securities registered pursuant to
Section 12(g) of the Act:

Common Stock, par value $.001 per
share


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 be the best of the registrants knowledge, in
definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendments
to this
Form 10-K.     o

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

At June 30,
2003, there were 35,881,230 shares of the registrants
Common Stock outstanding. As of the same date, 33,511,193 shares
of the Registrants Common Stock were held by
non-affiliates of the registrant, having an aggregate market
value of $826.7 million (based on the last sale price of a
share of Common Stock on June 30, 2003 ($24.67), as
reported on the Nasdaq National Market).

At March 2,
2004, there were 36,549,142 shares of the registrants
Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrants Proxy Statement
to be furnished to stockholders in connection with the
registrants 2004 Annual Meeting of Stockholders are
incorporated by reference in Part III of this Form 10-K.



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FORM 10-K

ODYSSEY HEALTHCARE, INC.

For the Year Ended December 31,
2003


TABLE OF CONTENTS

|                                         |  |                                                                                                        |    |  |    |  |  | 
|---------------------------------------- |  | ------------------------------------------------------------------------------------------------------ | -- |  | -- |  |  | 
|PART I                                  
|Item 1.                                  |  | Business                                                                                               |    |  | 2  | 
|Item 2.                                  |  | Properties                                                                                             |    |  | 32 | 
|Item 3.                                  |  | Legal Proceedings                                                                                      |    |  | 32 | 
|Item 4.                                  |  | Submission of Matters to a
    Vote of Security Holders                                                |    |  | 32 | 
|PART II                                 
|Item 5.                                  |  | Market for Registrants
    Common Equity and Related Stockholder Matters                              |    |  | 33 | 
|Item 6.                                  |  | Selected Financial Data                                                                                |    |  | 34 | 
|Item 7.                                  |  | Managements Discussion
    and Analysis of Financial Condition and Results of Operations              |    |  | 36 | 
|Item 7A.                                 |  | Quantitative and Qualitative
    Disclosures About Market Risk                                         |    |  | 48 | 
|Item 8.                                  |  | Financial Statements and
    Supplementary Data                                                        |    |  | 49 | 
|Item 9.                                  |  | Changes in and Disagreements
    With Accountants On Accounting and Financial Disclosure               |    |  | 49 | 
|Item 9A.                                 |  | Controls and Procedures                                                                                |    |  | 49 | 
|PART III                                
|Item 10.                                 |  | Directors and Executive
    Officers of the Registrant                                                 |    |  | 49 | 
|Item 11.                                 |  | Executive Compensation                                                                                 |    |  | 49 | 
|Item 12.                                 |  | Security Ownership of
    Certain Beneficial Owners and Management and Related Stockholder
    Matters |    |  | 49 | 
|Item 13.                                 |  | Certain Relationships and
    Related Transactions                                                     |    |  | 49 | 
|Item 14.                                 |  | Principal Accountant Fees
    and Services                                                             |    |  | 50 | 
|PART IV                                 
|Item 15.                                 |  | Exhibits, Financial
    Statement Schedules and Reports on Form 8-K                                    |    |  | 50 | 
|Signatures                               |  |                                                                                                        | 53 | 
|Subsidiaries                            
|Consent of Ernst & Young LLP            
|Certification of Chief Executive Officer
|Certification of Chief Financial Officer
|Certification Required by Rule 13a-14(a)



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FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K includes
forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 (as amended, the
Securities Act) and Section 21E of the
Securities Exchange Act of 1934 (as amended, the Exchange
Act). All statements other than statements of historical
facts contained in this report, including statements regarding
our future financial position, business strategy and plans and
objectives of management for future operations, are
forward-looking statements. The words believe,
may, will, estimate,
continue, anticipate,
intend, expect and similar expressions,
as they relate to us, are intended to identify forward-looking
statements. We have based these forward-looking statements
largely on our current expectations and projections about future
events and financial trends that we believe may affect our
financial condition, results of operations, business strategy
and financial needs. These forward-looking statements are
subject to a number of known and unknown risks, uncertainties
and assumptions described in Item 1. Business
of this Annual Report on Form 10-K, including, among other
things:



| |   |                                                                                                                  
| | - | -----------------------------------------------------------------------------------------------------------------
| |  | our dependence on revenue from the Medicare and
    Medicaid programs;                                           
|
| |  | our dependence on patient referrals;                                                                             
|
| |  | our ability to develop hospice programs in new
    markets or increase census in markets that we currently serve;
|
| |  | the effect of changes in healthcare licensure,
    regulation and payment methods;                               
|
| |  | our ability to identify suitable hospices to
    acquire on favorable terms;                                     
|
| |  | our ability to integrate effectively the
    operations of acquired hospices;                                    
|
| |  | our ability to attract and retain key personnel
    and skilled employees;                                       
|
| |  | the effect of reductions in, or cap on, amounts
    paid to us by the Medicare and Medicaid programs;            
|
| |  | the effect of rising prices on labor, pharmacy,
    durable medical equipment and medical supplies;              
|
| |  | our ability to control costs; and                                                                                
|
| |  | our ability to obtain additional capital to
    finance growth.                                                  

In light of these risks, uncertainties and
assumptions, the forward-looking events and circumstances
discussed in this Annual Report on Form 10-K may not occur
and actual results could differ materially from those
anticipated or implied in the forward-looking statements. Many
of these factors are beyond our ability to control or predict.
Given these uncertainties, readers are cautioned not to place
undue reliance on such forward-looking statements, which reflect
managements views only as of the date hereof. We undertake
no obligation to revise or update any of the forward-looking
statements or publicly announce any updates or revisions to any
of the forward-looking statements contained herein to reflect
any change in our expectations with regard thereto or any change
in events, conditions, circumstances or assumptions underlying
such statements.




PART I




Item 1.     Business

Overview

We are one of the largest providers of hospice
care in the United States in terms of both average daily census
and number of providers. As a hospice care provider, our goal is
to improve the quality of life of terminally ill patients and
their families. We believe that our overriding focus on the
delivery of quality, responsive service differentiates us from
other hospice care providers.

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We have grown rapidly since we opened our first
hospice provider location in January 1996. Through a series of
acquisitions and the development of new hospices, we now have 68
Medicare-certified hospice programs to serve patients and their
families in 29 states. During January 2004, our average daily
census was 7,007 patients, which represents a 36.1% increase
over our average daily census in January 2003 of 5,150 patients.
Our net patient service revenue increased from $1.0 million
in 1996 to $274.3 million in 2003. Our net patient service
revenue of $274.3 million for 2003 represents an increase
of 41.1% over our net patient service revenue of
$194.5 million for 2002. We intend to continue our growth
through internal growth, the development of new hospice programs
and a disciplined strategy of acquisitions. Financial
information about our segments is contained in
Item 8. Financial Statements and Supplementary
Data  Note 15 of this Annual Report on
Form 10-K.

We were incorporated in Delaware in August 1995
and began operations in January 1996. Our executive offices are
located at 717 N. Harwood, Suite 1500, Dallas, Texas 75201
and our telephone number is (214) 922-9711.

Hospice Care

The first hospice in the United States opened in
1974. In 1982, Congress enacted legislation creating the
Medicare hospice program. Hospice care became a covered benefit
under the Medicare program in 1983, separate and distinct from
home health care and nursing home care. Unlike home health care,
which focuses on the curative treatment of patients, hospice
care focuses primarily on improving the quality of life of
terminally ill patients and their families.

A central concept of hospice care involves the
creation of an interdisciplinary team that provides
comprehensive management of the healthcare services and products
needed by hospice patients and their families. An
interdisciplinary team is typically comprised of:



| |   |                                          
| | - | -----------------------------------------
| |  | a physician;                             
|
| |  | a patient care manager;                  
|
| |  | one or more registered nurses;           
|
| |  | one or more certified home health aides; 
|
| |  | a medical social worker;                 
|
| |  | a chaplain;                              
|
| |  | a homemaker; and                         
|
| |  | one or more specially trained volunteers.

We assign each of our hospice patients to an
interdisciplinary team, which assesses the clinical,
psychosocial and spiritual needs of the patient and his or her
family, develops a plan of care, and delivers, monitors and
coordinates that plan with the goal of providing appropriate
care for the patient and his or her family. This
interdisciplinary team approach offers significant benefits to
hospice patients, their families and payors including:



| |   |                                                                                      
| | - | -------------------------------------------------------------------------------------
| |  | the provision of coordinated care and treatment;                                     
|
| |  | clear accountability for clinical outcomes and
    cost of services; and             
|
| |  | the potential reduction of stress and dysfunction
    of patients and their families.

In contrast, the treatment of terminally ill
patients outside the hospice setting often results in the
patient receiving medical services from physicians, hospitals,
home health agencies, skilled nursing facilities, home infusion
therapy companies and/or pharmacies, with little or no effective
coordination among the providers. This lack of coordination
often results in a lack of clear accountability for clinical
outcomes and the cost of services provided. In addition, the
provision of services in this uncoordinated fashion may cause
additional stress and dysfunction to patients and their families
and result in higher costs.

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Medicare-certified hospice providers are
primarily compensated on a per diem basis based on the level of
care provided to an individual patient and must provide the
following four distinct levels of care:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Routine Home Care.Routine home care is hospice care
    provided to patients and their families at home or in a
    long-term care facility where the patient resides. Routine home
    care involves regular visits by members of the interdisciplinary
    team. Routine home care is the largest component of services
    provided by hospice care providers.                                                                                               
|
| |  | General Inpatient Care.General inpatient care is provided in
    instances where short-term inpatient care is required for pain
    control or symptom management that cannot feasibly be provided
    in other settings. These services are provided in either a
    free-standing inpatient facility, a hospital or a specially
    equipped and staffed long-term care facility.                                                                             
|
| |  | Continuous Home Care.Continuous home care is provided
    during periods of crisis when a patient requires constant care,
    primarily nursing care, to achieve palliation or management of
    acute medical symptoms. To qualify for Medicare continuous home
    care payments, the care must be provided for a minimum of eight
    hours during a 24-hour day and nursing care must account for
    fifty percent of the care provided during the periods.
|
| |  | Respite Care.Respite care is short-term inpatient
    care provided to a patient only when necessary to relieve the
    patients family or other caregiver from the demands of
    providing care and support to hospice patients in their homes.
    These services are provided in inpatient facilities similar to
    those used to provide general inpatient care.                                                                                         

For a complete description of our hospice
services, see  Our Hospice Services.

The Hospice Industry and Market
Opportunity

The Hospice
Industry

Medicare, the largest payor for hospice services,
pays hospice providers fixed daily or hourly amounts based on
one of the four levels of care provided to hospice patients and
their families. In addition to Medicare, hospice care is covered
by Medicaid in 43 states and the District of Columbia and
by most private insurance plans.

According to the Centers for Medicare and
Medicaid Services (CMS), Medicare payments for
hospice services increased from approximately $118 million in
1988 to approximately $4 billion in 2003. According to the
United States General Accounting Office (GAO) and
CMS, the number of Medicare beneficiaries electing hospice care
increased over 300% between 1992 and 2001. We believe that these
significant increases are due in large part to increasing public
awareness and acceptance of hospice care and the benefits
hospice provides to patients, their families and payors. Despite
the rapid growth of the Medicare hospice program, hospice
services represented less than three percent of total Medicare
spending in 2003.

In the past decade, the number of hospice
providers and beneficiaries in the United States has increased
significantly. According to the GAO and CMS, the number of
Medicare beneficiaries who elected hospice care increased from
approximately 143,000 in 1992 to approximately 594,000 in 2001.
To meet this growing demand, the number of Medicare-certified
hospice programs also increased from approximately 1,208 in 1992
to 2,275 in 2002.

As the hospice industry has grown significantly,
the types of medical conditions of patients who have chosen
hospice care have broadened. In 1992, according to the GAO,
75.6% of the Medicare beneficiaries electing hospice care had
conditions related to cancer. In 2001, the percentage of
Medicare beneficiaries electing hospice care who had conditions
related to cancer declined to 53.6%. According to the GAO, from
1992 to 1998, hospice enrollment by Medicare beneficiaries with
cancer increased 90.5%, while enrollment by beneficiaries with
all other conditions increased 338.0%. Our total admissions for
2003 increased 420.2% over our total admissions for 1998, with
cancer admissions and non-cancer admissions representing 32.4%
and 67.6%, respectively, of total growth. In 1998, our cancer
admissions and non-cancer admissions represented 45.0% and
55.0%, respectively, of all admissions. In 2003, cancer
admissions decreased to 34.8% of all admissions and non-cancer
admissions increased to 65.2% of all admissions. We believe that
the increasing

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diversity of the medical conditions of the
hospice patient population represents a growing acceptance and
understanding of hospice care by the general public and
healthcare practitioners. We believe that the trend in
increasing diversity of the medical conditions of the hospice
patient population is continuing.


The hospice industry has experienced an increase
in the average lengths of stay over the past several years.
According to the National Hospice and Palliative Care
Organization, the average hospice length of stay increased from
48 days in 1999 to 51 days in 2002. Our average
hospice length of stay has increased from 65 days in 2002
to 74 days in 2003. Decisions about whether and when to use
hospice care depend on physician preferences and practices,
patient choice and diagnosis, and public and professional
awareness of the Medicare hospice benefit. To increase awareness
of hospice, CMS sent a letter to all Medicare-certified hospices
in September 2000, and advertised in physician publications in
2002, reaffirming that Medicare hospice beneficiaries are not
limited to six months of coverage and that there is no limit on
how long a Medicare beneficiary can receive hospice benefits and
services, provided that the beneficiary continues to meet the
eligibility criteria under the Medicare hospice program. See
 Government Regulation  Overview of
Government Payments.

Market
Opportunity

We believe that a number of factors will drive
growth in the hospice industry. We believe that we are well
positioned to take advantage of these growth opportunities:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Aging Population in the United States.Over 85% of our patients are age 65
    and over. According to the 2000 census conducted by the United
    States Census Bureau, an estimated 35.0 million persons, or
    approximately 12.4% of the total United States population, were
    age 65 and over. The United States Census Bureau projects that
    the population of persons age 65 and over will rise to an
    estimated 53.7 million persons, or approximately 16.5% of
    the total United States population, by the year 2020.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| |  | Underserved Hospice Market.In 2001, approximately
    2.4 million persons died in the United States. Of these,
    approximately 1.9 million were age 65 and over. According
    to the National Hospice and Palliative Care Organization, only
    approximately 32% of those who died in 2001 received hospice
    care. We believe that a significant percentage of Medicare
    beneficiaries who do not receive hospice services would be
    appropriate for hospice care. Approximately 45% of our hospice
    patients resided in nursing homes and other long-term care
    facilities in December 31, 2002 and 2003. According to an
    article published in the Journal of the American Medical
    Association, nearly half of all persons in the United States who
    live to age 65 will enter a nursing home before they die. Many
    nursing home patients have medical conditions that may make them
    appropriate for hospice care. However, only an estimated one
    percent of the nursing home population enrolls in hospice care.
    We believe that the relatively low level of hospice care
    penetration and the growing population of persons age 65 and
    over demonstrate that the market for hospice care services is
    substantially underserved.
|
| |  | Cost Savings of Hospice Care to the Medicare
    Program.According to CMS, Medicare
    beneficiaries incur an estimated 28% of all Medicare costs in
    their last year of life, with an estimated 50% of that total
    incurred in the last two months of life. Studies have
    demonstrated that hospice care generates significant savings to
    the Medicare program. These Medicare savings are generated
    because patients are typically treated in their residence
    throughout their illness without the need for treatment in
    expensive acute care facilities. We believe that the cost
    savings related to hospice care, combined with the projected
    substantial increase in Medicare beneficiaries, further enhance
    the potential growth of the hospice industry.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| |  | Fragmented Hospice Market.Although there are several large
    national and regional hospice providers, we believe the hospice
    industry remains highly fragmented, consisting of approximately
    2,300 Medicare-certified hospice programs throughout the
    country, most of which are small- and medium-sized providers.
    According to the GAO, in 1999 approximately 56.7% and 37.2% of
    the Medicare-certified hospices were small- and medium-sized
    providers, respectively. In its study, the GAO included all
    Medicare-certified hospice providers with less than 100 patient
    admissions in 1999 as small providers and included all
    Medicare-certified hospice providers with at least 100, but less
    than                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | 500, patient admissions in 1999 as medium-sized
    providers. We believe that the fragmentation of the hospice
    industry provides significant opportunities for consolidation in
    the hospice industry.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| |  | Increasing Public Awareness and Acceptance of
    Hospice Care.Between 1992 and 2001
    the number of Medicare beneficiaries electing hospice care
    increased over 300% and the diversification of medical
    conditions of patients electing hospice care also increased
    significantly. Public and professional awareness and acceptance
    of hospice care significantly influences the use of hospice
    care. The need for greater public and professional understanding
    of options for end-of-life care, including hospice, has been
    highlighted in Congressional hearings and other public forums
    and by medical societies, patient advocacy groups and the
    hospice industry. We believe that public awareness and
    acceptance of hospice care is increasing and is likely to
    continue to increase in the future.

Our Competitive Advantages

We have grown rapidly and achieved profitability
as a result of the following competitive advantages:

We are one of
the largest providers of hospice care

We are one of the largest providers of hospice
care in the United States in terms of both average daily census
and number of providers. Our average daily census for January
2004 was 7,007 patients, and we currently have 68 hospice
providers to serve patients and their families in 29 states. We
believe that our size provides us with numerous operating
advantages over small hospices, which make up most of the
hospice industry, including:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Professionally Trained Community Education
    Team.We employ a professionally
    trained team of approximately 200 community education
    representatives who regularly educate new and existing patient
    referral sources about the benefits of hospice care and the
    services that we provide. Our team of community education
    representatives has enabled us to develop a significant base of
    patient referral sources in our markets. Unlike most hospice
    care providers, we have the resources to maintain this dedicated
    community education staff.                                                                                                                                                                                                                                                                                                                                            
|
| |  | Comprehensive Compliance and Continuous
    Quality Improvement Programs.We have
    developed, implemented and maintain comprehensive compliance and
    continuous quality improvement programs as part of our provision
    of centralized corporate services to our 68 hospice providers.
    We believe this provides a competitive advantage because it
    facilitates the delivery of consistent and quality service to
    our patients and their families, allows us dedicated staffing to
    oversee our hospice programs for compliance purposes which
    facilitates ongoing growth, and ensures that our clinical
    employees are well trained. For a more detailed discussion of
    our compliance and continuous quality improvement programs, see
     Compliance and Continuous Quality Improvement
    Programs.                                                                                   
|
| |  | Active Cost Management and Centralized
    Corporate Services.We actively manage
    and monitor several indicators to track performance across our
    multiple hospice programs, which enables us to develop best
    practices, improve efficiencies and manage costs. In addition,
    we have centralized many of our administrative functions,
    thereby enabling us to spread administrative costs over our
    multiple hospice programs. We also believe that our size and
    local market presence allow us to negotiate more favorable
    purchasing arrangements with suppliers of drugs, durable medical
    equipment and disposable medical supplies. We have successfully
    negotiated local purchasing contracts that provide for discounts
    and in some instances per diem arrangements for drugs and
    durable medical equipment, rather than the more typical
    fee-for-service arrangements.



| |                                                                            
| | ---------------------------------------------------------------------------
| | We are a responsive, comprehensive provider
    of quality hospice services

We focus on the prompt and efficient delivery of
services to our patients and their families by adhering to our
14 service standards, which stress:



| |   |                                                                                                
| | - | -----------------------------------------------------------------------------------------------
| |  | patient admissions within three hours after
    receiving a physicians order for hospice care;
|
| |  | daily contact with our patients and their
    families to assess their needs;                  

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| |   |                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------
| |  | prompt, responsive and comprehensive service for
    our patients and their families at all times; and
|
| |  | satisfaction of individualized patient and family
    needs.                                          

We believe that our ability to consistently
provide responsive, quality service to our patients and their
families has been a key factor in our ability to increase
patient referrals. We also believe that our commitment to
provide comprehensive hospice care is an important factor in
increasing patient referrals.



| |                                                                                             
| | --------------------------------------------------------------------------------------------
| | We have a proven track record in growing
    our business through a balanced growth strategy

We have grown rapidly through internal growth,
development of new hospice programs and a focused strategy of
acquisitions. Since we began our operations, our net patient
service revenue has increased from $1.0 million in 1996 to
$274.3 million in 2003. We reported net income of
$21.1 million and $31.2 million in 2002 and 2003,
respectively.

We have developed over 20 new hospice
programs since we began operations, and we are currently
developing seven additional programs. When developing a new
hospice program, we utilize our standardized operating model
that includes daily cost management and community education
programs to increase patient referrals. Applying our
standardized development approach, on average, we have reached
breakeven, as measured by income, excluding corporate overhead
allocations, at our new programs within approximately
13 months from the date we began development.

We have acquired over 50 hospice programs since
beginning our operations in 1996, including our recent
acquisition in the first quarter of 2004 of hospice programs in
Amarillo and Conroe, Texas. Nine of these programs were combined
with other programs and one program was subsequently closed. We
have successfully integrated our acquired hospice programs into
our operations by implementing our standardized operating model
that focuses on providing outstanding care, minimizing costs and
growing patient census.

We have successfully increased our patient
referrals in substantially all of the markets in which we
operate by providing responsive, quality service and utilizing
our community education representatives to establish and develop
referral sources.

We have a
standardized and efficient operating model

We operate in a fixed payment environment, with
primarily per diem payments, based on the level of care that we
provide to our patients and their families. Accordingly,
controlling our costs is essential to maintaining our
profitability.

We actively manage and monitor several day-to-day
indicators, including admissions, discharges by type of
discharge and admission conversions on a daily basis. We also
track on a regular basis various key measures of our costs per
day of care, including costs of labor, medication, durable
medical equipment, medical supplies and mileage expense incurred
by our caregivers. These measurement tools assist us in tracking
the performance of our business and efficiently providing
quality, responsive care to our patients and their families. We
believe that most hospice providers do not have the resources to
implement systems to effectively monitor and manage the cost of
providing hospice care.

Each of our hospice programs is supported by our
corporate office in Dallas, Texas, which provides coordination,
centralized resources and corporate services to each of our
hospice programs. The support services that our corporate office
provides allows us to reduce our administrative overhead and
should allow us to gain additional operating efficiencies as we
grow.

We can apply our standardized operating model at
programs which are acquired in approximately 90-180 days.
We apply our standardized operating model from the inception of
the start-up program.

We have an
experienced management team

Our ability to grow profitably, deliver quality
services and implement our operating model is due, in large
part, to our senior management team. Our top seven executive
officers have significant experience in the

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hospice and healthcare industries. Our senior
management team operates as a cohesive, complementary group,
reflecting extensive marketing experience, as well as operating
knowledge and understanding of the regulatory environment in
which we operate. We believe that our management team
differentiates us from small hospice providers, which generally
lack the resources to attract and maintain an experienced
management team.


Our Business Strategy

Our goal is to become the leading provider of
hospice care in the United States. To achieve this goal, we have
adopted the following strategies:



| |                                                                                    
| | -----------------------------------------------------------------------------------
| | Provide high quality hospice service to
    patients, families and referral sources

The most important aspect of our business is our
commitment to deliver high quality hospice service to all of our
constituencies. Those constituencies and the services we provide
include the following:

Patients and their families.Our interdisciplinary team, comprised
of a physician, nurse, home health aide, social worker, and
chaplain, seeks to improve the quality of life of terminally ill
patients and their families by providing care directed at
managing pain and other discomforting symptoms and addressing
the psychosocial and spiritual needs of patients and their
families. Care-giving services; drugs; durable medical
equipment, such as hospital beds and wheelchairs; and medical
supplies associated with the terminal illness are provided at no
cost to the patient under the Medicare benefit. In addition,
trained volunteers, managed and supervised by our staff, assist
the patient with non-medical projects or errands and provide
relief for family caregivers.

Medical community.We work with others in the medical
community in ways that best meet their needs. For example,
various physicians, hospitals and long-term care facilities
prefer differing methods of communicating with hospice
providers, tracking their patients conditions, or
coordinating their continued involvement with the patient. We
seek to accommodate the needs of those we work with in the
community.

Fundamental to the care we provide is a set of 14
service standards, which we believe, sets us apart from other
hospice providers. We regularly monitor and measure the
satisfaction level of the families whose loved ones we serve to
help identify service issues we may have.

In addition, we are also committed to complying
fully with all applicable Medicare and Medicaid rules and
regulations. When our hospice programs are caring for
approximately 60 patients, a fulltime nurse dedicated to
compliance is hired for the program. In addition, our Clinical
and Regulatory Affairs Department, staffed with fulltime nurses,
actively audits and monitors our hospice programs and conducts
training on a regular basis.

We believe that our reputation for consistently
delivering our quality, responsive services to our patients and
their families will continue to contribute to our admissions and
patient census trends.

Actively seek
to increase patient referrals

We actively seek to increase patient referrals at
all hospice programs by both increasing patient referrals from
existing referral sources and establishing new referral sources.
Our referrals originate from:



| |   |                                                                                                           
| | - | ----------------------------------------------------------------------------------------------------------
| |  | physicians;                                                                                               
|
| |  | long-term care facilities, including nursing
    homes, assisted living facilities and adult care centers;
|
| |  | hospitals;                                                                                                
|
| |  | managed care companies; and                                                                               
|
| |  | insurance companies.                                                                                      

In each of our markets, we have implemented a
community education plan designed to address the specific needs
of the patient referral sources in that market and to promote
the quality, responsive and comprehensive service we provide to
our patients and their families. We utilize two or more dedicated

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community education representatives in each of
our markets and currently employ approximately 200 community
education representatives company-wide. Each community education
representative seeks to develop relationships with patient
referral sources located in the community education
representatives territory by regularly calling on these
referral sources and educating groups of physicians, social
workers, nurses and nursing home personnel regarding hospice
care, generally, and our services, specifically. As part of a
community education representatives ongoing contact with a
patient referral source, the community education representative
assists the referral source in identifying patients who are
appropriate for hospice care and provides periodic information
on a referred patients status.


At each of our hospice programs, our general
manager, patient care manager and community education
representatives coordinate their efforts to obtain contracts
with nursing homes, managed care companies and insurance
companies. In addition, in many of the markets we serve, we
conduct local public relations campaigns that promote hospice
care. We also actively participate in community-related projects
to increase public awareness of hospice care.

We believe that our education efforts, combined
with our quality, responsive and comprehensive service, will
enable us to continue to increase patient referrals.

Expand our
business in new and existing markets

We intend to expand our business by continuing to
grow our existing hospice programs and by actively pursuing the
development of hospice programs in new markets throughout the
United States. After we identify a market in which to develop a
new hospice program, we utilize our standardized development
approach, beginning with the identification and recruitment of a
general manager who is familiar with the local market, the
hiring of other key personnel and the leasing of office space.
We then begin training key personnel and preparing for the
initial Medicare survey. During this phase, we also hire two or
more community education representatives to allow time for
extensive training and the development of relationships in the
community. This approach has been successful in increasing
patient census in our new hospice programs. We also begin
establishing contractual arrangements with local suppliers,
nursing homes, assisted living facilities, adult care centers
and managed care companies. During the next phase of the
start-up model, which generally occurs during the third month of
the development of a new hospice program, we seek to admit our
first patients, at which time we request the Medicare survey.
After we complete the initial Medicare survey and become
certified, we aggressively expand community education and
admissions activities and begin billing for our services.



| |                                                                                            
| | -------------------------------------------------------------------------------------------
| | Expand our business in new and existing
    markets by selectively acquiring other hospices

We intend to expand our business by actively
pursuing strategic acquisitions of other hospices in new and
existing markets throughout the United States. We believe that
significant opportunities exist for growth through acquisitions
of hospices. The hospice industry consists of approximately
2,300 Medicare-certified hospice programs, most of which
are operated by small- and medium-sized providers. The current
healthcare environment presents these providers with several
challenges, such as changing regulatory requirements and
increasing cost pressures. We believe that the fragmented nature
of the hospice industry, combined with these other factors,
provides us with significant opportunities to grow our business
through acquisitions. To take advantage of acquisition
opportunities, we have developed a focused acquisition program
that is overseen and coordinated by our director of mergers and
acquisitions.

Before completing an acquisition, we actively
seek to retain employees of the acquired hospice by emphasizing
our compensation and benefits programs, our corporate philosophy
and their future responsibilities with us. After we acquire a
hospice, we:



| |   |                                                                                                                                                        
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | continue to seek to retain employees and maintain
    the existing patient referral base of the hospice;                                               
|
| |  | improve operations by implementing our efficient
    operating model and service standards at the hospice;                                             
|
| |  | implement our community education program to
    increase patient referrals by, among other things, hiring
    community education representatives; and

9



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| |   |                                                                                                                             
| | - | ----------------------------------------------------------------------------------------------------------------------------
| |  | conduct extensive education and clinical
    training, including customer service and quality assurance, at
    the hospice.

Actively
manage patient care costs

Because we operate in a fixed payment
environment, paid primarily on a per diem basis by
Medicare, controlling costs is critical to our profitability. We
allocate our resources to patients and their families according
to their changing needs, as determined by our patients and their
families and physicians in consultation with an
interdisciplinary team, rather than providing all services at
all times. Along a patients care continuum, the patient
and his or her family may have greater psychosocial and
spiritual needs initially and later have greater medical needs.

Our Hospice Services

When a patient is referred to us, one of our
admissions coordinators contacts the referral source to obtain
the necessary patient information and physician approvals. We
then contact the patient and his or her family to explain our
hospice program and the services we provide in greater detail
and obtain all necessary patient and family consents and forms.
In order to qualify for the Medicare hospice benefit, the
patients treating physician and our medical director must
certify that the patient has less than six months to live if the
disease runs its normal course in the best judgment of the
physician or medical director. In addition, the patient must
certify that he or she understands the nature of the illness and
of hospice care. By signing the certification statement, the
patient surrenders any rights to other Medicare benefits related
to the patients terminal illness while receiving hospice
care. The patient retains access to Medicare benefits for
conditions not related to the terminal illness. After these
admission requirements are met, a full nursing assessment is
performed by one of our nurses, and we assign the patient to an
interdisciplinary team that assumes responsibility for
developing and delivering the patients plan of care.

In keeping with the hospice concept, we provide
intensive treatment of the physical and emotional pain and
symptoms associated with terminally ill patients. This
palliative care focuses primarily on enhancing a patients
comfort and overall quality of life and is generally provided in
the patients home, a nursing home or a hospital. Our
services are available 24 hours a day, seven days a week and
include, among others:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Nursing Care.Registered nurses coordinate the care
    for every patient, provide direct patient care and check
    symptoms and medications.                                                                                                                                                                                                                                                                                           
|
| |  | Home Care Aide and Homemaker Services.Home care aides provide personal care
    to patients, such as bathing, feeding and dressing. Homemaker
    services include light housekeeping and assistance with daily
    living.                                                                                                                                                                                                             
|
| |  | Spiritual Support and Counseling.Clergy and other counselors provide
    spiritual support and counseling to patients and their families.                                                                                                                                                                                                                                                                                               
|
| |  | Medical Social Services.Social workers provide advice and
    counseling to patients and their families.                                                                                                                                                                                                                                                                                                                                
|
| |  | Physical, Occupational and Speech Therapy
    Services.Professional therapists
    provide therapy to patients to assist them in remaining
    independent.                                                                                                                                                                                                                                                                             
|
| |  | Medications, Equipment and Supplies.We provide drugs, equipment and
    supplies related to the terminal illness to patients to treat
    physical pain and symptoms and to enable patients to receive
    hospice care where they reside.                                                                                                                                                                                              
|
| |  | Continuous Home Care.During periods of crisis, we provide
    continuous home care for our patients and their families. This
    care is predominantly nursing care and is provided in increments
    of at least eight hours in a 24-hour period. We provide
    continuous care when, because of the need for pain and symptom
    management, constant monitoring and support are required, but
    inpatient care is not yet needed.

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| |   |                                                                                                                                                                                                                                                           
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Respite Care.We
    provide or arrange for short-term care to patients in inpatient
    facilities to provide temporary relief to family members caring
    for the hospice patient.                                                                      
|
| |  | Hospice Inpatient Care.We provide or arrange for short-term
    hospice inpatient care when adequate care is not feasible in the
    patients home due to the patients condition.                                                                       
|
| |  | Volunteer Services and Support.Trained volunteers assist with
    everyday tasks, such as shopping, and provide support and
    companionship, short-term relief for the primary caregivers,
    personal care services and certain professional services.
|
| |  | Financial Counseling.We provide financial counseling to
    hospice patients and their families to assist them in handling
    the financial issues associated with a terminal illness.                                                                   
|
| |  | Bereavement Care and Counseling.We provide, at our cost, counseling
    services to family members for a period of up to one year
    following the patients death.                                                                                      

We often provide hospice care to patients
residing in nursing homes, assisted living facilities and other
similar long-term care facilities, treating the facility
essentially as the patients home. We have entered into
agreements with these facilities to render hospice care to
patients residing in these facilities. During 2002 and 2003,
approximately 44.7% and 43.5%, respectively, of our days of care
were attributable to patients who resided in long-term care
facilities. See Note 1 to our consolidated financial
statements included elsewhere in this Annual Report on
Form 10-K.

We provide or arrange for inpatient and respite
care and services primarily in long-term care facilities and
hospitals under contractual relationships. However, in four
communities we operate small free-standing inpatient facilities
and in two communities, we lease space from a hospital to
provide inpatient care. Our interdisciplinary team remains
ultimately responsible for the patient and the quality of the
services provided to the patient.

Education

Our patient referral sources are physicians,
hospitals, nursing homes, assisted living facilities, adult care
centers, managed care companies and insurance companies. We have
a staff of approximately 200 dedicated community education
representatives who seek to develop relationships with patient
referral sources located in their respective markets by
regularly calling on these referral sources and educating groups
of physicians, social workers, nurses, and staff at nursing
homes and other long-term care facilities regarding hospice care
generally and our services specifically. As part of a community
education representatives ongoing contact with a patient
referral source, the community education representative assists
the referral source in identifying patients and families who are
appropriate for hospice care and provides periodic information
on referred patients conditions. In addition to our
community education representatives, our more than 2,000
caregivers who routinely have contact with our referral sources,
regularly assist our referral sources in identifying patients
who are appropriate for hospice care.

When we acquire a hospice, we hire additional
community education representatives as needed. In each start-up
program, we hire two or more community education representatives
prior to the planned opening in the community to allow time for
extensive training and the development of relationships in the
community.

We have also developed tailored education plans
to meet the specific needs of each of our patient referral
sources:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Physicians.Our
    community education representatives target a broad variety of
    physicians, including primary care physicians and specialists,
    who regularly see a high number of patients potentially eligible
    for hospice care. We have developed disease specific education
    materials that we provide to these physicians. We update each
    physician who refers a patient to us on the patients
    condition on a regular basis according to each physicians
    instructions. We actively involve the local physician community
    in assisting us in creating the type of hospice programs that
    best meet its needs as well as those of patients and their
    families.

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Hospitals.Our
    community education representatives call on physicians, patient
    discharge planners and social workers at hospitals. We utilize
    our disease specific education materials when educating the
    various hospital departments, including oncology and cardiology.
    We educate hospital staff on the benefits and cost advantages of
    hospice care over traditional inpatient care for those patients
    who are candidates for hospice care.                                                                                                                                                                                                                                                                            
|
| |  | Long-Term Care Facilities.We negotiate contracts with nursing
    homes and have arrangements with assisted living facilities and
    adult care centers to provide routine home care, inpatient care
    and respite care at these facilities. Our community education
    representatives regularly call on nurses, social workers,
    directors of nursing, administrators and other staff members at
    these facilities who are in a position to identify or refer
    hospice patients. In addition, our community education
    representatives conduct regular training programs for the staff
    of these facilities to educate them on hospice care and its
    benefits.                                                                 
|
| |  | Managed Care Companies and Insurance
    Companies.Our community education
    representatives regularly call on case managers for managed care
    companies and insurance companies to discuss the advantages of
    our hospice services. We regularly conduct training programs to
    educate case managers of the benefits of hospice care, including
    potential cost savings. Our general managers and community
    education representatives coordinate their efforts to obtain
    contracts with managed care companies and insurance companies.
    Because managed care companies and insurance companies often
    have special needs, we strive to meet their requirements by
    providing them with individualized patient reports.

In many of the markets that we serve, we also
conduct local public relations campaigns to promote hospice
awareness.

Centralized Operations and Information
Systems

Centralized
Operations

We have designed our organizational structure to
achieve a high level of patient and family satisfaction, provide
quality care, permit our hospice programs to continue to grow
and develop, and minimize overhead. Our corporate office in
Dallas, Texas, supports each of our hospice programs by
providing coordination, centralized resources and corporate
services to each of our hospice programs, including:



| |   |                                                                                                        
| | - | -------------------------------------------------------------------------------------------------------
| |  | financial accounting systems, including billing,
    accounts receivable, accounts payable and payroll;
|
| |  | information and telecommunications systems;                                                            
|
| |  | clinical support services;                                                                             
|
| |  | human resources administration;                                                                        
|
| |  | regulatory compliance and quality assurance;                                                           
|
| |  | marketing and educational materials; and                                                               
|
| |  | training and development.                                                                              

We process all billing electronically at our
corporate office. Our corporate office bills Medicare monthly
and generally receives payment electronically within fourteen
working days. Our corporate accounting personnel prepare monthly
operating statements for each of our hospice programs and review
these statements for operating trends and variance to budget
forecasts. We prepare annual operating budgets for each of our
hospice programs. We also provide centralized cash management
and accounts payable and payroll processing.

Information
Systems

We utilize multiple server-based systems with
laptop and desktop computers to connect all of our hospice
programs to one another electronically. Billings are handled
through a centralized server based system. Each local office
enters all initial patient registration information and updates
to the billing status through our intranet system. Our billing
system and the use of our intranet system have resulted in
greater accuracy and

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more rapid collections. We continue to seek ways
to implement relevant technology to enhance business processes,
thereby increasing efficiency. Through the use of our company
intranet site, we are facilitating communications and enhancing
standardization of all of our operations through publication and
dissemination of a standard vision and a consistent,
comprehensive direction. We have appointed a task force to
direct our compliance with proposed federal regulations
regarding the privacy and security of patient medical
information, and we have met all mandated deadlines. See
 Government Regulation.


Hospice Offices and Inpatient
Facilities

Below is a listing of our current hospice
programs by state and city.

Alabama

Birmingham


Mobile


Montgomery


Arizona


Phoenix (two inpatient facilities)(1)


Tucson (one inpatient facility)(1)


Arkansas


Little Rock


California


Bakersfield


West Covina(2)


Los Angeles (Culver City)


Orange County (Garden Grove)


Palm Springs


San Bernardino


San Diego


San Jose


Colorado


Colorado Springs


Denver


Delaware


Wilmington


Georgia


Athens (2)


Atlanta (one inpatient facility)(1)


Valdosta


Illinois


Chicago (Arlington Heights)


Chicago (South Chicago)


Indiana


Indianapolis


Kansas


Wichita


Louisiana


Baton Rouge


Lake Charles


New Orleans (Metairie)


Shreveport


Michigan


Detroit (Novi)


Mississippi


Gulfport


Jackson(2)


Missouri


Kansas City


St. Louis


Nebraska


Omaha


Nevada


Las Vegas (one inpatient facility)(1)


New Jersey


Edison


New Mexico


Albuquerque


Santa Fe


North Dakota


Fargo


Ohio


Cincinnati


Cleveland


Columbus


Toledo


Oklahoma


Oklahoma City


Tulsa


Oregon


Portland


Pennsylvania


Allentown(2)


Harrisburg(2)


Philadelphia


Pittsburgh


Rhode Island


Providence(2)


South Carolina


Charleston


Tennessee


Memphis


Nashville


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Texas


Amarillo (one inpatient facility)(1)


Austin


Baytown


Beaumont


Big Spring


Brownsville


Conroe


Dallas


El Paso


Fort Worth


Houston (Bellaire)


La Grange


Odessa


San Antonio


Temple


Waxahachie


Utah


Salt Lake City(3)


Virginia


Arlington(2)


Hampton Roads (Norfolk)


Richmond


Wisconsin


Milwaukee




---



|    |                                                                                                                                                                                                                                                                                                                                                              
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Each of our inpatient facilities has 11 beds,
    except for our facility in Las Vegas, Nevada, which has 22 beds
    and our facility in Amarillo, Texas, which has 7 beds.                                                                                                                                                                                 
|   
|(2) | We are currently developing new hospice programs
    in Arlington, Virginia; Athens, Georgia; West Covina,
    California; Allentown, Pennsylvania; Harrisburg, Pennsylvania;
    Jackson, Mississippi; and Providence, Rhode Island. We
    anticipate admitting our first hospice patients at most of these
    new programs by the fourth quarter of 2004.
|   
|(3) | Salt Lake City, Utah has two alternate delivery
    sites located in Ogden, Utah and St. George, Utah.                                                                                                                                                                                                                                                       

Government Regulation

General

The healthcare industry and our hospices are
subject to extensive federal and state regulation. Our hospice
programs are licensed as required under state law as either
hospices or home health agencies, or both, depending on the
regulatory requirements of each particular state. In addition,
our hospices are required to meet participation conditions to be
eligible to receive payments under the Medicare and Medicaid
programs. All of our hospice programs, other than the seven
programs currently in development, are certified for
participation in the Medicare program and are also eligible to
receive payments as hospices in the Medicaid programs of the
states in which we operate that offer a Medicaid hospice
benefit. Our hospices are subject to periodic survey by
governmental authorities to assure compliance with both state
licensing and certification requirements.

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 health insurance program
jointly funded by state and federal governments that provides
medical assistance to qualifying low-income persons. Each state
Medicaid program has the option to provide payment for hospice
services. Twenty-seven of the 29 states in which we
currently operate cover Medicaid hospice services; however, we
cannot assure that these states will continue to cover hospice
services or that states into which we expand our operations may
cover or continue to cover hospice services. We have not been
adversely affected by the absence of a Medicaid benefit in the
two states in which we currently operate that do not have a
Medicaid hospice benefit.

Medicare Conditions of Participation.The Medicare program requires each of
our hospice programs to satisfy prescribed conditions to be
eligible to receive payments, including the following:



| |   |                                                                                                                                                                                                                
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Governing Body.Each
    hospice program must have a governing body that is responsible
    for the overall operation of the hospice program and for
    ensuring that all services are consistent with accepted

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | standards of practice. The governing body must
    designate one individual who is responsible for the day-to-day
    administrative operations of the hospice program.                                                                                                                                                                                                                                                                                                                       
|
| |  | Medical Director.Each hospice program must have a
    medical director who is responsible for the medical component of
    patient care.                                                                                                                                                                                                                                                                                                                                                      
|
| |  | Professional Management.A hospice program may arrange for the
    provision of non-core services by another individual or entity.
    The hospice program must, however, retain professional
    management responsibility for arranged services and ensure that
    these services are furnished safely and effectively by qualified
    personnel in accordance with the patients plan of care.                                                                                            
|
| |  | Plan of Care.The
    patients attending physician, the medical director and the
    interdisciplinary team must establish a written plan of care
    prior to providing care to the patient.                                                                                                                                                                                                                                                                                                 
|
| |  | Continuation of Care.A hospice program cannot discontinue
    or reduce care provided to a Medicare beneficiary because of the
    beneficiarys inability to pay for that care.                                                                                                                                                                                                                                                                                                              
|
| |  | Informed Consent.The hospice program must obtain an
    informed consent form from either the hospice patient or a
    family member that specifies the type of care and services that
    may be provided as hospice care during the illness.                                                                                                                                                                                                                                                
|
| |  | In-Service Training.A hospice program must provide an
    ongoing training program for its employees.                                                                                                                                                                                                                                                                                                                                                                                         
|
| |  | Quality Assurance.A
    hospice program must provide an ongoing, comprehensive,
    integrated self-assessment of the quality and appropriateness of
    care. See  Compliance and Continuous Quality
    Improvement Programs.                                                                                                                                                                                                                                                            
|
| |  | Interdisciplinary Team.A hospice program must have an
    interdisciplinary team that establishes policies and supervises
    the provision of hospice care and services. The team must
    include at least a physician, registered nurse, social worker
    and pastoral or other counselor. All of the members of the team
    must be employees of the hospice program with the exception of
    the physician, who may be under contract with the hospice
    program.                   
|
| |  | Volunteers.Hospice
    programs must recruit and train volunteers to provide care and
    services under the supervision of hospice employees. These
    volunteers must provide administrative or direct patient care in
    an amount that, at a minimum, equals five percent of the total
    patient care hours provided by all paid hospice employees and
    contract staff.                                                                                                            
|
| |  | Licensure.Each
    hospice program and all hospice personnel must be licensed,
    certified or registered in accordance with applicable state laws
    and regulations.                                                                                                                                                                                                                                                                                                                      
|
| |  | Central Clinical Records.Hospice programs must maintain
    centralized clinical records for each hospice patient. The
    records must meet standards relating to content and protection.                                                                                                                                                                                                                                                                                                    
|
| |  | Furnishing Core Services.Substantially all core
    services must be provided directly by hospice employees.
    Core services include nursing, medical, social,
    physician and counseling services. The hospice program may use
    contracted staff to perform core services during periods of peak
    patient loads or under extraordinary circumstances, but the
    hospice program must maintain professional, financial and
    administrative responsibility for the services.

In addition to the above conditions of
participation, Medicare regulations also establish additional
conditions of participation related to the provision of other
hospice care services and supplies, including physical therapy,
occupational therapy, speech therapy, home health aide and
homemaker services, medical supplies, short-term inpatient care
and direct inpatient care. Each of our hospice programs, other
than our programs currently in development, is certified for
participation in the Medicare program and is eligible to receive
payment as a hospice in the Medicaid hospice program, if any, of
the state in which it operates. We anticipate that most of our
hospice programs under development will be Medicare certified
and Medicaid eligible by the fourth quarter of 2004. We believe
that we are in material compliance with all conditions of
participation for the Medicare program and all eligibility
requirements for the Medicaid program.

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Surveys and Audits.Each of our hospice programs is
subject to periodic survey by federal and state governmental
authorities to assure compliance with both state licensing and
certification requirements. From time to time, we receive survey
reports containing statements of deficiencies for alleged
failure to comply with the various regulatory requirements.
These survey reports and statements of deficiencies are common
in the healthcare industry. We review these reports, prepare
responses, and take appropriate corrective action, if required.
The reviewing agency is generally authorized to take various
adverse actions against a hospice program found to be in
non-compliance, including the imposition of fines or suspension
or revocation of a hospice programs license. If this
adverse action were taken against any of our hospice programs,
this action could materially adversely affect that hospice
programs ability to continue to operate and to participate
in the Medicare and Medicaid programs. This could materially
adversely affect our net patient service revenue and
profitability. None of our hospice programs has been suspended
at any time from participation in the Medicare or Medicaid
programs or had its state licensure suspended or revoked. We
believe that each of our hospice programs is in material
compliance with these licensing and certification requirements.

Certificate of Need Laws and Other
Restrictions.Many states have enacted
certificate of need laws that require state approval prior to
opening new healthcare facilities or expanding services at
existing healthcare facilities. Approval under the certificate
of need laws is generally conditioned on the showing of a
demonstrable need for services in the community. Certificate of
need laws in some states apply to hospice services. Many states
with certificate of need requirements permit the transfer of a
certificate of need from an existing provider to a new provider.
Our hospice programs in Tennessee and Arkansas are our only
hospice programs located in states that have a certificate of
need law in effect; however, in the future we may seek to
develop or acquire hospice programs in other states that may
have certificate of need laws. While several states have
abolished certificate of need laws, and other states do not
apply them to hospice services, these laws could affect our
ability to expand services at our existing hospice programs or
to make acquisitions or develop hospices in new or existing
geographic markets.

In addition, a few states have additional laws
that restrict the development and expansion of hospice programs.
For example, Florida does not permit the operation of a hospice
program by a for-profit corporation, except in limited
circumstances. Under Florida law, a for-profit hospice
incorporated on or before July 1, 1978 is exempt from the
restriction and may continue to operate as a for-profit hospice.
In addition, under Florida law an exempt hospice may transfer
its operations and license to another for-profit entity. Under
New York law, a hospice cannot be owned by a corporation that
has another corporation as a stockholder. These additional state
restrictions could affect our ability to expand into these
states and other jurisdictions with similar restrictions.

Overview of
Government Payments

Substantially all of our net patient service
revenue is attributable to payments received from the Medicare
and Medicaid programs. 97.5% and 97.0% of our net patient
service revenue for the years ended December 31, 2002 and
2003, respectively, were attributable to Medicare and Medicaid
payments. Payment from Medicare and Medicaid is affected by
budgetary pressures and is subject to changes in legislation and
regulation. Our revenues and profitability, similar to other
healthcare companies, are subject to the effect of such
legislative or regulatory changes and to possible reductions in
coverage or payment rates by private third-party payors.

As with most government programs, the Medicare
and Medicaid programs are subject to statutory and regulatory
changes, possible retroactive and prospective rate adjustments,
administrative rulings, and freezes and funding reductions, all
of which may adversely affect payments to us. Reductions or
changes in Medicare or Medicaid funding could significantly
affect our results of operations. We cannot predict at this time
whether any additional healthcare reform initiatives will be
implemented or whether other changes in the administration of
governmental healthcare programs or interpretations of
governmental policies or other changes affecting the healthcare
system will occur.

Medicare.Medicare
pays us based on a prospective payment system under which we
receive one of four predetermined daily or hourly rates in which
the Medicare beneficiary is under our care. As discussed below,
these rates are subject to annual adjustments for inflation and
are also adjusted based on geographic location.

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The rate we receive from Medicare for a day of
hospice care varies depending on which of the following four
levels of care is being furnished to the beneficiary:




| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Routine Home Care.We currently receive between $103.54
    and $158.73 per day for routine home care, depending on the
    geographic location. We are paid the routine home care rate for
    each day a patient is under our care and not receiving one of
    the other categories of hospice care. This rate is not adjusted
    for the volume or intensity of care provided on a given day.
    This rate is also paid when a patient is receiving hospital care
    for a condition unrelated to the terminal condition. Routine
    home care services accounted for 89.8% and 89.5% of our gross
    patient service revenue for 2002 and 2003, respectively.
|
| |  | General Inpatient Care.We currently receive between $465.03
    and $693.76 per day for general inpatient care, depending on the
    geographic location. General inpatient care services accounted
    for 8.3% and 8.7% of our gross patient service revenue for 2002
    and 2003, respectively.                                                                                                                                                                                                                                                                                                                                                                   
|
| |  | Continuous Home Care.We currently receive between $604.32
    and $926.47 per day for continuous home care, depending on the
    geographic location. This daily continuous home care rate is
    divided by 24 in order to arrive at an hourly rate. The hourly
    rate is paid for every hour that continuous home care is
    furnished, up to 24 hours in a single day. A minimum of eight
    hours must be provided in a single day to qualify for this rate.
    Continuous home care services accounted for 0.8% and 0.6% of our
    gross patient service revenue for 2002 and 2003, respectively.                                                          
|
| |  | Respite Care.We
    currently receive between $110.30 and $155.28 per day for
    respite care, depending on the geographic location. Respite care
    is provided when the family or caregiver of a patient requires
    temporary relief from his or her caregiving responsibilities for
    certain reasons. We can receive payment for respite care
    provided to a given patient for up to five consecutive days. Our
    payment for any additional days of respite care provided to the
    patient is limited to the routine home care rate. Respite care
    services accounted for 0.2% of our gross patient service revenue
    for both 2002 and 2003.  

The Medicare program has entered into contracts
with managed care companies to provide a managed care benefit to
electing Medicare beneficiaries. These managed care programs are
often referred to as Medicare HMO programs or Medicare risk
contracts. We provide hospice care to many Medicare
beneficiaries who participate in Medicare HMO programs. Under
Medicare HMO programs, Medicare pays the hospice directly. This
direct payment reduces the per member per month payment
otherwise receivable by the managed care company. As a result,
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 other Medicare beneficiaries.

Medicare limits the amount of payment we may
receive for inpatient care services. Under the so-called
80-20 rule, if the number of inpatient care days
furnished by us to Medicare beneficiaries exceeds 20% of the
total days of hospice care furnished by us to Medicare
beneficiaries, Medicare payments to us for inpatient care days
exceeding the inpatient cap will be reduced to the routine home
care rate. This determination is made annually based on the
twelve month period beginning on November 1st of each year. This
limit is computed on a program-by-program basis. None of our
hospices has exceeded the cap on inpatient care services.
However, we cannot assure you that one or more of our hospices
will not exceed the inpatient cap in the future.

Overall payments made by Medicare to us are also
subject to a cap amount calculated by the Medicare fiscal
intermediary at the end of the hospice cap period. The hospice
cap period runs from November 1st of each year through
October 31st of the following year. Total Medicare payments
to us during this period are compared to the cap amount for this
period. Payments in excess of the cap amount must be returned by
us to Medicare. The cap amount is calculated by multiplying the
number of beneficiaries electing hospice care during the period
by a statutory amount that is indexed for inflation annually.
The cap amount was $18,661 for the twelve-month period ending
October 31, 2003. The cap amount for the twelve month
period ending October 31, 2004 has not been established by
Medicare. Once published, the new cap amount will become
effective retroactively for all initial hospice elections
performed since October 1, 2003. The hospice cap

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amount is computed on a program-by-program basis.
Our net patient service revenue for 2003 was reduced by
$1.2 million as a result of six of our hospice programs
exceeding the Medicare cap. We cannot assure that additional
hospices will not exceed the cap amount in the future.


Direct patient care physician services delivered
by physicians contracted with us are billed separately by us to
the Medicare intermediary and paid at the lesser of the actual
charge or 100% of the Medicare allowable charge for these
services. This payment is in addition to the daily rates we
receive for hospice care. Payment for our contractual
physicians administrative and general supervisory
activities are included in the daily payment rates discussed
above. Payments for a patients attending physicians
professional services, other than services furnished by
physicians contracted with us, are not paid to us, but rather
are paid directly to the attending physician by the Medicare
carrier based on the Medicare physician fee schedule. Physician
services represented 0.5% of our net patient service revenue for
both 2002 and 2003.

Medicare fiscal intermediaries periodically
conduct focused medical reviews and other audits on our claims.
Medicare fiscal intermediaries have recently increased their
review of claims for hospice patients with non-cancer diagnoses.
Focused medical reviews and other audits of our hospice programs
could result in material recoupments or denials of claims.
Further, Medicare payments for hospice services may not continue
to remain at their current levels or keep pace with the costs of
providing hospice services.

The Balanced Budget Act of 1997 made changes in
Medicare coverage of and payment for hospice care services. The
law reduced the amount of anticipated increases in Medicare
payments for hospice services by setting the payment rate
increases at the market basket inflation rate minus
one percentage point for each of the Medicare fiscal years 1998
through 2002. The Medicare fiscal year begins on October 1 of
each year and runs through September 30 of the following
year. In addition, the Balanced Budget Act of 1997 requires us
to file annual cost reports with the Department of Health and
Human Services on each of our hospice programs for informational
purposes. The Balanced Budget Act of 1997 also requires us to
submit claims on the basis of the location where we actually
furnish the hospice services. The purpose of this requirement is
to adjust payment rates for regional differences in wage costs.

On October 1, 2002 and 2003, the base
Medicare payment rates for hospice care increased by
approximately 3.4% over the base rates previously in effect. The
new Medicare daily rates for October 1, 2002 and 2003 were
further adjusted by the hospice wage index.

In May 2002, the Medicare Payment Advisory
Commission issued its report to Congress assessing Medicare
beneficiaries access to and use of the hospice benefit.
The Medicare Payment Advisory Commission recommended that the
hospice payment rates be reviewed to insure that they are
consistent with the costs of providing hospice care, including
whether a case-mix adjusted payment system and outlier policy
should be incorporated into the Medicare hospice payment system.

Medicare Six-Month Eligibility Rule.In order for a Medicare beneficiary to
qualify for the Medicare hospice benefit, two physicians must
certify that the beneficiary has less than six months to live,
assuming the disease runs it normal course in the best judgment
of the physician or medical director. In addition, the Medicare
beneficiary must affirmatively elect hospice care and waive any
rights to other Medicare benefits related to the
beneficiarys terminal illness. Each benefit period, a
physician must recertify that the Medicare beneficiarys
life expectancy is six months or less in order for the
beneficiary to continue to qualify for and to receive the
Medicare hospice benefit. The first and second benefit periods
are measured at 90-day intervals and subsequent benefit periods
are measured at 60-day intervals. The Medicare, Medicaid and
SCHIP (State Childrens Health Insurance Program) Benefits
Improvement and Protection Act of 2000 provides that the
physician certification of a Medicare beneficiarys
eligibility for the Medicare hospice benefit is based on the
physicians clinical judgment regarding the normal course
of the individuals illness. There is no limit on the
number of periods that a Medicare beneficiary may be
recertified. A Medicare beneficiary may revoke his or her
election at anytime and resume receiving regular Medicare
benefits.

Increased regulatory scrutiny of compliance with
the Medicare six-month eligibility rule has impacted the hospice
industry. CMS, however, reaffirmed that Medicare hospice
beneficiaries are not limited to six months of coverage and that
there is no limit on how long a Medicare beneficiary can
continue to receive

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hospice benefits and services, provided that the
beneficiary continues to meet the eligibility criteria under the
Medicare hospice program.


Medicaid.State
Medicaid programs are another source of net patient service
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.
In 1986, hospice services became an optional state Medicaid
benefit. For those states that elect to provide a hospice
benefit, Medicaid is required to pay us rates that are at least
equal to the hospice rates paid by Medicare. For our patients
receiving nursing home care under a state Medicaid program who
elect hospice care under Medicare or Medicaid, the state must
pay us, in addition to the applicable Medicare or Medicaid
hospice per diem rate, an amount equal to at least 95% of the
Medicaid per diem nursing home rate for room and
board furnished to the patient by the nursing home. We
contract with various nursing homes for the nursing homes
provision of certain room and board services that
the nursing homes would otherwise provide Medicaid nursing home
patients. We bill and collect from the applicable state Medicaid
program an amount equal to at least 95% of the amount that would
otherwise have been paid directly to the nursing home under the
states Medicaid plan. Under our standard nursing home
contracts, we pay the nursing home for these room and
board services at the Medicaid per diem nursing home rate.
See Item 7. Managements Discussion and Analysis
of Financial Condition and Results of Operations 
Expenses.

Other Healthcare Regulations

Fraud and Abuse Laws.Provisions of the Social Security Act,
commonly referred to as the fraud and abuse provisions, prohibit
the filing of false or fraudulent claims with Medicare or
Medicaid and the payment or receipt of any form of remuneration
in return for the referral of Medicare or Medicaid patients or
arranging for the referral of patients, or in return for the
recommendation, arrangement, purchase, lease or order of items
or services that are covered by Medicare or Medicaid programs.
Violation of these provisions could constitute a felony criminal
offense and applicable sanctions include imprisonment of up to
five years, criminal fines of up to $25,000, civil money
penalties of up to $50,000 per act plus three times the amount
claimed or three times the remuneration offered and exclusion
from the Medicare and Medicaid programs. Many states have
adopted similar prohibitions against payments that are intended
to induce referrals of Medicaid and other third-party payor
patients. The Office of Inspector General, Department of Health
and Human Services (OIG), has published numerous
safe harbors that exempt some practices from
enforcement action under the federal fraud and abuse laws. These
safe harbors exempt specified activities, including bona fide
employment relationships, some contracts for the rental of space
or equipment, and some personal service arrangements and
management contracts. While the failure to satisfy all of the
requirements of a particular safe harbor does not necessarily
mean that the arrangement is unlawful, arrangements that do not
satisfy a particular safe harbor may be subject to scrutiny by
the OIG.

We are required under the Medicare conditions of
participation and some state licensing laws to contract with
numerous healthcare providers and practitioners, including
physicians, hospitals and nursing homes, and to arrange for
these individuals or entities to provide services to our
patients. In addition, we have contracts with other suppliers,
including pharmacies, ambulance services and medical equipment
companies. 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. These arrangements may not qualify for a safe harbor.
We believe that our contracts and arrangements with providers,
practitioners and suppliers are not in violation of applicable
fraud and abuse laws. We cannot assure you, however, that these
laws will ultimately be interpreted in a manner consistent with
our practices.

From time to time, various federal and state
agencies, such as the Department of Human Services, issue a
variety of pronouncements, including fraud alerts, the Office of
Inspector Generals Annual Work Plan and other reports,
identifying practices that may be subject to heightened
scrutiny. For example, in March 1998, the OIG issued a special
fraud alert titled Fraud and Abuse in Nursing Home
Arrangements with Hospices. This special fraud alert
focused on payments received by nursing homes from hospices.

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We believe that we are in material compliance
with all applicable federal and state fraud and abuse laws.
However, we cannot assure that these laws will not be
interpreted in the future in such a way as to cause us to be in
violation of these laws.

HIPAA Fraud and Abuse Provisions.The Health Insurance Portability and
Accountability Act of 1996 (HIPAA) broadened the
application of the federal fraud and abuse provisions beyond the
Medicare and Medicaid programs. An amendment included in HIPAA
extended the federal fraud and abuse provisions
prohibitions to all federal healthcare programs,
which include all state healthcare programs receiving federal
funding but exclude the federal Employees Health Benefit
Program. Additionally, HIPAA created five new categories of
criminal federal offenses that apply to all healthcare benefit
programs regardless of whether such programs are funded in whole
or in part with federal funds. The five new categories of
federal offenses created by HIPAA are healthcare fraud, theft or
embezzlement in connection with healthcare, false statements
relating to healthcare matters, obstruction of criminal
investigations of healthcare offenses, and money laundering.
Violations of these provisions constitute felony criminal
offenses and applicable sanctions include imprisonment and/or
substantial monetary fines.

Civil Monetary Penalties Statute.The federal civil monetary penalties
statute prohibits any person or entity from knowingly submitting
false or fraudulent claims, offering to or making payments to a
beneficiary to induce the beneficiary to use a particular
provider or supplier, or arranging or contracting with an
individual or entity that the person or entity knows or should
know is excluded from the Medicare or Medicaid programs for the
provision of items or services that may be reimbursed, in whole
or in part, by the Medicare or Medicaid programs. Violations can
result in civil monetary penalties ranging from $10,000 to
$50,000 per claim or act, plus damages of not more than three
times the amount claimed for each such item or service.

False Claims Act.In
addition to federal fraud and abuse laws, under separate
statutes, the submission of claims for items and services that
are not provided as claimed may lead to civil money
penalties, criminal fines and imprisonment, and/or exclusion
from participation in federally funded healthcare programs,
including the Medicare and Medicaid programs. These false claims
statutes include the Federal False Claims Act. Under the Federal
False Claims Act, in addition to actions being initiated by the
federal government, a private party may bring an action on
behalf of the federal government. These private parties are
often referred to as qui tam relators, and are entitled to share
in any amounts recovered by the government. Both direct
enforcement activity by the government and qui tam actions have
increased significantly in recent years and have increased the
risk that a healthcare company, like us, will have to defend a
false claims action, pay fines or be excluded from the Medicare
and/or Medicaid programs as a result of an investigation arising
out of this type of an action. Many states have enacted similar
laws providing for the imposition of civil and criminal
penalties for the filing of fraudulent claims. Because of the
complexity of the government regulations applicable to our
industry, we cannot assure that we will not be the subject of an
action under the False Claims Act or similar state law.

The Stark Law and State Physician
Self-Referral Laws.Section 1877
of the Social Security Act, commonly known as the Stark
Law, prohibits physicians, subject to the exceptions
described below, from referring Medicare or Medicaid patients to
any entity providing designated health services in
which the physician has an ownership or investment interest or
with which the physician has entered into a compensation
arrangement. Persons who violate the Stark Law are subject to
civil monetary penalties and exclusion from the Medicare and
Medicaid programs.

Hospice care is not specifically enumerated as a
health service subject to this prohibition; however, some of the
ten designated health services under the Stark Law, including
physical therapy, pharmacy services and certain infusion
therapies, are among the specific services furnished by our
hospices. Regulations interpreting the Stark Law currently
provide that investments by referring physicians in a hospice
will not violate the Stark Law. We cannot assure you, however,
that future regulatory changes will not result in us becoming
subject to the Stark Laws prohibition in the future.

Many states have also enacted physician
self-referral laws, which generally prohibit financial
relationships with referral sources that are not limited to
services for which Medicare or Medicaid payment may be made.
Similar penalties, including loss of license or eligibility to
participate in government programs and civil and

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criminal fines, apply to violations of these
state self-referral laws. These laws vary from state to state
and have seldom been interpreted by the courts or regulatory
agencies. We believe that our relationships with physicians do
not violate these state self-referral laws. However, we cannot
assure that these laws will not be interpreted in the future in
such a way as to call into question our relationships with
physicians.


Corporate Practice of Medicine and
Fee-Splitting.Most states have laws
that restrict or prohibit unlicensed persons or business
entities, including corporations, from employing physicians
and/or prohibit direct or indirect payments or fee-splitting
arrangements between physicians and unlicensed persons or
business entities. Possible sanctions for violations of these
restrictions include loss of a physicians license, civil
and criminal penalties and rescission of business arrangements.
These laws vary from state to state, are often vague and have
seldom been interpreted by the courts or regulatory agencies.

We contract with physicians to provide medical
direction and patient care services. A state with these
prohibitions could determine that the provision of patient care
services by our contracted physicians violates the corporate
practice of medicine and/or fee-splitting prohibitions. We
structure our arrangements with healthcare providers to comply
with the relevant state law. However, we cannot assure you that
government officials charged with the responsibility for
enforcing these laws will not assert that we, or transactions in
which we are involved, are in violation of these laws. These
laws may also be interpreted by the courts in a manner
inconsistent with our interpretations. The determinations or
interpretations by a state may require us to restructure our
arrangements with physicians in the applicable state.

Health Information Practices.The administrative simplification
provisions of HIPAA contain provisions that require many
organizations, including us, to implement very significant,
potentially expensive new computer systems and business
procedures designed to protect each patients individual
healthcare information. HIPAA requires the Department of Health
and Human Services to issue rules to define and implement
patient privacy standards. Among the standards that the
Department of Health and Human Services has or will adopt
pursuant to HIPAA are standards for the following:



| |   |                                                                               
| | - | ------------------------------------------------------------------------------
| |  | electronic transactions and code sets;                                        
|
| |  | unique identifiers for providers, employers,
    health plans and individuals;
|
| |  | privacy;                                                                      
|
| |  | security and electronic signatures; and                                       
|
| |  | enforcement.                                                                  

On December 28, 2000, the Secretary of the
Department of Health and Human Services published a final rule
establishing standards for the privacy of individually
identifiable health information. The final rule became effective
on April 14, 2001, and compliance was required by
April 14, 2003. These privacy standards apply to all health
plans, all healthcare clearinghouses and many healthcare
providers, including healthcare providers that transmit health
information in an electronic form in connection with certain
standard transactions. We are a covered entity under the final
rule. The privacy standards apply to protect individually
identifiable health information held or disclosed by a covered
entity in any form, whether communicated electronically, on
paper or orally. These standards not only require our compliance
with rules governing the use and disclosure of protected health
information, but they also require us to impose those rules, by
contract, on any business associate to whom such information is
disclosed.

On February 20, 2003, the Secretary of the
Department of Health and Human Services published a final rule
that establishes, in part, standards for the security of health
information by health plans, healthcare clearinghouses and
healthcare providers that maintain or transmit any health
information in electronic form, regardless of format. The final
rule became effective April 21, 2003, with a compliance date of
April 21, 2005. We are a covered entity under the final
rule. These security standards require covered entities to
establish and maintain reasonable and appropriate
administrative, technical and physical safeguards to ensure
integrity, confidentiality and availability of the information.
The security standards were designed to protect health
information against reasonably anticipated threats or hazards to
the security or integrity of the information and to protect the
information against unauthorized use or disclosure. Although the
security standards do not

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reference or advocate a specific technology, and
affected entities have the flexibility to choose their own
technical solutions, we expect that compliance with the security
standards will require us to implement significant systems and
procedures.


A violation of these standards could result in
civil monetary penalties of $100 per incident, up to a maximum
of $25,000 per person, per year, per standard. The final rule
also provides for criminal penalties of up to $50,000 and one
year in prison for knowingly and improperly obtaining or
disclosing protected health information, up to $100,000 and five
years in prison for obtaining protected health information under
false pretenses, and up to $250,000 and ten years in prison for
obtaining or disclosing protected health information with the
intent to sell, transfer or use such information for commercial
advantage, personal gain or malicious harm.

Compliance with these standards has required
significant commitment and action by us. We have management in
place to direct our compliance with these standards and we are
now in compliance with the privacy standards and the electronic
transactions and code sets standards.

Additional Federal and State Laws.The federal government and all states
also regulate other aspects of the hospice industry. In
particular, our operations are subject to federal and state laws
covering professional services, the dispensing of drugs and
other types of hospice activities. Some of our employees are
subject to state laws and regulations governing the ethics and
practice of medicine, respiratory therapy, pharmacy and nursing.
Our operations are subject to periodic survey by government
entities to assure compliance with applicable state licensing
and Medicare and Medicaid certification, as the case may be.
From time to time in the ordinary course of business, we, like
other healthcare companies, receive survey reports containing
deficiencies for alleged failure to comply with applicable
requirements. We review these reports and take appropriate
corrective action. The failure to effect corrective action or to
obtain, renew or maintain any of the required regulatory
approvals, certifications or licenses could materially adversely
affect our business and could prevent our hospice programs
involved from offering services to patients. In addition, laws
and regulations often are adopted to regulate new products,
services and industries. We cannot assure that either the states
or the federal government will not impose additional regulations
upon our activities that might adversely affect us.

As a large employer, we are subject to various
federal and state laws regulating employment practices. We are
specifically subject to audits by various federal and state
agencies regarding our compliance with these laws. We believe
that our employment practices are in material compliance with
applicable federal and state laws. However, we cannot assure
that government officials charged with the responsibility of
enforcing these laws will not assert that we are in violation of
these laws, or that these laws will be interpreted by the courts
in a manner consistent with our interpretations.

A substantial number of hospice programs which
could be potential acquisition targets for us are operated by
not-for-profit entities. Some states require government review,
and in some cases approval, of transactions in which a
not-for-profit entity sells a healthcare facility or business.
This increased scrutiny may increase the difficulty in
completing or prevent the completion of acquisitions in some
states in the future. We have acquired two not-for-profit
hospice programs and did not encounter any substantial
regulatory or governmental obstacles to our acquisition or
integration of those hospice programs. We cannot, however,
assure that we will not encounter regulatory or governmental
obstacles in connection with our acquisition of not-for-profit
hospices in the future.

We maintain an internal corporate compliance
program and from time to time retain regulatory counsel for
guidance on applicable laws and regulations. However, we cannot
assure that our practices, if reviewed, would be found to be in
compliance with applicable federal and state laws, as the laws
ultimately may be interpreted.

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Compliance and Continuous Quality Improvement
Programs

We have a comprehensive company-wide compliance
program. Our compliance program provides for:



| |   |                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------
| |  | the appointment of a compliance officer and
    committee;                                         
|
| |  | adoption of a corporate code of business conduct
    and ethics;                                   
|
| |  | employee education and training;                                                                   
|
| |  | implementation of an internal system for
    reporting concerns on a confidential, anonymous basis;
|
| |  | ongoing internal auditing and monitoring
    programs; and                                         
|
| |  | a means for enforcing the compliance programs
    policies.                                        

As part of our ongoing internal auditing and
monitoring programs, we conduct periodic, at least annual,
internal regulatory audits and mock surveys at each of our
hospice programs. If a program does not achieve a satisfactory
rating, we require it to prepare and implement a plan of
correction. We then perform a follow-up audit and survey to
verify that all deficiencies identified in the initial audit and
survey have been corrected.

As required under the Medicare conditions of
participation, we have a continuous quality improvement program
in place. Our continuous quality improvement program involves:



| |   |                                                                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | on-going education of staff and quarterly
    continuous quality improvement meetings at each of our hospice
    programs and at our corporate office;
|
| |  | quarterly comprehensive audits of patient charts
    performed by each of our hospice programs; and                                                   
|
| |  | at least once a year, a comprehensive audit of
    patient charts performed on each of our hospice programs by our
    corporate staff.               

If a hospice program fails to achieve a
satisfactory rating on a patient chart audit, we require the
program to prepare and implement a plan of correction. We then
conduct a follow-up patient chart audit to verify that
appropriate action has been taken to prevent future deficiencies.

We continually expand and refine our compliance
and continuous quality improvement programs. Specific written
policies, procedures, training and educational materials and
programs, as well as auditing and monitoring activities, have
been prepared and implemented to address the functional and
operational aspects of our business. Our programs also address
specific problem areas identified through regulatory
interpretation and enforcement activities. Our policies,
training, standardized documentation requirements, reviews and
audits also specifically address our financial arrangements with
our referral sources, including fraud and abuse laws and
physician self-referral laws.

Competition

Hospice care in the United States is competitive.
Because payments for hospice services are primarily paid on a
per diem basis, we compete primarily on our ability to deliver
quality, responsive services. The hospice care market is highly
fragmented, and we compete with a large number of organizations,
some of which have or may obtain significantly greater financial
and marketing resources than us. Based on industry data, we
estimate that approximately 72% of existing hospice programs are
local not-for-profit programs. Most hospice programs are
small-and medium-sized programs.

We also compete with a number of national and
regional hospice providers, including Vitas Healthcare
Corporation and VistaCare, Inc., hospitals, nursing homes, home
health agencies and other healthcare providers, including those
with which we presently maintain contractual relationships, that
offer hospice and/or palliative care services. Many of them
offer home care to patients who are terminally ill, and some
actively market palliative care and hospice-like
programs. In addition, various healthcare companies have
diversified into the hospice market. For example, Beverly
Enterprises, Inc. and Manor Care, Inc. compete with us in some
of our markets.

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Relatively few barriers to entry exist in the
markets served by us. Accordingly, other companies that are not
currently providing hospice care may enter these markets and
expand the variety of services offered.

Insurance

We maintain primary general and professional
liability coverage on a claims made and company-wide basis with
limits of $1.0 million per occurrence and $3.0 million
in the aggregate. In addition, we maintain umbrella coverage on
a claims made and company-wide basis with a limit of
$20.0 million. While we believe that our insurance coverage
is adequate for our current operations, we cannot assure that
our coverage will cover all future claims or will be available
in adequate amounts or at a reasonable cost.

Our current general and professional liability
policy does not provide coverage for claims that arise from acts
that occurred prior to the policys start date of
April 12, 2000. From March 12, 1999 to April 12,
2000, Reliance National Insurance Company provided our insurance
coverage. Since April 12, 2000, Lexington Insurance
Company, a subsidiary of American International Group, Inc., has
provided our insurance coverage. During the fourth quarter of
2001, the Insurance Commissioner of the Commonwealth of
Pennsylvania placed Reliance National Insurance Company in
liquidation. Based on our estimation of open claims, we are
maintaining a reserve to cover potential losses resulting from
current and future litigation claims covered by Reliance
National Insurance Company to the extent its assets are not
sufficient to pay such claims. Although we believe that the
amount reserved is adequate to cover our potential losses, there
can be no assurance that our losses will not exceed the amount
reserved. Our profitability will be negatively impacted to the
extent our actual losses exceed the amount reserved.

Employees

As of February 15, 2004, we had 3,167
full-time employees and 737 part-time employees. None of our
employees are covered by collective bargaining agreements. We
believe that our relations with our employees are good.

Some Risks Related to Our Business

An investment in our common stock is subject to
the significant risks inherent in our business. Readers should
consider carefully the risks and uncertainties described below
and the other information included in this Annual Report on
Form 10-K. The occurrence of any of the events described
below could have a material adverse effect on our business. This
could cause the trading price of our common stock to decline,
perhaps significantly.



| |                                                                                                                                                                                                                                              
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We are highly dependent on payments from
    Medicare and Medicaid. If there are changes in the rates or
    methods governing these payments for our services, our net
    patient service revenue and profits could materially
    decline.

We are highly dependent on payments from Medicare
and Medicaid. Approximately 97.2%, 97.5% and 97.0% of our net
patient service revenue for the years ended December 31,
2001, 2002 and 2003, respectively, consisted of payments, paid
primarily on a per diem basis, from the 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. Reductions in amounts paid by
government programs for our services or changes in methods or
regulations governing payments could cause our net patient
service revenue and profits to materially decline.

Overall payments made by Medicare to us are
subject to a cap amount calculated by the Medicare fiscal
intermediary at the end of the hospice cap period. The hospice
cap period runs from November 1st of each year through
October 31st of the following year. Total Medicare payments
to us during this period are compared to the cap amount for this
period. Payments in excess of the cap amount must be returned by
us to Medicare. The cap amount is calculated by multiplying the
number of beneficiaries electing hospice care during the period
by a statutory amount that is indexed for inflation. The cap
amount was $18,661 for the twelve-month period ending
October 31, 2003. The cap amount for the twelve month
period ending

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October 31, 2004 has not been established by
Medicare. Once published, the new cap amount will become
effective retroactively for all services performed since
November 1, 2003. The hospice cap amount is computed on a
program-by-program. Our net patient service revenue for 2003 was
reduced by approximately $1.2 million as a result of six of
our hospice programs exceeding the Medicare cap. Our ability to
comply with this limitation depends on a number of factors
relating to a given hospice program, including the rate at which
our patient census increases, the average length of stay and mix
in level of care. Our revenue and profitability may be
materially reduced if we are unable to comply with this and
other Medicare payment limitations. We cannot assure that
additional hospices will not exceed the cap amount in the future.




| |                                                                                                                                                                                                                          
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We operate in an industry that is subject
    to extensive federal, state and local regulation, and changes in
    law and regulatory interpretations could reduce our net patient
    service revenue and profitability.

The healthcare industry is subject to extensive
federal, state and local laws, rules and regulations relating
to, among others:



| |   |                                                                                                                                                                                       
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | payment for services;                                                                                                                                                                 
|
| |  | conduct of operations, including fraud and abuse,
    anti-kickback prohibitions, physician self-referral prohibitions
    and false claims;                                          
|
| |  | privacy and security of medical records;                                                                                                                                              
|
| |  | employment practices; and                                                                                                                                                             
|
| |  | facility and professional licensure, including
    certificates of need, surveys, certification and recertification
    requirements, and corporate practice of medicine prohibitions.

In recent years, Congress and some state
legislatures have introduced an increasing number of proposals
to make significant changes in the healthcare system. Changes in
law and regulatory interpretations could reduce our net patient
service revenue and profitability.

Recently, there have been heightened coordinated
civil and criminal enforcement efforts by both federal and state
government agencies relating to the healthcare industry. There
has also been an increase in the filing of actions by private
individuals on behalf of the federal government against
healthcare companies alleging the filing of false or fraudulent
Medicare or Medicaid claims. This heightened enforcement
activity increases our potential exposure to damaging lawsuits,
investigations and other enforcement actions. Any such action
could distract our management and adversely affect our business
reputation and profitability.

In the future, different interpretations or
enforcement of laws, rules and regulations governing the
healthcare industry could subject our current business practices
to allegations of impropriety or illegality or could require us
to make changes in our facilities, equipment, personnel,
services and capital expenditure programs, increase our
operating expenses and distract our management. If we fail to
comply with these extensive laws and government regulations, we
could become ineligible to receive government program payments,
suffer civil and criminal penalties or be required to make
significant changes to our operations. In addition, we could be
forced to expend considerable resources responding to an
investigation or other enforcement action under these laws or
regulations. For a more detailed discussion of the regulatory
environment in which we operate, see  Government
Regulation.



| |                                                                                                                                                                                                                                                                                                             
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Almost half of our hospice patients reside
    in nursing homes. Changes in the laws and regulations regarding
    payments for hospice services and room and board
    provided to our hospice patients residing in nursing homes could
    reduce our net patient service revenue and
    profitability.

For our hospice patients receiving nursing home
care under certain state Medicaid programs who elect hospice
care under Medicare or Medicaid, the state must pay us, in
addition to the applicable Medicare or Medicaid hospice per diem
rate, an amount equal to at least 95% of the Medicaid per diem
nursing home rate for room and board furnished to
the patient by the nursing home. We contract with various
nursing homes for the nursing homes provision of certain
room and board services that the nursing homes would
otherwise provide Medicaid nursing home patients. We bill and
collect from the applicable state Medicaid program an

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amount equal to at least 95% of the amount that
would otherwise have been paid directly to the nursing home
under the states Medicaid plan. Under our standard nursing
home contracts, we pay the nursing home for these room and
board services at 100% of the Medicaid per diem nursing
home rate.


Government studies conducted in the last several
years have suggested that the reimbursement levels for hospice
patients living in nursing homes may be excessive. In
particular, the federal government has expressed concern that
hospice programs may provide fewer services to patients residing
in nursing homes than to patients living in other settings due
to the presence of the nursing homes own staff to address
problems that might otherwise be handled by hospice personnel.
Because hospice programs are paid a fixed per diem amount,
regardless of the volume or duration of services provided, the
government is concerned that hospice programs may be increasing
their profitability by shifting the cost of certain patient care
services to the nursing home.

The reduction or elimination of Medicare payments
for hospice patients residing in nursing homes would
significantly reduce our net patient service revenue and
profitability. In addition, changes in the way nursing homes are
reimbursed for room and board services provided to
hospice patients residing in nursing homes could affect our
ability to obtain referrals from nursing homes. A reduction in
referrals from nursing homes would adversely affect our net
patient service revenue and profitability.



| |                                                                                                                                                                                              
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we are unable to maintain relationships
    with existing patient referral sources or to establish new
    referral sources, our growth and profitability could be
    adversely affected.

Our success is heavily dependent on referrals
from physicians, nursing homes, assisted living facilities,
adult care centers, hospitals, managed care companies, insurance
companies and other patient referral sources in the communities
that our hospice locations serve, as well as on our ability to
maintain good relations with these referral sources. Our
referral sources are not contractually obligated to refer
hospice patients to us and may refer their patients to other
hospice care providers, or not at all. Our growth and
profitability depend significantly on our ability to provide
good patient and family care, to establish and maintain close
working relationships with these patient referral sources and to
increase awareness and acceptance of hospice care by our
referral sources and their patients. We cannot assure 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
that awareness or acceptance of hospice care will increase.



| |                                                                                                                                                                               
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our growth strategy to develop new hospice
    locations in new and existing markets may not be successful,
    which could adversely impact our growth and
    profitability.

A significant element of our growth strategy is
expansion of our business by developing new hospice programs in
new markets and growth in our existing markets. This aspect of
our growth strategy may not be successful, which could adversely
impact our growth and profitability. We cannot assure that we
will be able to:



| |   |                                                                                                         
| | - | --------------------------------------------------------------------------------------------------------
| |  | identify markets that meet our selection criteria
    for new hospice programs;                         
|
| |  | hire and retain a qualified management team to
    operate each of our new hospice programs;            
|
| |  | manage a large and geographically diverse group
    of hospice programs;                                
|
| |  | become Medicare and Medicaid certified in new
    markets;                                              
|
| |  | transfer provider numbers between hospice
    programs in a timely manner;                              
|
| |  | generate sufficient hospice admissions in new
    markets to operate profitably in these new markets; or
|
| |  | compete effectively with existing programs in new
    markets.                                          

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| |                                                                                                                                                                                    
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our growth strategy to acquire other
    hospices may not be successful and the integration of future
    acquisitions may be difficult and disruptive to our ongoing
    business.

In addition to growing existing programs and
developing new hospice programs, an element of our growth
strategy is expansion through the acquisition of other hospice
programs. We cannot assure that our acquisition strategy will be
successful. The success of our acquisition strategy is dependent
upon a number of factors, including:



| |   |                                                                                                                                                                        
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | our ability to identify suitable acquisition
    candidates;                                                                                                           
|
| |  | our ability to negotiate favorable acquisition
    terms, including purchase price, which may be adversely affected
    due to increased competition with other buyers;
|
| |  | the availability of financing on terms favorable
    to us, or at all;                                                                                                 
|
| |  | our ability to integrate effectively the systems
    and operations of acquired hospices;                                                                              
|
| |  | our ability to retain key personnel of acquired
    hospices; and                                                                                                      
|
| |  | our ability to obtain required regulatory
    approvals.                                                                                                               

Acquisitions involve a number of other risks,
including diversion of managements attention from other
business concerns and the assumption of known or unknown
liabilities of acquired hospices, including liabilities for
failure to comply with healthcare laws and regulations. The
integration of acquired hospices may place significant strains
on our current operating and financial systems and controls. We
may not successfully overcome these risks or any other problems
encountered in connection with our acquisition strategy.

An estimated 72% of hospice programs in the
United States are not-for-profit programs. Accordingly, it is
likely that a substantial number of acquisition opportunities
may involve hospices operated by not-for-profit entities. In
recent years, several states have increased review and oversight
of transactions involving the sale of healthcare facilities by
not-for-profit entities. Although the level of review varies
from state to state, the current trend is to provide for
increased governmental review, and in some cases approval, of
transactions in which a not-for-profit entity sells a healthcare
facility or business. This increased scrutiny may increase the
difficulty in completing, or prevent the completion of,
acquisitions in some states in the future.



| |                                                                                                                                                                                          
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our loss of key management personnel or our
    inability to hire and retain skilled employees could adversely
    affect our business and our ability to increase patient
    referrals.

Our future success depends, in significant part,
upon the continued service of our senior management personnel.
The loss of services of one or more of our key senior management
personnel or our inability to hire and retain new skilled
employees could adversely affect our future operating results.
In addition, the loss of key community education representatives
could negatively impact our ability to maintain or increase
patient referrals, a key aspect of our growth strategy.

As we previously disclosed in our earnings
release in February 2003, as part of our CEO succession plan,
David C. Gasmire, President and former Chief Operating Officer,
has been promoted to the position of President and Chief
Executive Officer, effective January 1, 2004. Richard R.
Burnham, Chairman of the Board and former Chief Executive
Officer, will continue as Chairman of the Board. During 2003,
with the assistance of Mr. Burnham, Mr. Gasmire began
the orderly transition to Chief Executive Officer as part of our
CEO succession plan. We do not expect Mr. Gasmires
and Mr. Burnhams changing management roles to have
any adverse affect on our future operating results. Deborah
Hoffpauir, former Senior Vice President of Operations, has been
promoted to the position of Chief Operating Officer.

Competition for skilled employees is intense, and
the process of locating and recruiting skilled employees with
the combination of qualifications and attributes required to
care effectively for terminally ill patients and their families
can be difficult and lengthy. We cannot assure that we will be
successful in attracting, retaining or training highly skilled
nursing, management, community education, operations, admissions
and other personnel. Our business could be disrupted and our
growth and profitability negatively impacted if we are unable to
attract and retain skilled employees.

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| |                                                                                                                                                                                                                                                
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | A nationwide shortage of qualified nurses
    could adversely affect our profitability and our ability to grow
    and continue to provide quality, responsive hospice services to
    our patients as nursing wages and benefits
    increase.

We currently employ approximately 900 full-time
nurses and 400 part-time nurses. We depend on qualified nurses
to provide quality, responsive hospice services to our patients.
There is currently a nationwide shortage of qualified nurses
that is being felt in some of the markets in which we provide
hospice services, primarily in California. In response to the
shortage of qualified nurses in these markets, we have increased
and are likely to continue to increase our wages and benefits to
recruit and retain nurses or to engage contract nurses until we
hire permanent staff nurses. Our inability to attract and retain
qualified nurses could adversely affect our ability to provide
quality, responsive hospice services to our patients and our
ability to increase patient census in those markets. In
addition, because we operate in a fixed reimbursement
environment, increases in the wages and benefits that we must
provide to attract and retain qualified nurses or an increase in
our reliance on contract nurses could negatively impact our
profitability.



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

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



| |                                                                                                                                                                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If any of our hospice programs fails to
    comply with the Medicare conditions of participation, that
    program could be terminated from Medicare hospice reimbursement,
    thereby adversely affecting our net patient service revenue and
    profitability.

Each of our hospice programs must comply with the
extensive conditions of participation of the Medicare hospice
reimbursement benefit. If any of our hospice programs fails to
meet any of the Medicare conditions of participation, that
program may receive a notice of deficiency from the applicable
state surveyor. If that hospice program then fails to institute
a plan of correction and correct the deficiency within the
correction period provided by the state surveyor, that program
could be terminated from receiving Medicare reimbursement. For
example, under Medicare hospice program, each of our hospice
programs must demonstrate that volunteers provide administrative
and direct patient care services in an amount equal to at least
five percent of the total patient care hours provided by our
employees and contract staff at the hospice program. If we are
unable to attract a sufficient number of volunteers at one of
our hospice programs to meet this requirement, that program
could be terminated from the Medicare benefit if the program
fails to address the deficiency within the applicable correction
period. Any termination of one or more of our hospice programs
from Medicare reimbursement for failure to satisfy the volunteer
or other conditions of participation could adversely affect our
net patient service revenue and profitability.



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

Many states have enacted certificate of need laws
that require prior state approval to open new healthcare
facilities or expand services at existing facilities. Currently,
the states of Arkansas, Florida, Hawaii, Kentucky, Maryland, New
York, North Carolina, Tennessee, Vermont, Washington and West
Virginia have certificate of need laws that apply to hospices.
Of these states, we currently operate in Arkansas and Tennessee.
Florida and New York have additional barriers to entry. Florida
places restrictions on the ability of for-profit corporations to
own and operate hospices, and New York places restrictions on
the corporate ownership of hospices.

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Accordingly, our ability to operate in Florida
and New York is restricted. These laws could affect our ability
to expand into new markets and to expand our services and
facilities in existing markets.




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

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



| |   |                                                         
| | - | --------------------------------------------------------
| |  | community-based hospice providers;                      
|
| |  | national and regional companies;                        
|
| |  | hospital-based hospice and palliative care
    programs;
|
| |  | nursing homes; and                                      
|
| |  | home health agencies.                                   

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



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

We generally receive fixed payments for our
hospice services based on the level of care we provide to
patients and their families. Accordingly, our profitability is
largely dependent on our ability to manage costs of providing
hospice services. 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; however, the increases
have usually been less than actual inflation. If this adjustment
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.



| |                                                                                                                                                                                                                                                             
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | New federal and state legislative and
    regulatory initiatives relating to patient privacy could require
    us to expend substantial sums on acquiring and implementing new
    information systems, which could negatively impact our
    profitability.

There are currently numerous legislative and
regulatory initiatives at both the state and federal levels that
address patient privacy concerns. In particular, HIPAA contains
provisions that may require us to implement expensive new
computer systems and business procedures designed to protect the
privacy and security of each of our patients individual
health information. The Department of Health and Human Services
published final regulations addressing patient privacy on
December 28, 2000 and final regulations addressing the
security of such health information on February 20, 2003.
We have complied with the requirements of the privacy
regulations and must comply with the requirements of the
security regulations by April 21, 2005. Because the final
security regulations have only recently been issued, we cannot
predict the total financial or other impact of the regulations
on our operations. Compliance with these rules could require us
to spend substantial sums, which could negatively impact our
profitability.

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| |                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our net patient service revenue and
    profitability may be constrained by cost containment initiatives
    undertaken by insurers and managed care companies.

Initiatives undertaken by insurers and managed
care companies to contain healthcare costs affect the
profitability of our hospice programs. We have a number of
contractual arrangements with insurers and managed care
companies for providing hospice care for a fixed fee. These
payors attempt to control healthcare costs by contracting with
hospices and other healthcare providers to obtain services on a
discounted basis. We believe that this trend may continue and
may limit payments for healthcare services, including hospice
services. In addition, future changes in Medicare related to
Medicare HMO programs could result in managed care companies
becoming financially responsible for providing hospice care. If
such changes were to occur, managed care companies could be
responsible for payments to us out of their Medicare payments,
and a greater percentage of our net patient service revenue
could come from managed care companies. As managed care
companies attempt to control hospice-related costs, they could
reduce payments to us for hospice services. These developments
could negatively impact our net patient service revenue and
profitability.



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

A significant portion of our total assets
consists of intangible assets, primarily goodwill. Goodwill
accounted for approximately 37.1% of our total assets as of
December 31, 2003. Any event that results in the
significant impairment of our goodwill, such as closure of a
hospice program or sustained operating losses, could have a
material adverse effect on our profitability.



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

In recent years, participants in the healthcare
industry have become subject to an increasing number of
lawsuits, including allegations of medical malpractice. Many of
these lawsuits involve large claims and substantial defense
costs. From time to time, we are subject to these types of
lawsuits. While we maintain professional and general liability
insurance, some risks and liabilities, including claims for
punitive damages, are not covered by insurance. In addition, we
cannot assure that our coverage will be adequate to cover
potential losses. While we have been able to obtain liability
insurance in the past, insurance can be expensive and may not be
available in the future on terms acceptable to us, or at all.
Claims, regardless of their merit or eventual outcome, may also
adversely affect our reputation, our ability to obtain patient
referrals or our ability to expand our business, as well as
divert management resources from the operation of our business.

Our current general and professional liability
policy does not provide coverage for claims that arise from acts
that occurred prior to the policys start date of
April 12, 2000. From March 12, 1999 to April 12,
2000, Reliance National Insurance Company provided our insurance
coverage. Since April 12, 2000, Lexington Insurance
Company, a subsidiary of American International Group, Inc., has
provided our insurance coverage. During the fourth quarter of
2001, the Insurance Commissioner of the Commonwealth of
Pennsylvania placed Reliance National Insurance Company in
liquidation. Based on our estimation of open claims, we are
maintaining a reserve to cover potential losses resulting from
current and future litigation claims covered by Reliance
National Insurance Company to the extent its assets are not
sufficient to pay such claims. Although we believe that the
amount reserved is adequate to cover our potential losses, there
can be no assurance that our losses will not exceed the amount
reserved. Our profitability will be negatively impacted to the
extent our actual losses exceed the amount reserved.



| |                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may need additional capital to fund our
    operations and finance our growth, and we may not be able to
    obtain it on terms acceptable to us, or at all.

We expect that our existing funds, cash flows
from operations and borrowings under our credit agreement will
be sufficient to fund our working capital needs, anticipated
hospice development and acquisition plans,

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debt service requirements and other anticipated
capital requirements for at least 12 months following the date
of this Annual Report on Form 10-K. Continued expansion of
our business through the development of new hospice programs and
acquisitions may require additional capital, in particular if we
were to accelerate our hospice program development and
acquisition plans. In the past, we have relied on funds raised
through our initial public offering and private issuances of
debt and equity and also through bank financing and cash flows
from operations to support our growth. In the future, required
financing may not be available or may be available only on terms
that are not favorable to us. If we are unable to raise
additional funds, we may have to delay or abandon some or all of
our growth strategies. Further, if additional funds are raised
through the issuance of additional equity securities, the
percentage ownership of our stockholders would be diluted. Any
new equity securities may have rights, preferences or privileges
senior to those of our common stock.




| |                                                                                                                                                                              
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Provisions in our charter documents, under
    Delaware law, and in our stockholder rights plan could
    discourage a takeover that stockholders may consider
    favorable.

Our certificate of incorporation and bylaws may
discourage, delay or prevent a merger or acquisition that a
stockholder may consider favorable because they:



| |   |                                                                                                                                                                                                                                             
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | authorize the issuance by the board of directors
    of preferred stock without the requirement of stockholder
    approval, which could make it more difficult for a third party
    to acquire a majority of our outstanding voting stock;
|
| |  | provide for a classified board of directors with
    staggered, three-year terms;                                                                                                                                                           
|
| |  | prohibit cumulative voting in the election of
    directors;                                                                                                                                                                                
|
| |  | prohibit our stockholders from acting by written
    consent;                                                                                                                                                                               
|
| |  | limit the persons who may call special meetings
    of stockholders;                                                                                                                                                                        
|
| |  | prohibit our stockholders from amending our
    bylaws unless the amendment is approved by the holders of at
    least 80% of our shares of common stock; and                                                                               
|
| |  | establish advance notice requirements for
    nominations for election to the board of directors or for
    proposing matters to be approved by stockholders at stockholder
    meetings.                                                   

In addition, our certificate of incorporation
prohibits the amendment by our stockholders of many provisions
of our certificate of incorporation unless the amendment is
approved by the holders of at least 80% of our shares of common
stock.

Delaware law may also discourage, delay or
prevent someone from acquiring or merging with us. Under
Delaware law, a corporation may not engage in a business
combination with any holder of 15% or more of its capital stock
until the holder has held the stock for three years unless,
among other possibilities, the board of directors approves the
transaction. Our board of directors could use this provision to
prevent or delay takeovers.

In addition, purchase rights distributed under
our stockholder rights plan will cause substantial dilution to
any person or group that attempts to acquire us without
conditioning the offer on our redemption of the rights.

These provisions could discourage potential
acquisition proposals and could delay or prevent a change of
control transaction. As a result, they may limit the price
investors may be willing to pay for our stock in the future.

Available Information

We file reports with the Securities and Exchange
Commission (SEC). We are a reporting company and
file an Annual Report on Form 10-K, Quarterly Reports on
Form 10-Q and Current Reports on Form 8-K when
necessary. The public may read and copy any materials that we
file with the SEC at the SECs Public Reference Room at 450
Fifth Street, NW, Washington, D.C. 20549. The public may obtain
information on the operation of the Public Reference Room by
calling the SEC at 1-800-SEC-0330. The SEC maintains an

31



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Internet site that contains reports, proxy and
information statements, and other information regarding issuers
that file electronically with the SEC. That website address is
http://www.sec.gov. Our Internet address is www.odsyhealth.com.
We make available free of charge on our Internet website our
Annual Report on Form 10-K, Quarterly Reports on Form 10-Q,
Current Reports on Form 8-K and amendments to those reports
filed or furnished pursuant to Section 13(a) or 15(d) of
the Securities Exchange Act of 1934 as soon as reasonably
practicable after we electronically file such material with, or
furnish it to, the SEC.


Our code of business conduct and ethics for
directors, officers and employees, our corporate governance
guidelines and our committee charters, including the audit
committee and compensation committee, are all available on our
website and are available in print to any stockholder upon
request.




Item 2.     Properties

Our executive offices are located at 717 N.
Harwood, Suite 1500, Dallas, Texas 75201, where we
currently lease approximately 70,000 square feet of space. We
believe that these facilities are adequate for our current uses
and that additional space is available to accommodate our
anticipated growth. Our 68 hospice programs, including 6
inpatient units, and 7 hospice programs under development are in
leased facilities in 29 states with varying terms from one to
ten years extending through 2013. We believe these facilities
are in good operating condition and suitable for their intended
purposes. Refer to Item 1. Business 
Hospice Offices and Inpatient Facilities for a complete
listing of the locations of our hospice offices and inpatient
facilities.




Item 3.     Legal
Proceedings

From time to time, we may be involved in
litigation relating to claims arising out of our operations in
the normal course of business. As of the date of this Annual
Report on Form 10-K, we are not aware of any legal
proceedings pending or threatened that we expect would have a
material adverse effect on us.




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

No matters were submitted to a vote of our
stockholders, through the solicitation of proxies or otherwise,
during the quarter ended December 31, 2003.

32



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##### Table of Contents






PART II




Item 5.     Market
for Registrants Common Equity and Related Stockholder
Matters

Market for Common Stock.Our common stock has been quoted on
the Nasdaq National Market under the symbol ODSY
since October 31, 2001. Prior to that time there was no
public market for our common stock. As of March 2, 2004,
there were 33 record holders of our common stock. 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 and as adjusted to take into account the
February 24, 2003 and August 12, 2003 fifty percent
stock dividends:

|     |                |      |   |       |     |  |   |       | 
|---- | -------------- | ---- | - | ----- | --- |  | - | ----- | 
|     |                | High |   |       | Low | 
|     |                |      |   |       |     | 
|2002 |                |      |   |       |     |  |   |      
|     | First Quarter  |      | $ | 9.07  |     |  | $ | 6.66  | 
|     | Second Quarter |      | $ | 10.90 |     |  | $ | 7.85  | 
|     | Third Quarter  |      | $ | 10.66 |     |  | $ | 6.30  | 
|     | Fourth Quarter |      | $ | 11.64 |     |  | $ | 8.64  | 
|2003 |                |      |   |       |     |  |   |      
|     | First Quarter  |      | $ | 16.94 |     |  | $ | 13.47 | 
|     | Second Quarter |      | $ | 24.67 |     |  | $ | 15.22 | 
|     | Third Quarter  |      | $ | 34.84 |     |  | $ | 24.16 | 
|     | Fourth Quarter |      | $ | 37.35 |     |  | $ | 27.00 | 

Dividends.On
January 27, 2003, we announced that our Board of Directors
authorized a three-for-two stock split payable in the form of a
fifty percent stock dividend that was distributed on
February 24, 2003, to stockholders of record at the close
of business on February 6, 2003. We had approximately 15.8
million shares outstanding at the close of business on
February 6, 2003 and issued approximately 7.9 million
shares to our stockholders of record.

On July 18, 2003, we announced that our
Board of Directors authorized a second three-for-two stock split
payable in the form of a fifty percent stock dividend that was
distributed on August 12, 2003, to stockholders of record
at the close of business on July 28, 2003. We had
approximately 23.9 million shares outstanding at the close
of business on July 28, 2003 and issued approximately
12.0 million shares to our stockholders of record.

The payment of any future dividends will be at
the discretion of our board of directors and will depend on:



| |   |                                                                                   
| | - | ----------------------------------------------------------------------------------
| |  | any applicable contractual restrictions limiting
    our ability to pay dividends;
|
| |  | our earnings;                                                                     
|
| |  | our financial condition;                                                          
|
| |  | our ability to fund capital requirements; and                                     
|
| |  | other factors our board deems relevant.                                           

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 currently intend to retain future
earnings, if any, to fund our development and acquisition
initiatives.

Equity-Based Compensation Plans.The following table provides
information, as of December 31, 2003, about our common
stock that may be issued upon the exercise of options under the
Odyssey HealthCare, Inc. Stock Option Plan and the 2001
Equity-Based Compensation Plan.

33



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##### Table of Contents



EQUITY COMPENSATION PLAN INFORMATION

|                                                           |  |                                               |       |  |                   |               |               |                      |  |  |       | 
|---------------------------------------------------------- |  | --------------------------------------------- | ----- |  | ----------------- | ------------- | ------------- | -------------------- |  |  | ----- | 
|                                                           |  |                                               |       |  |                   | (c) Number of |              
|                                                           |  |                                               |       |  |                   | Securities    |              
|                                                           |  |                                               |       |  |                   | Remaining     |              
|                                                           |  | (a) Number of                                 |       |  |                   |               | Available for |                     
|                                                           |  | Securities to be                              |       |  | (b) Weighted-     |               |               | Future Issuance      | 
|                                                           |  | Issued Upon                                   |       |  | Average Exercise  |               |               | Under Equity         | 
|                                                           |  | Exercise of                                   |       |  | Price of          |               |               | Compensation         | 
|                                                           |  | Outstanding                                   |       |  | Outstanding       |               |               | Plans (Excluding     | 
|                                                           |  | Options, Warrants                             |       |  | Options, Warrants |               |               | Securities Reflected | 
|Plan Category                                              |  | and Rights                                    |       |  | and Rights        |               |               | in Column(a))        | 
|                                                           |  |                                               |       |  |                   |               |               |                      | 
|                                                           |  |                                              
|                                                           |  | (In thousands, except average exercise price) |      
|Equity Compensation Plans Approved by Stockholders         |  |                                               | 2,742 |  |                   | $             | 12.85         |                      |  |  | 1,745 | 
|Equity Compensation Plans Not Approved by
    Stockholders |  |                                               |      |  |                   |               |              |                      |  |  |      | 
|                                                           |  |                                               |       |  |                   |               |               |                      | 
|Total                                                      |  |                                               | 2,742 |  |                   | $             | 12.85         |                      |  |  | 1,745 | 
|                                                           |  |                                               |       |  |                   |               |               |                      | 

Recent Sales of Unregistered Securities. None.

Use of Proceeds from Initial Public Offering.On November 5, 2001, we completed
our initial public offering in which we registered and sold 4.1
million shares (including 0.5 million shares issued upon
the exercise of the underwriters option to purchase such
shares to cover overallotments) of our common stock at an
offering price of $15.00 (pre-splits) per share. The shares of
common stock sold in the offering were registered under the
Securities Act of 1933 on a Registration Statement on
Form S-1 (Registration No. 333-51522) that was
declared effective by the Securities and Exchange Commission on
October 30, 2001. Our managing underwriters were Merrill
Lynch, Pierce, Fenner & Smith Incorporated, CIBC World
Markets Corp. and SG Cowen Securities Corporation.

The aggregate gross proceeds to us from the
offering were $62.1 million. In connection with the
offering, we paid an aggregate of $4.3 million in
underwriting discounts and commissions to the underwriters. In
addition, the expenses incurred in connection with the offering
for legal costs, accounting costs, registration, filing and
other costs were approximately $1.8 million. The aggregate
net proceeds to us from the offering after these expenses were
$56.0 million. Subsequent to the offering, a portion of the
net proceeds from the offering was used to repay
$7.1 million, including accrued and unpaid interest, under
our credit agreement and to repay $10.6 million, including
accrued and unpaid interest, under our 12% senior subordinated
notes. Also during 2001, $1.5 million was used for the
acquisition of a hospice. During 2002, $21.0 million was
used for the acquisition of hospices and $8.3 million was
used for general corporate purposes. During 2003, the remaining
$7.5 million was used for the acquisition of hospices.




Item 6.     Selected
Financial Data

The selected consolidated statement of operations
data set forth below for the years ended December 31, 2001,
2002 and 2003 and the consolidated balance sheet data at
December 31, 2002 and 2003 are derived from our
consolidated financial statements that have been audited by
Ernst & Young LLP, and that are included elsewhere in this
Annual Report on Form 10-K, and are qualified by reference
to those consolidated financial statements. The selected
consolidated statement of operations data set forth below for
the years ended December 31, 1999 and 2000 and the
consolidated balance sheet data at December 31, 1999, 2000
and 2001 are derived from our consolidated financial statements
that have been audited by Ernst & Young LLP, but are not
included in this Annual Report on Form 10-K.

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The historical results presented below are not
necessarily indicative of the results to be expected for any
future period. You should read the selected financial
information set forth below in conjunction with
Item 7. Managements Discussion and Analysis of
Financial Condition and Results of Operations and our
consolidated financial statements and the notes thereto
appearing elsewhere in this Annual Report on Form 10-K. On
February 24, 2003 and August 12, 2003, the Company
completed two separate three-for-two stock splits each payable
in the form of a fifty percent stock dividend. All share
information has been adjusted for the stock dividends which are
more fully described in Item 5. Market for
Registrants Common Equity and Related Stockholder Matters
 Dividends.

|                                                                                                                                                                                                                                                                           |                                            |                         |        |           |      |   |        |            |  |   |         |            |  |      |         |            |  |   |         |            | 
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ----------------------- | ------ | --------- | ---- | - | ------ | ---------- |  | - | ------- | ---------- |  | ---- | ------- | ---------- |  | - | ------- | ---------- | 
|                                                                                                                                                                                                                                                                           |                                            |                        
|                                                                                                                                                                                                                                                                           |                                            | Year Ended December 31, |       
|                                                                                                                                                                                                                                                                           |                                            |                         |       
|                                                                                                                                                                                                                                                                           |                                            | 1999                    |        |           | 2000 |   |        | 2001       |  |   | 2002    |            |  | 2003 |        
|                                                                                                                                                                                                                                                                           |                                            |                         |        |           |      |   |        |            |  |   |         |            |  |      |        
|                                                                                                                                                                                                                                                                           |                                            |                        
|                                                                                                                                                                                                                                                                           |                                            | (Dollars in thousands)  |       
|Statements of Operations Data:                                                                                                                                                                                                                                             |                                            |                         |        |           |      |   |        |            |  |   |         |            |  |      |         |            |  |   |         |           
|Net patient service revenue                                                                                                                                                                                                                                                |                                            | $                       | 46,460 |           |      | $ | 85,271 |            |  | $ | 130,181 |            |  | $    | 194,459 |            |  | $ | 274,309 |           
|Operating expenses:                                                                                                                                                                                                                                                        |                                            |                         |        |           |      |   |        |            |  |   |         |            |  |      |         |            |  |   |         |           
|Direct hospice care                                                                                                                                                                                                                                                        |                                            |                         | 24,014 |           |      |   | 44,964 |            |  |   | 62,269  |            |  |      | 94,944  |            |  |   | 136,366 |           
|General and administrative (exclusive of $1.1
    million for both the years ended December 31, 2000 and 2001 and
    $0.7 and $0.4 million for the years ended December 31,
    2002 and 2003, respectively, reported separately as stock-based
    compensation charges) |                                            |                         | 18,873 |           |      |   | 28,375 |            |  |   | 43,043  |            |  |      | 60,414  |            |  |   | 80,181  |           
|Stock-based compensation charges                                                                                                                                                                                                                                           |                                            |                         |       |           |      |   | 1,113  |            |  |   | 1,112   |            |  |      | 685     |            |  |   | 409     |           
|Provision for uncollectible accounts                                                                                                                                                                                                                                       |                                            |                         | 2,031  |           |      |   | 2,708  |            |  |   | 3,207   |            |  |      | 2,952   |            |  |   | 4,015   |           
|Depreciation and amortization                                                                                                                                                                                                                                              |                                            |                         | 1,563  |           |      |   | 1,656  |            |  |   | 2,211   |            |  |      | 1,509   |            |  |   | 2,542   |           
|                                                                                                                                                                                                                                                                           |                                            |                         |        |           |      |   |        |            |  |   |         |            |  |      |        
|Total operating expenses                                                                                                                                                                                                                                                   |                                            |                         | 46,481 |           |      |   | 78,816 |            |  |   | 111,842 |            |  |      | 160,504 |            |  |   | 223,513 |           
|                                                                                                                                                                                                                                                                           |                                            |                         |        |           |      |   |        |            |  |   |         |            |  |      |        
|Income (loss) from operations                                                                                                                                                                                                                                              |                                            |                         | (21    | )         |      |   | 6,455  |            |  |   | 18,339  |            |  |      | 33,955  |            |  |   | 50,796  |           
|Other income (expense):                                                                                                                                                                                                                                                    |                                            |                         |        |           |      |   |        |            |  |   |         |            |  |      |         |            |  |   |         |           
|Minority interest                                                                                                                                                                                                                                                          |                                            |                         | (5     | )         |      |   | (46    | )          |  |   | (150    | )          |  |      | 50      |            |  |   |        |           
|Interest income                                                                                                                                                                                                                                                            |                                            |                         | 35     |           |      |   | 31     |            |  |   | 239     |            |  |      | 544     |            |  |   | 390     |           
|Interest expense                                                                                                                                                                                                                                                           |                                            |                         | (2,209 | )         |      |   | (2,931 | )          |  |   | (2,512  | )          |  |      | (269    | )          |  |   | (140    | )         
|                                                                                                                                                                                                                                                                           |                                            |                         |        |           |      |   |        |            |  |   |         |            |  |      |        
|                                                                                                                                                                                                                                                                           |                                            |                         | (2,179 | )         |      |   | (2,946 | )          |  |   | (2,423  | )          |  |      | 325     |            |  |   | 250     |           
|                                                                                                                                                                                                                                                                           |                                            |                         |        |           |      |   |        |            |  |   |         |            |  |      |        
|Income (loss) before provision for income
    taxes                                                                                                                                                                                                                        |                                            |                         | (2,200 | )         |      |   | 3,509  |            |  |   | 15,916  |            |  |      | 34,280  |            |  |   | 51,046  |           
|Provision for income taxes                                                                                                                                                                                                                                                 |                                            |                         |       |           |      |   | 417    |            |  |   | 3,020   |            |  |      | 13,140  |            |  |   | 19,839  |           
|                                                                                                                                                                                                                                                                           |                                            |                         |        |           |      |   |        |            |  |   |         |            |  |      |        
|Net income (loss)                                                                                                                                                                                                                                                          |                                            |                         | (2,200 | )         |      |   | 3,092  |            |  |   | 12,896  |            |  |      | 21,140  |            |  |   | 31,207  |           
|Preferred stock dividends                                                                                                                                                                                                                                                  |                                            |                         | (1,320 | )         |      |   | (1,302 | )          |  |   | (1,097  | )          |  |      |        |            |  |   |        |           
|Gain on conversion of preferred securities(1)                                                                                                                                                                                                                              |                                            |                         |       |           |      |   |       |            |  |   | 5,755   |            |  |      |        |            |  |   |        |           
|                                                                                                                                                                                                                                                                           |                                            |                         |        |           |      |   |        |            |  |   |         |            |  |      |        
|Net income (loss) available to common
    stockholders                                                                                                                                                                                                                     |                                            | $                       | (3,520 | )         |      | $ | 1,790  |            |  | $ | 17,554  |            |  | $    | 21,140  |            |  | $ | 31,207  |           
|                                                                                                                                                                                                                                                                           |                                            |                         |        |           |      |   |        |            |  |   |         |            |  |      |        
|Net income (loss) per common share:                                                                                                                                                                                                                                        |                                            |                         |        |           |      |   |        |            |  |   |         |            |  |      |         |            |  |   |         |           
|Basic net income (loss) per common share                                                                                                                                                                                                                                   |                                            | $                       | (0.81  | )         |      | $ | 0.41   |            |  | $ | 1.83    |            |  | $    | 0.61    |            |  | $ | 0.87    |           
|                                                                                                                                                                                                                                                                           |                                            |                         |        |           |      |   |        |            |  |   |         |            |  |      |        
|                                                                                                                                                                                                                                                                           | Diluted net income (loss) per common share |                         | $      | (0.81     | )    |   | $      | 0.11       |  |   | $       | 0.45       |  |      | $       | 0.58       |  |   | $       | 0.84       | 
|                                                                                                                                                                                                                                                                           |                                            |                         |        |           |      |   |        |            |  |   |         |            |  |      |        
|Weighted average shares outstanding:                                                                                                                                                                                                                                       |                                            |                         |        |           |      |   |        |            |  |   |         |            |  |      |         |            |  |   |         |           
|                                                                                                                                                                                                                                                                           | Basic                                      |                         |        | 4,372,194 |      |   |        | 4,379,900  |  |   |         | 9,552,654  |  |      |         | 34,781,331 |  |   |         | 35,944,844 | 
|                                                                                                                                                                                                                                                                           | Diluted                                    |                         |        | 4,372,194 |      |   |        | 26,595,525 |  |   |         | 28,620,512 |  |      |         | 36,691,449 |  |   |         | 37,256,252 | 

35



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|                                                          |  |                         |         |   |      |   |         |      |  |   |           |   |  |      |           |   |  |   |           |  
|--------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | --------- | - |  | ---- | --------- | - |  | - | --------- | -
|                                                          |  |                        
|                                                          |  | Year Ended December 31, |        
|                                                          |  |                         |        
|                                                          |  | 1999                    |         |   | 2000 |   |         | 2001 |  |   | 2002      |   |  | 2003 |          
|                                                          |  |                         |         |   |      |   |         |      |  |   |           |   |  |      |          
|                                                          |  |                        
|                                                          |  | (Unaudited)             |        
|                                                          |  | (Dollars in thousands)  |        
|Operating Data:                                           |  |                         |         |   |      |   |         |      |  |   |           |   |  |      |           |   |  |   |           |  
|Number of hospice programs(2)                             |  |                         | 30      |   |      |   | 32      |      |  |   | 42        |   |  |      | 58        |   |  |   | 75        |  
|Admissions(3)                                             |  |                         | 8,303   |   |      |   | 12,965  |      |  |   | 15,969    |   |  |      | 22,062    |   |  |   | 26,763    |  
|Days of care(4)                                           |  |                         | 422,577 |   |      |   | 737,088 |      |  |   | 1,111,168 |   |  |      | 1,608,556 |   |  |   | 2,197,110 |  
|Average daily census(5)                                   |  |                         | 1,158   |   |      |   | 2,014   |      |  |   | 3,044     |   |  |      | 4,407     |   |  |   | 6,019     |  
|Cash flows provided by (used in) operating
    activities |  | $                       | (1,588  | ) |      | $ | 3,520   |      |  | $ | 14,956    |   |  | $    | 18,732    |   |  | $ | 27,605    |  
|Cash flows used in investing activities                   |  | $                       | (5,340  | ) |      | $ | (1,503  | )    |  | $ | (31,001   | ) |  | $    | (28,348   | ) |  | $ | (40,088   | )
|Cash flows provided by (used in) financing
    activities |  | $                       | 6,702   |   |      | $ | (2,293  | )    |  | $ | 36,019    |   |  | $    | (2,724    | ) |  | $ | 4,983     |  

|                                                |  |                        |         |   |      |   |         |      |  |   |        |  |  |      |         |  |  |   |         | 
|----------------------------------------------- |  | ---------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------ |  |  | ---- | ------- |  |  | - | ------- | 
|                                                |  |                       
|                                                |  | As of December 31,     |        
|                                                |  |                        |        
|                                                |  | 1999                   |         |   | 2000 |   |         | 2001 |  |   | 2002   |  |  | 2003 |        
|                                                |  |                        |         |   |      |   |         |      |  |   |        |  |  |      |        
|                                                |  |                       
|                                                |  | (Dollars in thousands) |        
|Balance Sheet Data:                             |  |                        |         |   |      |   |         |      |  |   |        |  |  |      |         |  |  |   |         | 
|Working capital (deficit)                       |  | $                      | (2,356  | ) |      | $ | (1,691  | )    |  | $ | 50,363 |  |  | $    | 51,498  |  |  | $ | 72,806  | 
|Total assets                                    |  |                        | 31,925  |   |      |   | 38,845  |      |  |   | 98,216 |  |  |      | 125,414 |  |  |   | 179,558 | 
|Total long-term debt, including current portion |  |                        | 21,852  |   |      |   | 20,311  |      |  |   | 3,781  |  |  |      | 274     |  |  |   | 17      | 
|Total convertible preferred stock               |  |                        | 19,860  |   |      |   | 21,162  |      |  |   |       |  |  |      |        |  |  |   |        | 
|Stockholders equity (deficit)                  |  |                        | (16,657 | ) |      |   | (13,746 | )    |  |   | 77,635 |  |  |      | 100,933 |  |  |   | 144,725 | 



---



|    |                                                                                                                                                                                                                                                                                                                                                             
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The accumulated dividends on our Series A
    convertible preferred stock, Series B convertible preferred
    stock and Series C convertible preferred stock were
    reversed in connection with the conversion of preferred stock
    upon completion of our initial public offering and recognized as
    a gain to common stockholders.                 
|   
|(2) | Number of hospice programs at end of period.
    During 2003, we have begun development of Arlington, Virginia;
    Athens, Georgia; West Covina, California; Allentown,
    Pennsylvania; Harrisburg, Pennsylvania; Jackson, Mississippi;
    and Providence, Rhode Island. We acquired our Amarillo, Texas
    and Conroe, Texas programs in January 2004.
|   
|(3) | Represents the total number of patients admitted
    into our hospice program 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.                                                                                                                                                        






|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis
    of Financial Condition and Results of Operations

The following discussion of our financial
condition and results of operations should be read in
conjunction with our selected consolidated financial and
operating data and the consolidated financial statements and
related notes included elsewhere in this Annual Report on
Form 10-K.

Overview

We are one of the largest providers of hospice
care in the United States in terms of both average daily census
and number of hospice programs, that is, communities served. We
have grown rapidly since we opened our first hospice program in
January 1996. Through the development of new hospice programs
and a series of acquisitions, we now have 68 Medicare-certified
hospice providers to serve patients and their families in
29 states. We currently have 75 programs, including seven
programs under development, in 30 states. We operate all of our
hospice programs through our operating subsidiaries. Our net
patient service revenue of $274.3 million in 2003
represents an increase of 41.1% over net patient service revenue
of $194.5 million in 2002 and an increase of 110.7% over
net patient service revenue of $130.2 million in 2001. In
2001, 2002 and 2003, we reported net income of
$12.9 million, $21.1 million and $31.2 million,
respectively.

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On January 27, 2003, we announced that our
Board of Directors authorized a three-for-two stock split
payable in the form of a fifty percent stock dividend that was
distributed on February 24, 2003, to stockholders of record
at the close of business on February 6, 2003. We had
approximately 15.8 million shares of common stock
outstanding at the close of business on February 6, 2003
and issued approximately 7.9 million shares of common stock
to the stockholders of record.

On July 18, 2003, we announced that our
Board of Directors authorized a three-for-two stock split
payable in the form of a fifty percent stock dividend to be
distributed on August 12, 2003, to stockholders of record
at the close of business on July 28, 2003. We had
approximately 23.9 million shares of common stock
outstanding at the close of business on July 28, 2003 and
issued approximately 12.0 million shares of common stock to
the stockholders of record.

Developed Hospices

We have developed the following hospice programs
since January 1, 2001:

During 2001, we began development of four hospice
programs in Norfolk, Virginia; Chicago (South), Illinois; Tulsa,
Oklahoma and Austin, Texas.

During 2002, we continued development of the
Norfolk, Virginia; Chicago (South), Illinois; Tulsa, Oklahoma
and Austin, Texas hospice programs and began development of new
hospice programs in Montgomery, Alabama; St. Louis, Missouri;
Cleveland, Ohio and Big Spring, Texas. Our Norfolk, Virginia;
Chicago (South), Illinois; Tulsa, Oklahoma; Austin, Texas;
Montgomery, Alabama and St. Louis, Missouri hospice programs
have all become Medicare and Medicaid certified.

In 2003, we continued development of the
Cleveland, Ohio and Big Spring, Texas hospice programs and
started development of hospice programs in Philadelphia,
Pennsylvania; Richmond, Virginia; Cincinnati, Ohio; Portland,
Oregon; Santa Fe, New Mexico; Toledo, Ohio; Mobile, Alabama and
Fargo, North Dakota. Our Cleveland, Ohio; Big Spring, Texas;
Cincinnati, Ohio; Portland, Oregon and Mobile, Alabama hospice
programs have all become Medicare and Medicaid certified. Our
Philadelphia, Pennsylvania; Richmond, Virginia; Santa Fe, New
Mexico; Toledo, Ohio and Fargo, North Dakota hospice programs
have all become Medicare certified and are awaiting Medicaid
certification.

In 2004, we have started development of hospice
programs in Arlington, Virginia; Athens, Georgia; West Covina,
California; Allentown, Pennsylvania; Harrisburg, Pennsylvania;
Jackson, Mississippi and Providence, Rhode Island.

Acquisitions

We have acquired the following hospice programs
since January 1, 2001:

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

During 2002, we acquired twelve hospice programs
for a combined purchase price of $19.9 million, and also
acquired the remaining 33% interest in Hospice of Houston, L.P.
for $1.1 million. We financed our acquisitions in 2002,
including the interest in Hospice of Houston, with
$21.3 million in cash from the proceeds of our initial
public offering.

During 2003, we acquired eight hospice programs
for a combined purchase price of $22.4 million. We financed
our acquisitions in 2003 with the remaining $7.5 million in cash
from the proceeds of our initial public offering and $14.9
million in cash generated through our operations.

In January 2004, we acquired one hospice program
with two provider numbers for a combined purchase price of
$22.5 million. We financed our acquisition in 2004 with
cash generated through our operations.

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We accounted for these acquisitions as purchases.
See Note 3 to the consolidated financial statements
included elsewhere in this Annual Report on Form 10-K.

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

Goodwill from our hospice acquisitions was
$66.7 million as of December 31, 2003. Goodwill was 46.1%
of stockholders equity and 37.1% of total assets as of
December 31, 2003. During fiscal 2001 and prior years, we
amortized our goodwill over 20 years for acquisitions
completed through June 30, 2001 and did not amortize
goodwill for acquisitions subsequent to June 30, 2001.
Under new rules issued by the Financial Accounting Standards
Board, effective for fiscal 2002, goodwill and intangible assets
deemed to have indefinite lives are no longer amortized but are
subject to annual impairment tests in accordance with the new
rules. Other intangible assets continue to be amortized over
their useful lives. We are applying the new rules on accounting
for goodwill and other intangible assets. See Note 4 to our
consolidated financial statements included elsewhere in this
Annual Report on Form 10-K.

The following table lists our acquisitions since
January 1, 2001, and patient census data at acquisition:

|        |                              |             |  |     | 
|------- | ---------------------------- | ----------- |  | --- | 
|        |                              | Patient     | 
|        |                              | Census on   | 
|        |                              | Date of     | 
|Hospice |                              | Acquisition | 
|        |                              |             | 
|2001    |                              |             |  |    
|        | Little Rock, Arkansas        |             |  | 81  | 
|        | Colorado Springs, Colorado   |             |  | 30  | 
|        | Charleston, South Carolina   |             |  | 32  | 
|        | Beaumont, Texas              |             |  | 55  | 
|        | Pittsburgh, Pennsylvania (1) |             |  | 80  | 
|        | Palm Springs, California (2) |             |  | 68  | 
|        | Odessa, Texas                |             |  | 110 | 
|2002    |                              |             |  |    
|        | Baton Rouge, Louisiana       |             |  | 50  | 
|        | New Orleans, Louisiana       |             |  | 56  | 
|        | Shreveport, Louisiana        |             |  | 104 | 
|        | Columbus, Ohio               |             |  | 19  | 
|        | Bakersfield, California      |             |  | 11  | 
|        | Wichita, Kansas              |             |  | 0   | 
|        | Gulf Coast, Mississippi      |             |  | 38  | 
|        | Albuquerque, New Mexico      |             |  | 80  | 
|        | Omaha, Nebraska              |             |  | 3   | 
|        | Lake Charles, Louisiana      |             |  | 101 | 
|        | La Grange, Texas             |             |  | 20  | 
|        | Round Rock, Texas (3)        |             |  | 60  | 

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|        |                        |             |  |     | 
|------- | ---------------------- | ----------- |  | --- | 
|        |                        | Patient     | 
|        |                        | Census on   | 
|        |                        | Date of     | 
|Hospice |                        | Acquisition | 
|        |                        |             | 
|2003    |                        |             |  |    
|        | Waxahachie, Texas      |             |  | 104 | 
|        | Valdosta, Georgia      |             |  | 16  | 
|        | Memphis, Tennessee     |             |  | 8   | 
|        | Wilmington, Delaware   |             |  | 15  | 
|        | Brownsville, Texas     |             |  | 60  | 
|        | Salt Lake City, Utah   |             |  | 280 | 
|        | Omaha, Nebraska        |             |  | 35  | 
|        | San Antonio, Texas (4) |             |  | 100 | 
|2004    |                        |             |  |    
|        | Amarillo, Texas        |             |  | 204 | 
|        | Conroe, Texas          |             |  | 221 | 



---



|    |                                                                                                                                                                                                                                                                                                                  
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Operations of our Pittsburgh, Pennsylvania
    hospice program acquired in 2001 were transferred to our
    Pittsburgh, Pennsylvania hospice program opened in 1996.                                                                                                                                             
|   
|(2) | Operations of our Riverside, California hospice
    program acquired in 1999, were relocated to our San Bernardino,
    California hospice program acquired in 2001. Existing Riverside
    patients were split between our San Bernardino hospice program
    and a new program in Palm Springs, California.    
|   
|(3) | Patients of our Round Rock, Texas hospice, which
    we acquired in 2002, were relocated to our Austin, Texas hospice
    program, which we opened in 2002. The provider number for our
    Round Rock location was transferred to Temple, Texas in order
    for us to initiate a hospice program there in 2003.
|   
|(4) | Operations of our San Antonio, Texas hospice
    program acquired in 2003 were transferred to our existing San
    Antonio, Texas program opened in 1998.                                                                                                                                                        

Net Patient Service Revenue

Net patient service revenue is the estimated net
realizable revenue from patients, Medicare, Medicaid, commercial
insurance, managed care payors and others for services rendered.
Payors may determine that the services provided are not covered
and do not qualify for a payment or, for commercial payors, that
payments are subject to usual and customary rates. To determine
net patient service revenue, we adjust gross patient service
revenue for estimated payment denials and contractual
adjustments based on historical experience. We recognize net
patient service revenue in the month in which our services are
delivered. Services provided under the Medicare program
represented approximately 94.1%, 94.2% and 92.9% of our net
patient service revenue for the years ended December 31,
2001, 2002 and 2003, respectively. Services provided under
Medicaid programs represented approximately 3.1%, 3.3% and 4.1%
of our net patient service revenue for the years ended
December 31, 2001, 2002 and 2003, respectively. The
payments we receive from Medicare and Medicaid are calculated
using daily or hourly rates for each of the four levels of care
we deliver and are adjusted based on geographic location.

Routine home care is the largest component of our
gross patient service revenue, representing 88.7%, 89.8% and
89.5% of gross patient service revenue for the years ended
December 31, 2001, 2002 and 2003, respectively. Inpatient
care represented 9.0%, 8.3% and 8.7% of gross patient service
revenue for the years ended December 31, 2001, 2002 and
2003, respectively. Continuous care and respite care, combined,
represented most of the remaining 2.3%, 1.9% and 1.8% of gross
patient service revenue for these periods, respectively.

The principal factors that impact net patient
service revenue are our average daily census, levels of care
provided to our patients and changes in Medicare and Medicaid
payment rates due to adjustments for

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inflation. Average daily census is affected by
the number of patients referred and admitted into our hospice
program and average length of stay of those patients once
admitted. Average length of stay is impacted by patients
decisions of when to enroll in hospice care after diagnoses of
terminal illnesses and, once enrolled, the length of the
terminal illnesses. Our average hospice length of stay has
increased from 65 days in 2002 to 74 days in 2003.
This increase is, in part, related to a change in the patient
diagnosis mix, to increased admissions of non-cancer ailments,
whose lengths of stay are typically higher than those with
cancer related illnesses. See  Expenses
and
Item 1.     Business 
Hospice Industry and Market Opportunity.


Payment rates under Medicare and Medicaid are
indexed for inflation annually; however, the increases have
historically been less than actual inflation. On October 1,
2002 and 2003, the base Medicare payment rates for hospice care
increased by approximately 3.4% over the base rates previously
in effect. These rates were further adjusted geographically by
the hospice wage index. In the future, reductions in the rate of
increase in Medicare and Medicaid payments may have an adverse
impact on our net patient service revenue and profitability. See
Item 1.     Business 
Government Regulation  Overview of Government
Payments.

Expenses

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

For our patients receiving nursing home care
under a state Medicaid program who elect hospice care under
Medicare or Medicaid, we contract with nursing homes for room
and board services. The state must pay us, in addition to the
applicable Medicare or Medicaid hospice daily or hourly rate, an
amount equal to at least 95% of the Medicaid daily nursing home
rate for room and board furnished to the patient by the nursing
home. Under our standard nursing home contracts, we pay the
nursing home for these room and board services at the Medicaid
daily nursing home rate. We refer to these costs, net of
Medicaid payments, as nursing home costs, net. See
Note 1 to our consolidated financial statements included
elsewhere in this Annual Report on Form 10-K.

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

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The following table sets forth the percentage of
net patient service revenue represented by the items included in
direct hospice care expenses and general and administrative
expenses (exclusive of $1.1 million in 2001,
$0.7 million in 2002 and $0.4 million in 2003 reported
separately as stock-based compensation) for the periods
indicated:

|                                     |                                                                                         |                         |  |      |      |   |  |      |      |   |  |      |      |  
|------------------------------------ | --------------------------------------------------------------------------------------- | ----------------------- |  | ---- | ---- | - |  | ---- | ---- | - |  | ---- | ---- | -
|                                     |                                                                                         |                        
|                                     |                                                                                         | Year Ended December 31, | 
|                                     |                                                                                         |                         | 
|                                     |                                                                                         | 2001                    |  |      | 2002 |   |  | 2003 |     
|                                     |                                                                                         |                         |  |      |      |   |  |      |     
|Direct hospice care expenses:        |                                                                                         |                         |  |      |      |   |  |      |      |   |  |     
|                                     | Salaries and payroll taxes                                                              |                         |  | 27.2 | %    |   |  | 28.0 | %    |   |  | 28.6 | %   
|                                     | Pharmaceuticals                                                                         |                         |  | 7.1  |      |   |  | 6.9  |      |   |  | 6.9  |     
|                                     | Medical equipment and supplies                                                          |                         |  | 6.1  |      |   |  | 6.1  |      |   |  | 6.0  |     
|                                     | Inpatient costs                                                                         |                         |  | 2.0  |      |   |  | 2.3  |      |   |  | 2.9  |     
|                                     | Other (including nursing home costs, net)                                               |                         |  | 5.4  |      |   |  | 5.5  |      |   |  | 5.3  |     
|                                     |                                                                                         |                         |  |      |      |   |  |      |     
|                                     |                                                                                         | Total                   |  |      | 47.8 | % |  |      | 48.8 | % |  |      | 49.7 | %
|                                     |                                                                                         |                         |  |      |      |   |  |      |     
|General and administrative expenses: |                                                                                         |                         |  |      |      |   |  |      |      |   |  |     
|                                     | Salaries and benefits                                                                   |                         |  | 19.6 | %    |   |  | 18.6 | %    |   |  | 18.5 | %   
|                                     | Leases                                                                                  |                         |  | 2.8  |      |   |  | 2.7  |      |   |  | 2.5  |     
|                                     | Other (including bad debts, travel, office
    supplies, printing and equipment rental) |                         |  | 13.1 |      |   |  | 11.3 |      |   |  | 8.2  |     
|                                     |                                                                                         |                         |  |      |      |   |  |      |     
|                                     |                                                                                         | Total                   |  |      | 35.5 | % |  |      | 32.6 | % |  |      | 29.2 | %
|                                     |                                                                                         |                         |  |      |      |   |  |      |     

Stock-Based and Other Compensation
Charges

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

We have recorded deferred stock-based
compensation charges related to unvested stock options granted
to employees and directors during 2000 and 2001. Based on the
number of outstanding stock options granted during 2000 and
2001, we expect to amortize approximately $0.3 million of
deferred stock-based compensation during 2004 and in future
periods.

Upon completion of our initial public offering,
we forgave the repayment of promissory notes payable to us by
Richard R. Burnham, and David C. Gasmire, who at the
time of our initial public offering were Chairman and Chief
Executive Officer and President and Chief Operating Officer,
respectively. We recorded a compensation charge of
$0.2 million in connection with the forgiveness of these
notes in the fourth quarter of 2001.

Provision for Income Taxes

Our provision for income taxes consists of
current and deferred federal and state income tax expenses. We
estimate that our effective tax rate will be approximately 38.5%
during 2004. See Note 12 to our consolidated financial
statements included elsewhere in this Annual Report on
Form 10-K.

Critical Accounting Policies

Our significant accounting policies are more
fully described in Note 1 to our consolidated financial
statements included elsewhere in this Annual Report on
Form 10-K. Certain of our accounting policies are

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particularly important to the portrayal of our
financial position and results of operations included elsewhere
in this Annual Report on Form 10-K and require the
application of significant judgment by us; as a result, they are
subject to an inherent degree of uncertainty. In applying those
policies, we use our judgment to determine the appropriate
assumptions to be used in the determination of certain
estimates. Those estimates are based on our historical payment
experience, our observance of trends in the industry and
information available from other outside sources, as appropriate.


Net Patient
Service Revenue and Allowance for Uncollectible
Accounts

We report net patient service revenue at the
estimated net realizable amounts from patients, Medicare,
Medicaid, commercial insurance, managed care payors and others
for services rendered. Payors may determine that the services
provided are not covered and do not qualify for payment or, for
commercial payors, that payments are subject to usual and
customary rates. To determine net patient service revenue, we
adjust gross patient service revenue for estimated payment
denials and contractual adjustments based on historical
experience. We recognize net patient service revenue in the
month in which our services are delivered. Due to the complexity
of the laws and regulations affecting Medicare and Medicaid, a
reasonable possibility exists that recorded estimates could
change by a material amount in the future.

Overall payments made by Medicare to us are
subject to a cap amount calculated by the Medicare fiscal
intermediary at the end of the hospice cap period. The hospice
cap period runs from November 1st of each year through
October 31st of the following year. Total Medicare payments
to us during this period are compared to the cap amount for this
period. Payments in excess of the cap amount must be returned by
us to Medicare. The cap amount is calculated by multiplying the
number of beneficiaries electing hospice care during the period
by a statutory amount that is indexed for inflation. The cap
amount was $18,661 for the twelve-month period ending
October 31, 2003. The cap amount for the twelve month
period ending October 31, 2004 has not been established by
Medicare. Once established, the new cap amount will become
effective retroactively for all services performed since
November 1, 2003. The hospice cap amount is computed on a
program-by-program basis. Our net patient service revenue for
2003 was reduced by $1.2 million as a result of six of our
hospice programs exceeding the Medicare cap. We cannot assure
you that additional hospices will not exceed the cap amount in
the future.

We maintain a policy for reserving for
uncollectible accounts. We calculate the allowance for
uncollectible accounts based on a formula tied to the aging of
accounts receivable by payor class. We reserve for specific
accounts that are determined to be uncollectible when such
determinations are made. Accounts are written off when all
collection efforts are exhausted.

Insurance
Risks

General and professional liability costs for the
healthcare industry have increased and become more difficult to
estimate. In addition, insurance coverage for patient care
liabilities and other risks has become more difficult to obtain.
Insurance carriers often require companies to increase their
liability retention levels and pay higher policy premiums for
reduced coverage. In our consolidated financial statements, we
provide for liabilities associated with the uninsured portion of
our general and professional liability risks, based on our
experience, consultation with our attorneys and insurers, and
our existing insurance coverage.

Goodwill

Goodwill is the excess of the purchase price over
the fair value of identifiable assets acquired in an
acquisition. Prior to the adoption of Statement of Financial
Accounting Standards No. 142 Goodwill and Other
Intangible Assets (SFAS 142), goodwill
was amortized using the straight-line method, generally over
periods ranging from 20-25 years. After the adoption of
SFAS 142, we review goodwill for impairment annually during
the fourth quarter. We determine the fair value of the reporting
units using multiples of revenue. If the fair value of the
reporting unit is less than the carrying value, then an
indication of impairment exists. The amount of the impairment
would be the difference between the carrying amount of the
goodwill

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and the fair value of the goodwill. No impairment
charges have been recorded, but we cannot guarantee that
impairment charges will not impact our results of operations or
financial position in the future.


Results of Operations

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

|                            |                                                                                                                                                                                                 |                         |       |      |      |  |       |      |  |  |       |      | 
|--------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------- | ----- | ---- | ---- |  | ----- | ---- |  |  | ----- | ---- | 
|                            |                                                                                                                                                                                                 |                        
|                            |                                                                                                                                                                                                 | Year Ended December 31, |      
|                            |                                                                                                                                                                                                 |                         |      
|                            |                                                                                                                                                                                                 | 2001                    |       |      | 2002 |  |       | 2003 | 
|                            |                                                                                                                                                                                                 |                         |       |      |      |  |       |      | 
|Net patient service revenue |                                                                                                                                                                                                 |                         | 100.0 | %    |      |  | 100.0 | %    |  |  | 100.0 | %   
|Operating expenses:         |                                                                                                                                                                                                 |                         |       |      |      |  |       |      |  |  |       |     
|                            | Direct hospice care                                                                                                                                                                             |                         |       | 47.8 |      |  |       | 48.8 |  |  |       | 49.7 | 
|                            | General and administrative (exclusive of
    $1.1 million, $0.7 million and $0.4 million in 2001,
    2002 and 2003, respectively, reported separately as stock-based
    compensation charges) |                         |       | 33.0 |      |  |       | 31.1 |  |  |       | 29.2 | 
|                            | Stock-based compensation charges                                                                                                                                                                |                         |       | 0.9  |      |  |       | 0.3  |  |  |       | 0.1  | 
|                            | Provision for uncollectible accounts                                                                                                                                                            |                         |       | 2.5  |      |  |       | 1.5  |  |  |       | 1.5  | 
|                            | Depreciation and amortization                                                                                                                                                                   |                         |       | 1.7  |      |  |       | 0.8  |  |  |       | 1.0  | 
|                            |                                                                                                                                                                                                 |                         |       |      |      |  |       |      | 
|                            |                                                                                                                                                                                                 |                         | 85.9  |      |      |  | 82.5  |      |  |  | 81.5  |     
|                            |                                                                                                                                                                                                 |                         |       |      |      |  |       |      | 
|Income from operations      |                                                                                                                                                                                                 |                         | 14.1  |      |      |  | 17.5  |      |  |  | 18.5  |     
|Other income (expense), net |                                                                                                                                                                                                 |                         | (1.8  | )    |      |  | 0.2   |      |  |  | 0.1   |     
|                            |                                                                                                                                                                                                 |                         |       |      |      |  |       |      | 
|Income before income taxes  |                                                                                                                                                                                                 |                         | 12.3  |      |      |  | 17.7  |      |  |  | 18.6  |     
|Provision for income taxes  |                                                                                                                                                                                                 |                         | 2.4   |      |      |  | 6.8   |      |  |  | 7.2   |     
|                            |                                                                                                                                                                                                 |                         |       |      |      |  |       |      | 
|Net income                  |                                                                                                                                                                                                 |                         | 9.9   | %    |      |  | 10.9  | %    |  |  | 11.4  | %   
|                            |                                                                                                                                                                                                 |                         |       |      |      |  |       |      | 

Year Ended
December 31, 2003 Compared to Year Ended December 31,
2002

Net
Patient Service Revenue

Net patient service revenue increased
$79.9 million, or 41.1%, from $194.5 million in 2002 to
$274.3 million in 2003 due primarily to an increase in
average daily census of 1,612, or 36.6%, from 4,407 in 2002 to
6,019 in 2003. Increases in patient referrals from existing and
new referral sources, resulting in increased billable days, and,
to a lesser extent, increases in payment rates, provided
approximately $52.2 million, or 65.3%, of this increase in
net patient service revenue. The remaining increase of
$27.7 million, or 34.7%, in net patient service revenue was
due to the inclusion of net patient service revenue from hospice
programs acquired and developed in 2002 and 2003. Net patient
service revenue per day of care was $120.89 and $124.85 in 2002
and 2003, respectively. This increase was primarily due to
overall increases in Medicare payment rates for our hospice
services. Medicare and Medicaid payments represented 97.5% and
97.0% of our net patient service revenue in 2002 and 2003,
respectively.

Direct
Hospice Care Expenses

Direct hospice care expenses increased
$41.4 million, or 43.6%, from $94.9 million in 2002 to
$136.4 million in 2003. This increase was primarily due to
the growth of our operations at our existing hospice programs
and, to a lesser extent, to hospice programs acquired in 2002
and 2003. As a percentage of net patient service revenue, direct
hospice care expenses increased from 48.8% in 2002 to 49.7% in
2003 primarily due to the growth of our operations through
developed hospice programs.

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

General and administrative expenses increased
$19.8 million, or 32.7%, from $60.4 million in 2002 to
$80.2 million in 2003. This increase was due to the growth
of our operations, including hospice programs

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acquired after December 31, 2002, to support
our patient census growth during 2003. As a percentage of net
patient service revenue, general and administrative expenses
decreased from 31.1% in 2002 to 29.2% in 2003, due primarily to
our hospice program and corporate costs being spread over our
increased patient census and, to a lesser extent, overall
increases in Medicare payment rates.


Stock-Based
Compensation Charges

Stock-based compensation charges decreased
$0.3 million, or 40.3%, from $0.7 million in 2002 to
$0.4 million in 2003. These charges related to stock
options granted to management prior to our initial public
offering with exercise prices below the deemed fair value of our
common stock. See  Stock-Based and Other
Compensation Charges.

Provision
for Uncollectible Accounts

Our provision for uncollectible accounts
increased $1.1 million, or 36.0%, from $3.0 million in
2002 to $4.0 million in 2003, due primarily to our
increased net patient service revenue and to additional reserves
for estimated payment denials from Medicare. As a percentage of
net patient service revenue, our provision for uncollectible
accounts remained at 1.5% in both 2002 and 2003.

Depreciation
and Amortization Expense

Depreciation and amortization expense increased
$1.0 million, or 68.5%, from $1.5 million in 2002 to
$2.5 million in 2003. The increase was due to the
depreciation of additions in fixed assets and the amortization
of new intangible assets with a fixed life. As a percentage of
net patient service revenue, depreciation and amortization
expense increased from 0.8% in 2002 to 1.0% in 2003.

Other
Income (Expense)

Other income (expense) decreased
$0.1 million, or 23.1%, from income of $325,000 in 2002 to
income of $250,000 in 2003, due to a decrease in interest income
related to the use of investment funds for acquisitions in 2003
and the maturity of bond holdings in 2002. Also, we acquired the
minority interest in the Hospice of Houston in the third quarter
of 2002, reversing $50,000 of previously recorded minority
interest expense.

Provision
for Income Taxes

Our provision for income taxes was
$13.1 million and $19.8 million in 2002 and 2003,
respectively. We had an effective income tax rate of
approximately 38% and 39% in 2002 and 2003, respectively. The
difference between our effective income tax rate and the
statutory rate in each year is primarily attributable to state
income taxes.

Net
Income

Net income increased $10.1 million, from
$21.1 million in 2002 to $31.2 million in 2003.

Year Ended
December 31, 2002 Compared to Year Ended December 31,
2001

Net
Patient Service Revenue

Net patient service revenue increased
$64.3 million, or 49.4%, from $130.2 million in 2001 to
$194.5 million in 2002 due primarily to an increase in
average daily census of 1,363, or 44.8%, from 3,044 in 2001 to
4,407 in 2002. Increases in patient referrals from existing and
new referral sources, resulting in increased billable days, and,
to a lesser extent, increases in payment rates, provided
approximately $51.4 million, or 79.9%, of this increase in
net patient service revenue. The remaining increase of
$12.9 million, or 20.1%, in net patient service revenue was
due to the inclusion of net patient service revenue from hospice
programs acquired and developed in 2001 and 2002. Net patient
service revenue per day of care was $117.16 and $120.89 in 2001
and 2002, respectively. This increase was primarily due to
overall increases in Medicare payment rates for our hospice
services. Medicare and Medicaid payments represented 97.2% and
97.5% of our net patient service revenue in 2001 and 2002,
respectively.

44



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##### Table of Contents



Direct
Hospice Care Expenses

Direct hospice care expenses increased
$32.7 million, or 52.5%, from $62.3 million in 2001 to
$94.9 million in 2002. This increase was primarily due to
the growth of our operations at our existing hospice programs
and, to a lesser extent, to hospice programs acquired in 2001
and 2002. As a percentage of net patient service revenue, direct
hospice care expenses increased from 47.8% in 2001 to 48.8% in
2002 primarily due to the growth of our operations through
developed hospice programs.



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

General and administrative expenses increased
$17.4 million, or 40.4%, from $43.0 million in 2001 to
$60.4 million in 2002. This increase was due to the growth
of our operations, including hospice programs acquired after
December 31, 2001, to support our patient census growth
during 2002. As a percentage of net patient service revenue,
general and administrative expenses decreased from 33.0% in 2001
to 31.1% in 2002, due primarily to our hospice program and
corporate costs being spread over our increased patient census
and, to a lesser extent, overall increases in Medicare payment
rates.

Stock-Based
Compensation Charges

Stock-based compensation charges decreased
$0.4 million, or 38.4%, from $1.1 million in 2001 to
$0.7 million in 2002. These charges related to stock
options granted to management prior to our initial public
offering with exercise prices below the deemed fair value of our
common stock. See  Stock-Based and Other
Compensation Charges.

Provision
for Uncollectible Accounts

Our provision for uncollectible accounts
decreased $0.3 million, or 8.0%, from $3.2 million in
2001 to $3.0 million in 2002, due primarily to improved
collection efforts. As a percentage of net patient service
revenue, our provision for uncollectible accounts decreased from
2.5% in 2001 to 1.5% in 2002.

Depreciation
and Amortization Expense

Depreciation and amortization expense decreased
$0.7 million, or 31.8%, from $2.2 million in 2001 to
$1.5 million in 2002. The decrease was due to the adoption
of SFAS 142 in which goodwill is no longer amortized but
assessed for impairment at least annually. See Note 1 to the
consolidated financial statements included elsewhere in this
Annual Report on Form 10-K. As a percentage of net patient
service revenue, depreciation and amortization expense decreased
from 1.7% in 2001 to 0.8% in 2002.

Other
Income (Expense)

Other income (expense) increased
$2.7 million, or 113.4%, from an expense of
$2.4 million in 2001 to income of $0.3 million in
2002, due primarily to a decrease in interest expense as a
result of paying off our line of credit and certain seller notes
with proceeds received from our initial public offering, and by
an increase in interest income received from the investment from
the proceeds of our initial public offering. Also, we acquired
the minority interest in the Hospice of Houston in the third
quarter of 2002, reversing $50,000 of previously recorded
minority interest expense.

Provision
for Income Taxes

Our provision for income taxes was
$3.0 million and $13.1 million in 2001 and 2002,
respectively. We had an effective income tax rate of 19% and 38%
in 2001 and 2002, respectively. The difference between our
effective income tax rate and the statutory rate in each year is
primarily attributable to state income taxes and our use of net
operating loss carryforwards in 2001. In 2001, we fully utilized
our net operating loss carryforwards of $9.5 million. At
December 31, 2001, no valuation allowance was required for
our net deferred tax assets because the assets met the criteria
for recognition under Statement of Financial Accounting
Standards No. 109 Accounting for Income
Taxes(SFAS 109).

45



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##### Table of Contents



Net
Income

Net income increased $8.2 million, from
$12.9 million in 2001 to $21.1 million in 2002.

Liquidity and Capital Resources

Our principal liquidity requirements have
historically been for debt service, hospice acquisitions and
development plans, working capital and other capital
expenditures. We have historically financed these requirements
primarily with borrowings under our credit facility, proceeds
from the issuance of convertible preferred and common stock,
warrants and debt, seller financing of hospice acquisitions,
operating and capital leases, normal trade credit terms, and
since 2000, with cash flows from operations. At
December 31, 2003, we had cash and cash equivalents of
$0.2 million and working capital of $72.8 million. At
such date, we also had short-term investments of
$38.7 million.

In November 2001, we raised $56.0 million in
net proceeds from our initial public offering, of which
$7.1 million was used to repay all outstanding indebtedness
under our revolving line of credit and $10.6 million was
used to repay our 12% senior subordinated notes.

Cash provided by operating activities was
$15.0 million, $18.7 million and $27.6 million
for the years ended December 31, 2001, 2002 and 2003,
respectively. The increase in cash provided by operating
activities in 2001, 2002 and 2003 was primarily attributable to
the increase in net income during those periods, partially
offset by increases in non-cash working capital requirements due
to the growth of our business.

Investing activities, consisting primarily of
cash paid to purchase hospices and property and equipment, and
also to establish short-term investments, used cash of
$31.0 million, $28.3 million and $40.1 million
for the years ended December 31, 2001, 2002 and 2003,
respectively.

Net cash provided by (used in) financing
activities was $36.0 million, $(2.7) million and
$5.0 million for the years ended December 31, 2001,
2002 and 2003, respectively, and represented payments on
acquisition notes and proceeds from the sale of capital stock,
warrants, and in 2001, net borrowings under our credit agreement
and our 12% senior subordinated notes. Net cash provided by
financing activities in 2001 included $56.0 million in net
proceeds from our initial public offering.

We made a principal payment of $0.8 million
on our 12% senior subordinated notes in June 2001 and a second
principal payment of $0.7 million in September 2001. We
paid $1.6 million in accrued interest on these notes in
2001. We used $10.6 million of the proceeds from our
initial public offering to repay the notes in full in November
2001.

In connection with our acquisition of a hospice
program in November 2000, we issued a promissory note payable to
the seller in the principal amount of $0.5 million bearing
interest at the rate of 8% per annum. In November 2001, we paid
the seller $0.2 million of the outstanding principal
balance, plus accrued and unpaid interest of $0.1 million.
The remaining principal amount of $0.3 million, plus
accrued and unpaid interest, was paid in May 2002.

In connection with our acquisition of seven
hospice programs in 2001, we paid an aggregate of
$8.2 million in cash and issued promissory notes payable to
the sellers in the aggregate principal amount of
$3.1 million. During the first quarter of 2002, we repaid
in full the principal balance of one note and all accrued and
unpaid interest in the aggregate amount of $0.3 million.
During the second quarter of 2002, we repaid in full the
principal balance and all accrued and unpaid interest relating
to one note in the aggregate amount of $0.5 million and
also repaid principal and accrued and unpaid interest relating
to three notes in the aggregate amount of $1.1 million.
During the third quarter of 2002, we repaid in full the
principal balance and all accrued and unpaid interest relating
to three notes in the aggregate amount of $1.0 million.
During the first quarter of 2003, we repaid in full the
principal balance and all accrued and unpaid interest relating
to one note in the aggregate amount of $0.3 million.

Our credit agreement with Heller Healthcare
Finance, Inc. provided us with a $20 million revolving line
of credit for working capital, acquisitions and general
corporate purposes. Borrowings outstanding under our revolving
line of credit bore interest at fluctuating rates equal to 1.0%
above the prime rate of interest

46



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##### Table of Contents



designated by Citibank, with a floor of 10% per
annum. Our revolving line of credit matured on October 2,
2003. At that time, we let our line of credit expire. Our
revolving line of credit was secured by all of our accounts
receivable and any other right to payment for goods sold or
leased or services rendered by us and all other property in our
possession or under our control. We and our subsidiaries were
subject to affirmative and negative covenants under the credit
agreement.


We were in full compliance with our financial and
other covenants as of October 2, 2003.

In February 2004, we signed a commitment letter
for a new revolving line of credit with General Electric Capital
Corporation and one of their affiliates that would provide us
with a $50 million revolving line of credit to fund future
acquisitions, working capital, capital expenditures, and general
corporate purposes. Borrowings outstanding under the revolving
line of credit will bear interest at LIBOR plus 2.5% or the
higher of prime or 50 basis points over the federal funds
rate plus .50%. The revolving line of credit will mature
36 months from the date of closing of the financing. The
revolving line of credit will have a facility fee of 0.375% per
annum and an annual monitoring fee of $30,000. Our revolving
line of credit will be secured by substantially all existing and
after-acquired personal property assets and all after-acquired
real property assets of ours and our subsidiaries. We and our
subsidiaries will be subject to affirmative and negative
covenants under the credit agreement. The closing of the
revolving line of credit is subject to various conditions,
including the negotiation and delivery of definitive loan
documents. We cannot assure that these closing conditions will
be satisfied or that the revolving line of credit will be
completed.

Contractual Obligations

We have various contractual obligations at
December 31, 2003 that could impact our liquidity as
summarized below:

|                              |  |                        |        |           |        |   |       |           |       |   |           |  |  |         |       |  |  |   |       | 
|----------------------------- |  | ---------------------- | ------ | --------- | ------ | - | ----- | --------- | ----- | - | --------- |  |  | ------- | ----- |  |  | - | ----- | 
|                              |  |                       
|                              |  | Payments Due by Period |       
|                              |  |                        |       
|                              |  |                        |        | Less Than |        |   |       |           | After |  
|                              |  | Total                  |        |           | 1 Year |   |       | 1-3 Years |       |   | 4-5 Years |  |  | 5 Years |      
|                              |  |                        |        |           |        |   |       |           |       |   |           |  |  |         |      
|                              |  |                       
|                              |  | (In thousands)         |       
|Long-Term Debt                |  | $                      | 17     |           |        | $ | 4     |           |       | $ | 10        |  |  | $       | 3     |  |  | $ |      | 
|Operating Leases              |  |                        | 32,168 |           |        |   | 6,872 |           |       |   | 12,106    |  |  |         | 6,555 |  |  |   | 6,635 | 
|                              |  |                        |        |           |        |   |       |           |       |   |           |  |  |         |      
|Total Contractual Obligations |  | $                      | 32,185 |           |        | $ | 6,876 |           |       | $ | 12,116    |  |  | $       | 6,558 |  |  | $ | 6,635 | 
|                              |  |                        |        |           |        |   |       |           |       |   |           |  |  |         |      

We expect that our principal liquidity
requirements will be for working capital, development plans,
anticipated hospice acquisitions, debt service and other
anticipated capital expenditures. We expect that our existing
funds, cash flows from operations and borrowings under our new
credit agreement will be sufficient to fund our principal
liquidity requirements for at least 12 months following the date
of this Annual Report on Form 10-K. Our future liquidity
requirements and the adequacy of our available funds will depend
on many factors, including payment for our services, regulatory
changes and compliance with new regulations, expense levels,
capital expenditures and future development of new hospice
programs and acquisitions.

Payment, Legislative and Regulatory
Changes

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

Inflation

The healthcare industry is labor intensive. Wages
and other expenses increase during periods of inflation and when
labor shortages occur in the marketplace. In addition, suppliers
pass along rising costs to us in the form of higher prices. We
have implemented cost control measures designed to curb
increases in operating

47



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##### Table of Contents



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


Recent Accounting Pronouncements

In April 2002, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards
No. 145 Rescission of FASB Statements No. 4, 44,
and 64, Amendment of FASB Statement No. 13, and Technical
Corrections (SFAS 145), which is required
to be applied in fiscal years beginning after May 15, 2002,
with early application encouraged. SFAS 145 rescinds
Statement of Financial Accounting Standards No. 4
Reporting Gains and Losses From Extinguishment of
Debt. SFAS 145 requires any gains or losses on
extinguishment of debt that were classified as an extraordinary
item in prior periods that do not meet the criteria in
APB 30 for classification as an extraordinary item be
reclassified into income from operations. We adopted the
provisions of SFAS 145 on January 1, 2003. The impact
of adoption of SFAS 145 reduced income from operations by
$0.6 million for the year ended December 31, 2001
through the reclassification of the loss on extinguishment of
debt to general and administrative expenses.

In April 2003, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards
No. 149 Amendment of SFAS 133 on Derivative
Instruments and Hedging Activities
(SFAS 149). SFAS 149 amends and clarifies
financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other
contracts and for hedging activities under Statement of
Financial Accounting Standards No. 133 Accounting for
Derivative Instruments and Hedging Activities.
SFAS 149 is effective for contracts entered into or
modified after June 30, 2003. The adoption of SFAS 149
did not have a material impact on our results of operations or
financial position.

In May 2003, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards
No. 150 Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity
(SFAS 150). SFAS 150 establishes standards
for how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity.
SFAS 150 is effective for financial instruments entered
into or modified after May 31, 2003, and otherwise is
effective beginning after July 1, 2003. On October 29,
2003, the Financial Accounting Standards Board voted to defer
for an indefinite period the application of SFAS 150 to
classification on non-controlling interests of limited-life
subsidiaries. The adoption of SFAS 150 did not have a
material impact on our results of operations or financial
position.

Contingencies

Our current general and professional liability
policy does not provide coverage for claims that arise from acts
that occurred prior to the policys start date of
April 12, 2000. From March 12, 1999 to April 12,
2000, Reliance National Insurance Company provided our insurance
coverage. Since April 12, 2000, Lexington Insurance
Company, a subsidiary of American International Group, Inc., has
provided our insurance coverage. During the fourth quarter of
2001, the Insurance Commissioner of the Commonwealth of
Pennsylvania placed Reliance National Insurance Company in
liquidation. Based on our estimation of open claims, we are
maintaining a reserve to cover potential losses resulting from
current and future litigation claims covered by Reliance
National Insurance Company to the extent its assets are not
sufficient to pay such claims. Although we believe that the
amount reserved is adequate to cover our potential losses, there
can be no assurance that our losses will not exceed the amount
reserved. Our profitability will be negatively impacted to the
extent our actual losses exceed the amount reserved.






|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures
    About Market Risk

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

48



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##### Table of Contents








|        |                                                
|------- | -----------------------------------------------
|Item 8. | Financial Statements and Supplementary
    Data

Reference is made to the Index to Consolidated
Financial Statements on page F-1 of this Annual Report on
Form 10-K for a listing of our consolidated financial
statements and related notes thereto. All financial statement
schedules are omitted because the required information is not
present, not present in material amounts or is presented within
the consolidated financial statements.






|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements With
    Accountants on Accounting and Financial Disclosure

None.






|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

Our Chief Executive Officer and Chief Financial
Officer have reviewed and evaluated the effectiveness of our
disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange
Act of 1934) as of December 31, 2003, and based on such
evaluation have concluded that such disclosure controls and
procedures are effective in timely alerting them to material
information that is required to be disclosed in the periodic
reports we file or submit under the Securities Exchange Act of
1934. There have been no changes in our internal control over
financial reporting (as defined in Rules 13a-15(f) and
15a-15(f) under the Securities Exchange Act of 1934) that
occurred during the quarter ended December 31, 2003, that
has materially affected or is reasonably likely to materially
affect our internal control over financial reporting.




PART III






|         |                                                       
|-------- | ------------------------------------------------------
|Item 10. | Directors and Executive Officers of the
    Registrant

The information set forth under the headings
Proposal One  Election of Class III
Directors, Directors, Code of
Ethics, Meetings and Committees of Directors,
Executive Officers and Section 16(a)
Beneficial Ownership Reporting Compliance contained in our
definitive Proxy Statement to be filed pursuant to
Regulation 14A of the Securities Exchange Act of 1934 (the
Exchange Act) in connection with our 2004 Annual
Meeting of Stockholders is incorporated herein by reference.






|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation

The information set forth under the headings
Executive Compensation, Compensation Committee
Interlocks and Insider Participation, Compensation
Committee Report on Executive Compensation and
Performance Graph contained in our definitive Proxy
Statement to be filed pursuant to Regulation 14A of the
Exchange Act in connection with our 2004 Annual Meeting of
Stockholders is incorporated herein by reference.






|         |                                                                                                       
|-------- | ------------------------------------------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial
    Owners and Management and Related Stockholder
    Matters

The information set forth under the heading
Security Ownership of Principal Stockholders and
Management contained in our definitive Proxy Statement to
be filed pursuant to Regulation 14A of the Exchange Act in
connection with our 2004 Annual Meeting of Stockholders is
incorporated herein by reference.

For information regarding common stock to be
issued pursuant to equity-based compensation plans, see
Item 5.     Market for
Registrants Common Equity and Related Stockholder
Matters.






|         |                                                   
|-------- | --------------------------------------------------
|Item 13. | Certain Relationships and Related
    Transactions

The information set forth under the headings
Executive Compensation and Certain
Relationships and Related Transactions contained in our
definitive Proxy Statement to be filed pursuant to
Regulation 14A of

49



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##### Table of Contents



the Exchange Act in connection with our 2004
Annual Meeting of Stockholders is incorporated herein by
reference.







|         |                                           
|-------- | ------------------------------------------
|Item 14. | Principal Accountant Fees and
    Services

The information set forth under the heading
Fees Paid to Independent Auditors contained in our
definitive Proxy Statement to be filed pursuant to
Regulation 14A of the Exchange Act in connection with our
2004 Annual Meeting of Stockholders is incorporated herein by
reference.




PART IV






|         |                                                                    
|-------- | -------------------------------------------------------------------
|Item 15. | Exhibits, Financial Statement Schedules and
    Reports on Form 8-K

(a) The following documents are filed as
part of this Annual Report on Form 10-K:



| |                                                                                                                                                                                                       
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) The financial statements filed as part
    of this Annual Report on Form 10-K are listed in the Index
    to Consolidated Financial Statements on page F-1 of this
    Annual Report on Form 10-K.
|
| | (2) All financial statement schedules are
    omitted because the required information is not present, not
    present in material amounts or is presented within the financial
    statements.       
|
| | (3) The following documents are filed or
    incorporated by reference as exhibits to this Annual Report on
    Form 10-K:                                                                            

|        |        |  |  |   |             |                                                                                                                                                                                                                                                                                                                                                                                                     
|------- | ------ |  |  | - | ----------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |        |  |  |   |            
|Number  |        |  |  |   | Description
|        |        |  |  |   |            
|        | 3.1    |  |  |  |             | Fifth Amended and Restated Certificate of
    Incorporation (incorporated by reference to Exhibit 3.1 to
    the Companys Amendment No. 2 to Registration
    Statement on Form S-1 (Registration No. 333-51522) as
    filed with the Commission on September 13, 2001)                                                                                                                           
|        | 3.2    |  |  |  |             | Second Amended and Restated Bylaws (incorporated
    by reference to Exhibit 3.2 to the Companys
    Registration Statement on Form S-1 (Registration
    No. 333-51522) as filed with the Commission on
    December 8, 2000)                                                                                                                                                                     
|        | 4.1    |  |  |  |             | Form of Common Stock Certificate (incorporated by
    reference to Exhibit 4.1 to the Companys Amendment
    No. 1 to Registration Statement on Form S-1
    (Registration No. 333-51522) as filed with the Commission
    on August 2, 2001)                                                                                                                                                      
|        | 4.2    |  |  |  |             | Second Amended and Restated Registration Rights
    Agreement, dated July 1, 1998, by and among Odyssey
    HealthCare, Inc. and the security holders named therein
    (incorporated by reference to Exhibit 4.3 to the
    Companys Registration Statement on Form S-1
    (Registration No. 333-51522) as filed with the Commission
    on December 8, 2000)                                    
|        | 4.3    |  |  |  |             | Rights Agreement (the Rights
    Agreement) dated November 5, 2001, between Odyssey
    HealthCare, Inc. and Rights Agent (incorporated by reference to
    Exhibit 4.1 to the Companys Registration Statement on
    Form 8-A as filed with the Commission on December 8,
    2001)                                                                                                             
|        | 4.4    |  |  |  |             | Form of Certificate of Designation of
    Series A Junior Participating Preferred Stock (included as
    Exhibit A to the Rights Agreement (Exhibit 4.3 hereto))                                                                                                                                                                                                                                    
|        | 10.1.1 |  |  |  |             | Amended and Restated Loan and Security Agreement,
    dated October 2, 2000 (the Credit Agreement),
    by and among Odyssey HealthCare, Inc. and subsidiaries and
    Heller Healthcare Finance, Inc. (incorporated by reference to
    Exhibit 10.1.1 to the Companys Registration Statement
    on Form S-1 (Registration No. 333-51522) as filed with
    the Commission on December 8, 2000)
|        | 10.1.2 |  |  |  |             | First Amendment to the Credit Agreement, dated
    March 29, 2001 (incorporated by reference to
    Exhibit 10.1.2 to the Companys Amendment No. 1
    to Registration Statement on Form S-1 (Registration
    No. 333-51522) as filed with the Commission on
    August 2, 2001)                                                                                                                  
|        | 10.1.3 |  |  |  |             | Second Amendment to Credit Agreement, dated
    May 8, 2001 (incorporated by reference to
    Exhibit 10.1.3 to the Companys Amendment No. 2
    to Registration Statement on Form S-1 (Registration
    No. 333-51522) as filed with the Commission on
    September 13, 2001)                                                                                                                    

50



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|        |        |  |  |   |             |                                                                                                                                                                                                                                                                                                                                             
|------- | ------ |  |  | - | ----------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |        |  |  |   |            
|Number  |        |  |  |   | Description
|        |        |  |  |   |            
|        | 10.2   |  |  |  |             | Amended and Restated Employment Agreement,
    effective as of February 28, 2002, by and between Odyssey
    HealthCare, Inc. and Richard R. Burnham (incorporated by
    reference to Exhibit 10.2 to the Companys Annual
    Report on Form 10-K as filed with the Commission on
    March 20, 2002)                                     
|        | 10.3   |  |  |  |             | Amended and Restated Employment Agreement,
    effective as of February 28, 2002, by and between Odyssey
    HealthCare, Inc. and David C. Gasmire (incorporated by
    reference to Exhibit 10.3 to the Companys Annual
    Report on Form 10-K as filed with the Commission on
    March 20, 2002)                                       
|        | 10.4   |  |  |  |             | Amended and Restated Employment Agreement,
    effective as of February 28, 2002, by and between Odyssey
    HealthCare, Inc. and Douglas B. Cannon (incorporated by
    reference to Exhibit 10.4 to the Companys Annual
    report on Form 10-K as filed with the Commission on
    March 20, 2002)                                      
|        | 10.5.1 |  |  |  |             | Odyssey HealthCare, Inc. Stock Option Plan (the
    Stock Option Plan) (incorporated by reference to
    Exhibit 10.5 to the Companys Registration Statement
    on Form S-1 (Registration No. 333-51522) as filed with
    the Commission on December 8, 2000)                                                                          
|        | 10.5.2 |  |  |  |             | First Amendment to the Stock Option Plan, dated
    January 31, 2001 (incorporated by reference to
    Exhibit 10.5.2 to the Companys Amendment No. 2
    to Registration Statement on Form S-1 (Registration
    No. 333-51522) as filed with the Commission on
    September 13, 2001)                                                   
|        | 10.6   |  |  |  |             | 2001 Equity-Based Compensation Plan (incorporated
    by reference to Exhibit 10.6 to the Companys
    Amendment No. 2 to Registration Statement on Form S-1
    (Registration No. 333-51522) as filed with the Commission
    on September 13, 2001)                                                                                      
|        | 10.7.1 |  |  |  |             | Employee Stock Purchase Plan (incorporated by
    reference to Exhibit 10.7 to the Companys Amendment
    No. 2 to Registration Statement on Form S-1
    (Registration No. 333-51522) as filed with the Commission
    on September 13, 2001)                                                                                             
|        | 10.7.2 |  |  |  |             | First Amendment to Employee Stock Purchase Plan,
    dated March 6, 2002 (incorporated by reference to
    Exhibit 10.7.2 to the Companys Annual Report on
    Form 10-K as filed with the Commission on March 20,
    2002)                                                                                                               
|        | 10.8   |  |  |  |             | Form of Indemnification Agreement between Odyssey
    HealthCare, Inc. and its directors and officers (incorporated by
    reference to Exhibit 10.8 to the Companys
    Registration Statement on Form S-1 (Registration
    No. 333-51522) as filed with the Commission on
    December 8, 2000)                                         
|        | 10.9.1 |  |  |  |             | Promissory Note and Warrant Purchase Agreement,
    dated May 22, 1998, by and among Odyssey HealthCare, Inc. and
    the other parties thereto (incorporated by reference to
    Exhibit 10.10.1 to the Companys Registration
    Statement on Form S-1 (Registration No. 333-51522) as
    filed with the Commission on December 8, 2000)
|        | 10.9.2 |  |  |  |             | Form of Warrant, dated May 22, 1998
    (incorporated by reference to Exhibit 10.10.2 to the
    Companys Registration Statement on Form S-1
    (Registration No. 333-51522) as filed with the Commission
    on December 8, 2000)                                                                                                        
|        | 10.9.3 |  |  |  |             | First Amendment to Warrants, dated
    December 6, 2000 (incorporated by reference to
    Exhibit 10.10.3 to the Companys Amendment No. 1
    to Registration Statement on Form S-1 (Registration
    No. 333-51522) as filed with the Commission on
    August 2, 2001)                                                                   
|        | 21     |  |  |  |             | Subsidiaries of Odyssey HealthCare, Inc. *                                                                                                                                                                                                                                                                                                  
|        | 23.1   |  |  |  |             | Consent of Ernst & Young LLP *                                                                                                                                                                                                                                                                                                              
|        | 31.1   |  |  |  |             | Certification required by Rule 13a-14(a),
    dated March 11, 2004, by David C. Gasmire, Chief
    Executive Officer *                                                                                                                                                                                                                      
|        | 31.2   |  |  |  |             | Certification required by Rule 13a-14(a),
    dated March 11, 2004, by Douglas B. Cannon, Chief
    Financial Officer *                                                                                                                                                                                                                     
|        | 32     |  |  |  |             | Certification required by Rule 13a-14(a),
    dated March 11, 2004, by David C. Gasmire, Chief
    Executive Officer, and Douglas B. Cannon, Chief Financial
    Officer *                                                                                                                                                                  



---



|  |                
|- | ---------------
|* | Filed herewith.

51



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##### Table of Contents



(b) We filed the following report on
Form 8-K during the quarterly period ended
December 31, 2003:



| |                                                                                                                                                                                                                             
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) Current report on Form 8-K
    (Item 12), furnished November 3, 2003, announcing the
    quarterly consolidated financial results of the Company for the
    third quarter and the nine months ended September 30, 2003.

(c) The exhibits required by Item 601
of Regulation S-K are filed as part of this Annual Report
on Form 10-K.

(d) The required financial statements and
financial statement schedules are filed as part of this Annual
Report on Form 10-K.

52



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##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) of the Securities Exchange Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.



| |                         
| | ------------------------
| | ODYSSEY HEALTHCARE, INC.



| |     |                     
| | --- | --------------------
| | By: | /s/ DAVID C. GASMIRE

| |                                          
| | -----------------------------------------
| |                                          
| | David C. Gasmire                         
| | President and Chief Executive
    Officer

Date: March 11, 2004

Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed below by the
following persons on behalf of registrant and in the capacities
and on the dates indicated:

|                                         |  |                                                                                                                              |  |                |  | 
|---------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------- |  | -------------- |  | 
|                                         |  |                                                                                                                              |  |               
|Signature                                |  | Title                                                                                                                        |  | Date          
|                                         |  |                                                                                                                              |  |               
|                                        
|/s/ RICHARD R. BURNHAMRichard R. Burnham |  | Chairman of the Board                                                                                                        |  | March 11, 2004
|                                        
|/s/ DAVID C. GASMIREDavid C. Gasmire     |  | President, Chief Executive Officer and Assistant
    Secretary                                                               |  | March 11, 2004
|                                        
|/s/ DOUGLAS B. CANNONDouglas B. Cannon   |  | Senior Vice President, Chief Financial Officer,
    Secretary and Treasurer (Principal Financial and Accounting
    Officer) |  | March 11, 2004
|                                        
|/s/ JOHN K. CARLYLEJohn K. Carlyle       |  | Director                                                                                                                     |  | March 11, 2004
|                                        
|/s/ DAVID W. CROSSDavid W. Cross         |  | Director                                                                                                                     |  | March 11, 2004
|                                        
|/s/ PAUL J. FELDSTEINPaul J. Feldstein   |  | Director                                                                                                                     |  | March 11, 2004
|                                        
|/s/ MARTIN S. RASHMartin S. Rash         |  | Director                                                                                                                     |  | March 11, 2004
|                                        
|/s/ SHAWN S. SCHABELShawn S. Schabel     |  | Director                                                                                                                     |  | March 11, 2004
|                                        
|/s/ DAVID L. STEFFYDavid L. Steffy       |  | Director                                                                                                                     |  | March 11, 2004

53



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ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL
STATEMENTS

|                                                                                                                                           |  |      |     | 
|------------------------------------------------------------------------------------------------------------------------------------------ |  | ---- | --- | 
|                                                                                                                                           |  | Page |    
|                                                                                                                                           |  |      |    
|Odyssey HealthCare, Inc.                                                                                                                   |  |      |     | 
|Report of Ernst & Young LLP, Independent
    Auditors                                                                                      |  |      | F-2 | 
|Consolidated Balance Sheets as of
    December 31, 2002 and 2003                                                                           |  |      | F-3 | 
|Consolidated Statements of Operations for the
    years ended December 31, 2001, 2002 and 2003                                             |  |      | F-4 | 
|Consolidated Statements of Preferred Stock and
    Stockholders Equity (Deficit) for the years ended
    December 31, 2001, 2002 and 2003 |  |      | F-5 | 
|Consolidated Statements of Cash Flows for the
    years ended December 31, 2001, 2002 and 2003                                             |  |      | F-6 | 
|Notes to Consolidated Financial Statements                                                                                                 |  |      | F-7 | 

F-1



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##### Table of Contents



REPORT OF ERNST & YOUNG LLP, INDEPENDENT
AUDITORS

Board of Directors and Stockholders

Odyssey HealthCare, Inc.


We have audited the accompanying consolidated
balance sheets of Odyssey HealthCare, Inc. and subsidiaries (the
Company) as of December 31, 2002 and 2003, and the related
consolidated statements of operations, preferred stock and
stockholders equity (deficit), and cash flows for each of
the three years in the period ended December 31, 2003.
These financial statements are the responsibility of the
Companys management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance with
auditing standards generally accepted in the United States.
Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In our opinion, the consolidated financial
statements referred to above present fairly, in all material
respects, the financial position of Odyssey HealthCare, Inc. and
subsidiaries as of December 31, 2002 and 2003, and the
results of their operations and their cash flows for each of the
three years in the period ended December 31, 2003, in
conformity with accounting principles generally accepted in the
United States.

As discussed in Note 1 to the consolidated
financial statements, effective January 1, 2002, the
Company changed its method of accounting for goodwill and other
intangible assets.



| |                      
| | ---------------------
| | /S/ ERNST & YOUNG LLP

Dallas, Texas

February 6, 2004


F-2



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##### Table of Contents



ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

|                                                                          |                                                                                                                                                                 |                                                                                                                                            |                                            |        |      |         |        |        |    |         | 
|------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------------------------ | ------ | ---- | ------- | ------ | ------ | -- | ------- | 
|                                                                          |                                                                                                                                                                 |                                                                                                                                           
|                                                                          |                                                                                                                                                                 | December 31,                                                                                                                               |                                           
|                                                                          |                                                                                                                                                                 |                                                                                                                                            |                                           
|                                                                          |                                                                                                                                                                 | 2002                                                                                                                                       |                                            |        | 2003 |        
|                                                                          |                                                                                                                                                                 |                                                                                                                                            |                                            |        |      |        
|                                                                          |                                                                                                                                                                 |                                                                                                                                           
|                                                                          |                                                                                                                                                                 | (In thousands, except                                                                                                                      |                                           
|                                                                          |                                                                                                                                                                 | share and per share                                                                                                                        |                                           
|                                                                          |                                                                                                                                                                 | amounts)                                                                                                                                   |                                           
|ASSETS                                                                   
|Current assets:                                                           |                                                                                                                                                                 |                                                                                                                                            |                                            |        |      |         |        |       
|                                                                          | Cash and cash equivalents                                                                                                                                       |                                                                                                                                            | $                                          | 7,732  |      |         | $      | 232    |   
|                                                                          | Short-term investments                                                                                                                                          |                                                                                                                                            |                                            | 25,898 |      |         |        | 38,742 |   
|                                                                          | Accounts receivable from patient services, net of
    allowance for uncollectible accounts of $2,962 and $3,913 at
    December 31, 2002 and 2003, respectively |                                                                                                                                            |                                            | 35,652 |      |         |        | 57,651 |   
|                                                                          | Deferred tax assets                                                                                                                                             |                                                                                                                                            |                                            | 1,752  |      |         |        | 1,170  |   
|                                                                          | Income taxes receivable                                                                                                                                         |                                                                                                                                            |                                            | 667    |      |         |        | 1,961  |   
|                                                                          | Other current assets                                                                                                                                            |                                                                                                                                            |                                            | 2,172  |      |         |        | 3,584  |   
|                                                                          |                                                                                                                                                                 |                                                                                                                                            |                                            |        |      |        
|                                                                          |                                                                                                                                                                 |                                                                                                                                            | Total current assets                       |        |      | 73,873  |        |        |    | 103,340 | 
|Property and equipment, net                                               |                                                                                                                                                                 |                                                                                                                                            | 3,670                                      |        |      |         | 6,435  |       
|Debt issue costs, net                                                     |                                                                                                                                                                 |                                                                                                                                            | 25                                         |        |      |         |       |       
|Goodwill                                                                  |                                                                                                                                                                 |                                                                                                                                            | 46,527                                     |        |      |         | 66,678 |       
|Intangibles, net                                                          |                                                                                                                                                                 |                                                                                                                                            | 1,319                                      |        |      |         | 3,105  |       
|                                                                          |                                                                                                                                                                 |                                                                                                                                            |                                            |        |      |        
|                                                                          |                                                                                                                                                                 |                                                                                                                                            | Total assets                               |        | $    | 125,414 |        |        | $  | 179,558 | 
|                                                                          |                                                                                                                                                                 |                                                                                                                                            |                                            |        |      |        
|                                                                         
|LIABILITIES AND STOCKHOLDERS
    EQUITY                                 
|Current liabilities:                                                      |                                                                                                                                                                 |                                                                                                                                            |                                            |        |      |         |        |       
|                                                                          | Accounts payable                                                                                                                                                |                                                                                                                                            | $                                          | 2,158  |      |         | $      | 5,414  |   
|                                                                          | Accrued compensation                                                                                                                                            |                                                                                                                                            |                                            | 7,277  |      |         |        | 9,647  |   
|                                                                          | Accrued nursing home costs                                                                                                                                      |                                                                                                                                            |                                            | 7,377  |      |         |        | 9,585  |   
|                                                                          | Other accrued expenses                                                                                                                                          |                                                                                                                                            |                                            | 5,289  |      |         |        | 5,884  |   
|                                                                          | Current maturities of long-term debt and capital
    lease obligations                                                                                          |                                                                                                                                            |                                            | 274    |      |         |        | 4      |   
|                                                                          |                                                                                                                                                                 |                                                                                                                                            |                                            |        |      |        
|                                                                          |                                                                                                                                                                 |                                                                                                                                            | Total current liabilities                  |        |      | 22,375  |        |        |    | 30,534  | 
|Long-term debt and capital lease obligations,
    less current maturities |                                                                                                                                                                 |                                                                                                                                            |                                           |        |      |         | 13     |       
|Deferred tax liability                                                    |                                                                                                                                                                 |                                                                                                                                            | 1,779                                      |        |      |         | 4,286  |       
|Other liabilities                                                         |                                                                                                                                                                 |                                                                                                                                            | 327                                        |        |      |         |       |       
|Commitments and contingencies Stockholders
    equity:                   |                                                                                                                                                                 |                                                                                                                                            |                                            |        |      |         |        |       
|                                                                          | Common stock, $.001 par value:                                                                                                                                  |                                                                                                                                            |                                            |        |      |         |        |        |   
|                                                                          |                                                                                                                                                                 | Authorized shares  75,000,000 Issued
    and outstanding shares  35,067,136 at
    December 31, 2002 and 36,547,132 at December 31, 2003 |                                            |        | 35   |         |        |        | 37 |        
|                                                                          | Additional paid-in capital                                                                                                                                      |                                                                                                                                            |                                            | 79,191 |      |         |        | 91,365 |   
|                                                                          | Deferred compensation                                                                                                                                           |                                                                                                                                            |                                            | (726   | )    |         |        | (317   | ) 
|                                                                          | Retained earnings                                                                                                                                               |                                                                                                                                            |                                            | 22,433 |      |         |        | 53,640 |   
|                                                                          |                                                                                                                                                                 |                                                                                                                                            |                                            |        |      |        
|                                                                          |                                                                                                                                                                 |                                                                                                                                            | Total stockholders equity                 |        |      | 100,933 |        |        |    | 144,725 | 
|                                                                          |                                                                                                                                                                 |                                                                                                                                            |                                            |        |      |        
|                                                                          |                                                                                                                                                                 |                                                                                                                                            | Total liabilities and stockholders equity |        | $    | 125,414 |        |        | $  | 179,558 | 
|                                                                          |                                                                                                                                                                 |                                                                                                                                            |                                            |        |      |        

See accompanying notes.

F-3



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##### Table of Contents



ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES

CONSOLIDATED STATEMENTS OF
OPERATIONS

|                                            |                                                                                                                                                                                                    |                         |         |        |      |   |         |        |   |   |         |         |  
|------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------- | ------- | ------ | ---- | - | ------- | ------ | - | - | ------- | ------- | -
|                                            |                                                                                                                                                                                                    |                        
|                                            |                                                                                                                                                                                                    | Year Ended December 31, |        
|                                            |                                                                                                                                                                                                    |                         |        
|                                            |                                                                                                                                                                                                    | 2001                    |         |        | 2002 |   |         | 2003   |  
|                                            |                                                                                                                                                                                                    |                         |         |        |      |   |         |        |  
|                                            |                                                                                                                                                                                                    |                        
|                                            |                                                                                                                                                                                                    | (In thousands, except   |        
|                                            |                                                                                                                                                                                                    | per share amounts)      |        
|Net patient service revenue                 |                                                                                                                                                                                                    | $                       | 130,181 |        |      | $ | 194,459 |        |   | $ | 274,309 |        
|Operating expenses:                         |                                                                                                                                                                                                    |                         |         |        |      |   |         |        |   |   |         |        
|                                            | Direct hospice care                                                                                                                                                                                |                         |         | 62,269 |      |   |         | 94,944 |   |   |         | 136,366 |  
|                                            | General and administrative (exclusive of $1,112,
    $685 and $409 for the years ended December 31, 2001, 2002
    and 2003, respectively, reported below as stock-based
    compensation charges) |                         |         | 43,043 |      |   |         | 60,414 |   |   |         | 80,181  |  
|                                            | Stock-based compensation charges                                                                                                                                                                   |                         |         | 1,112  |      |   |         | 685    |   |   |         | 409     |  
|                                            | Provision for uncollectible accounts                                                                                                                                                               |                         |         | 3,207  |      |   |         | 2,952  |   |   |         | 4,015   |  
|                                            | Depreciation                                                                                                                                                                                       |                         |         | 983    |      |   |         | 1,468  |   |   |         | 2,181   |  
|                                            | Amortization                                                                                                                                                                                       |                         |         | 1,228  |      |   |         | 41     |   |   |         | 361     |  
|                                            |                                                                                                                                                                                                    |                         |         |        |      |   |         |        |  
|                                            |                                                                                                                                                                                                    |                         | 111,842 |        |      |   | 160,504 |        |   |   | 223,513 |        
|                                            |                                                                                                                                                                                                    |                         |         |        |      |   |         |        |  
|Income from operations                      |                                                                                                                                                                                                    |                         | 18,339  |        |      |   | 33,955  |        |   |   | 50,796  |        
|Other income (expense):                     |                                                                                                                                                                                                    |                         |         |        |      |   |         |        |   |   |         |        
|                                            | Minority interest                                                                                                                                                                                  |                         |         | (150   | )    |   |         | 50     |   |   |         |        |  
|                                            | Interest income                                                                                                                                                                                    |                         |         | 239    |      |   |         | 544    |   |   |         | 390     |  
|                                            | Interest expense                                                                                                                                                                                   |                         |         | (2,512 | )    |   |         | (269   | ) |   |         | (140    | )
|                                            |                                                                                                                                                                                                    |                         |         |        |      |   |         |        |  
|                                            |                                                                                                                                                                                                    |                         | (2,423  | )      |      |   | 325     |        |   |   | 250     |        
|                                            |                                                                                                                                                                                                    |                         |         |        |      |   |         |        |  
|Income before provision for income taxes    |                                                                                                                                                                                                    |                         | 15,916  |        |      |   | 34,280  |        |   |   | 51,046  |        
|Provision for income taxes                  |                                                                                                                                                                                                    |                         | 3,020   |        |      |   | 13,140  |        |   |   | 19,839  |        
|                                            |                                                                                                                                                                                                    |                         |         |        |      |   |         |        |  
|Net income                                  |                                                                                                                                                                                                    |                         | 12,896  |        |      |   | 21,140  |        |   |   | 31,207  |        
|Preferred stock dividends                   |                                                                                                                                                                                                    |                         | (1,097  | )      |      |   |        |        |   |   |        |        
|Gain on conversion of preferred securities  |                                                                                                                                                                                                    |                         | 5,755   |        |      |   |        |        |   |   |        |        
|                                            |                                                                                                                                                                                                    |                         |         |        |      |   |         |        |  
|Net income available to common stockholders |                                                                                                                                                                                                    | $                       | 17,554  |        |      | $ | 21,140  |        |   | $ | 31,207  |        
|                                            |                                                                                                                                                                                                    |                         |         |        |      |   |         |        |  
|Net income per common share:                |                                                                                                                                                                                                    |                         |         |        |      |   |         |        |   |   |         |        
|                                            | Basic net income per common share                                                                                                                                                                  |                         | $       | 1.83   |      |   | $       | 0.61   |   |   | $       | 0.87    |  
|                                            |                                                                                                                                                                                                    |                         |         |        |      |   |         |        |  
|                                            | Diluted net income per common share                                                                                                                                                                |                         | $       | 0.45   |      |   | $       | 0.58   |   |   | $       | 0.84    |  
|                                            |                                                                                                                                                                                                    |                         |         |        |      |   |         |        |  
|Weighted average shares outstanding:        |                                                                                                                                                                                                    |                         |         |        |      |   |         |        |   |   |         |        
|                                            | Basic                                                                                                                                                                                              |                         |         | 9,552  |      |   |         | 34,782 |   |   |         | 35,945  |  
|                                            | Diluted                                                                                                                                                                                            |                         |         | 28,620 |      |   |         | 36,691 |   |   |         | 37,256  |  

See accompanying notes.

F-4



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##### Table of Contents



ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES

CONSOLIDATED STATEMENTS OF PREFERRED STOCK AND
STOCKHOLDERS EQUITY (DEFICIT)

|                             |                                                                           |                                        |       |        |          |   |       |          |   |  |             |        |              |        |        |            |         |  |       |          |   |   |          |        |   |               |      |     |         |  |        |              |  |   |          |    |  |                  |        |        |   |   |        |        |   |   |         |        |   |   |         |        |  
|---------------------------- | ------------------------------------------------------------------------- | -------------------------------------- | ----- | ------ | -------- | - | ----- | -------- | - |  | ----------- | ------ | ------------ | ------ | ------ | ---------- | ------- |  | ----- | -------- | - | - | -------- | ------ | - | ------------- | ---- | --- | ------- |  | ------ | ------------ |  | - | -------- | -- |  | ---------------- | ------ | ------ | - | - | ------ | ------ | - | - | ------- | ------ | - | - | ------- | ------ | -
|                             |                                                                           |                                        |       |        |          |   |       |          |   |  |             |        |              |        |        |           
|                             |                                                                           | Convertible Redeemable Preferred Stock |       |        |          |   |       |          |   |  |             |        |              |        |        |            |        
|                             |                                                                           |                                        |       |        |          |   |       |          |   |  |             |        |              |        |        |            |        
|                             |                                                                           |                                        |       |        |          |   |       |          |   |  |             |        |              |        |        |            |         | 
|                             |                                                                           | Series A                               |       |        | Series B |   |       | Series C |   |  |             |        | Common Stock |        |        | Additional |         |  |       |          |   |   | Total    |       
|                             |                                                                           |                                        |       |        |          |   |       |          |   |  | Stockholder |        |              |        |        |            | Paid-in |  |       | Deferred |   |   | Retained |        |   | Stockholders |     
|                             |                                                                           | Shares                                 |       |        | Amount   |   |       | Shares   |   |  | Amount      |        |              | Shares |        |            | Amount  |  |       | Loans    |   |   | Shares   |        |   | Amount        |      |     | Capital |  |        | Compensation |  |   | Earnings |    |  | Equity (Deficit) |       
|                             |                                                                           |                                        |       |        |          |   |       |          |   |  |             |        |              |        |        |            |         |  |       |          |   |   |          |        |   |               |      |     |         |  |        |              |  |   |          |    |  |                  |       
|                             |                                                                           |                                       
|                             |                                                                           | (amounts in thousands)                 |      
|Balance at January 1, 2001   |                                                                           |                                        | 6,918 |        |          | $ | 4,859 |          |   |  | 6,400       |        |              | $      | 10,479 |            |         |  | 2,857 |          |   | $ | 5,995    |        |   | $             | (171 | )   |         |  | 4,458  |              |  | $ | 5        |    |  | $                | 3,437  |        |   | $ | (944   | )      |   | $ | (16,244 | )      |   | $ | (13,746 | )     
|                             | Series A Convertible Preferred Stock
    dividends                        |                                        |       |       |          |   |       | 231      |   |  |             |       |              |        |        |           |         |  |       |         |   |   |          |       |   |               |      |    |         |  |        |             |  |   |          |   |  |                  |        |       |   |   |        |       |   |   |         | (231   | ) |   |         | (231   | )
|                             | Series B Convertible Preferred Stock
    dividends                        |                                        |       |       |          |   |       |         |   |  |             |       |              |        |        | 533        |         |  |       |         |   |   |          |       |   |               |      |    |         |  |        |             |  |   |          |   |  |                  |        |       |   |   |        |       |   |   |         | (533   | ) |   |         | (533   | )
|                             | Series C Convertible Preferred Stock
    dividends                        |                                        |       |       |          |   |       |         |   |  |             |       |              |        |        |           |         |  |       |         |   |   |          | 333    |   |               |      |    |         |  |        |             |  |   |          |   |  |                  |        |       |   |   |        |       |   |   |         | (333   | ) |   |         | (333   | )
|                             | Proceeds from Initial Public Offering                                     |                                        |       |       |          |   |       |         |   |  |             |       |              |        |        |           |         |  |       |         |   |   |          |       |   |               |      |    |         |  |        | 9,315        |  |   |          | 9  |  |                  |        | 56,000 |   |   |        |       |   |   |         | (5     | ) |   |         | 56,004 |  
|                             | Preferred Share Conversion in connection with
    initial public offering |                                        |       | (6,918 | )        |   |       | (5,090   | ) |  |             | (6,400 | )            |        |        | (11,012    | )       |  |       | (2,857   | ) |   |          | (6,328 | ) |               |      |    |         |  |        | 18,198       |  |   |          | 18 |  |                  |        | 16,667 |   |   |        |       |   |   |         | 5,745  |   |   |         | 22,430 |  
|                             | Forgiveness of stockholder loans                                          |                                        |       |       |          |   |       |         |   |  |             |       |              |        |        |           |         |  |       |         |   |   |          |       |   |               |      | 171 |         |  |        |             |  |   |          |   |  |                  |        |       |   |   |        |       |   |   |         |       |   |   |         |       |  
|                             | Deferred compensation related to stock options                            |                                        |       |       |          |   |       |         |   |  |             |       |              |        |        |           |         |  |       |         |   |   |          |       |   |               |      |    |         |  |        |             |  |   |          |   |  |                  |        | 1,579  |   |   |        | (1,579 | ) |   |         |       |   |   |         |       |  
|                             | Amortization of deferred compensation                                     |                                        |       |       |          |   |       |         |   |  |             |       |              |        |        |           |         |  |       |         |   |   |          |       |   |               |      |    |         |  |        |             |  |   |          |   |  |                  |        |       |   |   |        | 1,112  |   |   |         |       |   |   |         | 1,112  |  
|                             | Exercise of stock options                                                 |                                        |       |       |          |   |       |         |   |  |             |       |              |        |        |           |         |  |       |         |   |   |          |       |   |               |      |    |         |  |        | 123          |  |   |          |   |  |                  |        | 36     |   |   |        |       |   |   |         |       |   |   |         | 36     |  
|                             | Exercise of stock warrants                                                |                                        |       |       |          |   |       |         |   |  |             |       |              |        |        |           |         |  |       |         |   |   |          |       |   |               |      |    |         |  |        | 2,228        |  |   |          | 3  |  |                  |        | (1     | ) |   |        |       |   |   |         | (2     | ) |   |         |       |  
|                             | Net income                                                                |                                        |       |       |          |   |       |         |   |  |             |       |              |        |        |           |         |  |       |         |   |   |          |       |   |               |      |    |         |  |        |             |  |   |          |   |  |                  |        |       |   |   |        |       |   |   |         | 12,896 |   |   |         | 12,896 |  
|                             |                                                                           |                                        |       |        |          |   |       |          |   |  |             |        |              |        |        |            |         |  |       |          |   |   |          |        |   |               |      |     |         |  |        |              |  |   |          |    |  |                  |       
|Balance at December 31, 2001 |                                                                           |                                        |      |        |          |   |      |          |   |  |            |        |              |        |       |            |         |  |      |          |   |   |         |        |   |               |     |     |         |  | 34,322 |              |  |   | 35       |    |  |                  | 77,718 |        |   |   | (1,411 | )      |   |   | 1,293   |        |   |   | 77,635  |       
|                             | Expense related to Initial Public Offering                                |                                        |       |       |          |   |       |         |   |  |             |       |              |        |        |           |         |  |       |         |   |   |          |       |   |               |      |    |         |  |        |             |  |   |          |   |  |                  |        | (37    | ) |   |        |       |   |   |         |       |   |   |         | (37    | )
|                             | Amortization of deferred compensation                                     |                                        |       |       |          |   |       |         |   |  |             |       |              |        |        |           |         |  |       |         |   |   |          |       |   |               |      |    |         |  |        |             |  |   |          |   |  |                  |        |       |   |   |        | 685    |   |   |         |       |   |   |         | 685    |  
|                             | Tax benefit related to stock option exercise                              |                                        |       |       |          |   |       |         |   |  |             |       |              |        |        |           |         |  |       |         |   |   |          |       |   |               |      |    |         |  |        |             |  |   |          |   |  |                  |        | 891    |   |   |        |       |   |   |         |       |   |   |         | 891    |  
|                             | Exercise of stock options                                                 |                                        |       |       |          |   |       |         |   |  |             |       |              |        |        |           |         |  |       |         |   |   |          |       |   |               |      |    |         |  |        | 676          |  |   |          |   |  |                  |        | 581    |   |   |        |       |   |   |         |       |   |   |         | 581    |  
|                             | Exercise of stock warrants                                                |                                        |       |       |          |   |       |         |   |  |             |       |              |        |        |           |         |  |       |         |   |   |          |       |   |               |      |    |         |  |        | 69           |  |   |          |   |  |                  |        | 38     |   |   |        |       |   |   |         |       |   |   |         | 38     |  
|                             | Net income                                                                |                                        |       |       |          |   |       |         |   |  |             |       |              |        |        |           |         |  |       |         |   |   |          |       |   |               |      |    |         |  |        |             |  |   |          |   |  |                  |        |       |   |   |        |       |   |   |         | 21,140 |   |   |         | 21,140 |  
|                             |                                                                           |                                        |       |        |          |   |       |          |   |  |             |        |              |        |        |            |         |  |       |          |   |   |          |        |   |               |      |     |         |  |        |              |  |   |          |    |  |                  |       
|Balance at December 31, 2002 |                                                                           |                                        |      |        |          |   |      |          |   |  |            |        |              |        |       |            |         |  |      |          |   |   |         |        |   |               |     |     |         |  | 35,067 |              |  |   | 35       |    |  |                  | 79,191 |        |   |   | (726   | )      |   |   | 22,433  |        |   |   | 100,933 |       
|                             | Amortization of deferred compensation                                     |                                        |       |       |          |   |       |         |   |  |             |       |              |        |        |           |         |  |       |         |   |   |          |       |   |               |      |    |         |  |        |             |  |   |          |   |  |                  |        |       |   |   |        | 409    |   |   |         |       |   |   |         | 409    |  
|                             | Tax benefit related to stock option exercise                              |                                        |       |       |          |   |       |         |   |  |             |       |              |        |        |           |         |  |       |         |   |   |          |       |   |               |      |    |         |  |        |             |  |   |          |   |  |                  |        | 6,936  |   |   |        |       |   |   |         |       |   |   |         | 6,936  |  
|                             | Exercise of stock options                                                 |                                        |       |       |          |   |       |         |   |  |             |       |              |        |        |           |         |  |       |         |   |   |          |       |   |               |      |    |         |  |        | 1,450        |  |   |          | 2  |  |                  |        | 5,238  |   |   |        |       |   |   |         |       |   |   |         | 5,240  |  
|                             | Employee Stock Purchase Plan                                              |                                        |       |       |          |   |       |         |   |  |             |       |              |        |        |           |         |  |       |         |   |   |          |       |   |               |      |    |         |  |        | 30           |  |   |          |   |  |                  |        |       |   |   |        |       |   |   |         |       |   |   |         |       |  
|                             | Net income                                                                |                                        |       |       |          |   |       |         |   |  |             |       |              |        |        |           |         |  |       |         |   |   |          |       |   |               |      |    |         |  |        |             |  |   |          |   |  |                  |        |       |   |   |        |       |   |   |         | 31,207 |   |   |         | 31,207 |  
|                             |                                                                           |                                        |       |        |          |   |       |          |   |  |             |        |              |        |        |            |         |  |       |          |   |   |          |        |   |               |      |     |         |  |        |              |  |   |          |    |  |                  |       
|Balance at December 31, 2003 |                                                                           |                                        |      |        |          | $ |      |          |   |  |            |        |              | $      |       |            |         |  |      |          |   | $ |         |        |   | $             |     |     |         |  | 36,547 |              |  | $ | 37       |    |  | $                | 91,365 |        |   | $ | (317   | )      |   | $ | 53,640  |        |   | $ | 144,725 |       
|                             |                                                                           |                                        |       |        |          |   |       |          |   |  |             |        |              |        |        |            |         |  |       |          |   |   |          |        |   |               |      |     |         |  |        |              |  |   |          |    |  |                  |       

See accompanying notes.

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##### Table of Contents



ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                                         |                                                                                       |                                                                       |                                                                             |          |       |         |         |         |       |         |        |         |       |         |  
|-------------------------------------------------------- | ------------------------------------------------------------------------------------- | --------------------------------------------------------------------- | --------------------------------------------------------------------------- | -------- | ----- | ------- | ------- | ------- | ----- | ------- | ------ | ------- | ----- | ------- | -
|                                                         |                                                                                       |                                                                      
|                                                         |                                                                                       | Year Ended December 31,                                               |                                                                            
|                                                         |                                                                                       |                                                                       |                                                                            
|                                                         |                                                                                       | 2001                                                                  |                                                                             |          | 2002  |         |         | 2003    |      
|                                                         |                                                                                       |                                                                       |                                                                             |          |       |         |         |         |      
|                                                         |                                                                                       |                                                                      
|                                                         |                                                                                       | (In thousands)                                                        |                                                                            
|Operating Activities                                     |                                                                                       |                                                                       |                                                                             |          |       |         |         |         |       |         |        |        
|                                                         | Net income                                                                            |                                                                       | $                                                                           | 12,896   |       |         | $       | 21,140  |       |         | $      | 31,207  |      
|                                                         | Adjustments to reconcile net income to net cash
    provided by operating activities: |                                                                       |                                                                             |          |       |         |         |         |       |         |        |         |      
|                                                         |                                                                                       | Loss on debt extinguishment                                           |                                                                             |          | 572   |         |         |         |      |         |        |         |      |        
|                                                         |                                                                                       | Forgiveness of stockholder loans                                      |                                                                             |          | 171   |         |         |         |      |         |        |         |      |        
|                                                         |                                                                                       | Depreciation and amortization                                         |                                                                             |          | 2,211 |         |         |         | 1,509 |         |        |         | 2,542 |        
|                                                         |                                                                                       | Amortization of deferred charges and debt discount                    |                                                                             |          | 173   |         |         |         | 34    |         |        |         | 25    |        
|                                                         |                                                                                       | Stock-based compensation                                              |                                                                             |          | 1,112 |         |         |         | 685   |         |        |         | 409   |        
|                                                         |                                                                                       | Minority interest                                                     |                                                                             |          | 150   |         |         |         | (50   | )       |        |         |      |        
|                                                         |                                                                                       | Deferred tax expense                                                  |                                                                             |          | (323  | )       |         |         | 350   |         |        |         | 3,089 |        
|                                                         |                                                                                       | Tax benefit realized for stock option exercises                       |                                                                             |          |      |         |         |         | 891   |         |        |         | 6,936 |        
|                                                         |                                                                                       | Provision for uncollectible accounts                                  |                                                                             |          | 3,207 |         |         |         | 2,952 |         |        |         | 4,015 |        
|                                                         |                                                                                       | Changes in operating assets and liabilities, net
    of acquisitions: |                                                                             |          |       |         |         |         |       |         |        |         |       |        
|                                                         |                                                                                       |                                                                       | Accounts receivable                                                         |          |       | (9,242  | )       |         |       | (13,561 | )      |         |       | (26,341 | )
|                                                         |                                                                                       |                                                                       | Other current assets                                                        |          |       | (623    | )       |         |       | (1,275  | )      |         |       | (2,706  | )
|                                                         |                                                                                       |                                                                       | Accounts payable, accrued nursing home costs and
    other accrued expenses |          |       | 4,652   |         |         |       | 6,057   |        |         |       | 8,429   |  
|                                                         |                                                                                       |                                                                       |                                                                             |          |       |         |         |         |      
|                                                         |                                                                                       |                                                                       | Net cash provided by operating activities                                   |          |       | 14,956  |         |         |       | 18,732  |        |         |       | 27,605  |  
|Investing Activities                                     |                                                                                       |                                                                       |                                                                             |          |       |         |         |         |       |         |        |        
|                                                         | Cash paid for acquisitions                                                            |                                                                       |                                                                             | (7,845   | )     |         |         | (21,269 | )     |         |        | (22,469 | )    
|                                                         | Increase in short-term investments                                                    |                                                                       |                                                                             | (21,419  | )     |         |         | (4,479  | )     |         |        | (12,844 | )    
|                                                         | Purchases of property and equipment                                                   |                                                                       |                                                                             | (1,737   | )     |         |         | (2,600  | )     |         |        | (4,775  | )    
|                                                         |                                                                                       |                                                                       |                                                                             |          |       |         |         |         |      
|                                                         |                                                                                       |                                                                       | Net cash used in investing activities                                       |          |       | (31,001 | )       |         |       | (28,348 | )      |         |       | (40,088 | )
|Financing Activities                                     |                                                                                       |                                                                       |                                                                             |          |       |         |         |         |       |         |        |        
|                                                         | Proceeds from issuance of common stock                                                |                                                                       |                                                                             | 56,616   |       |         |         | 582     |       |         |        | 5,240   |      
|                                                         | Distributions to minority partners                                                    |                                                                       |                                                                             |         |       |         |         | (100    | )     |         |        |        |      
|                                                         | Proceeds from issuance of debt                                                        |                                                                       |                                                                             | 116,893  |       |         |         | 15      |       |         |        | 13      |      
|                                                         | Payments on debt                                                                      |                                                                       |                                                                             | (137,490 | )     |         |         | (3,221  | )     |         |        | (270    | )    
|                                                         |                                                                                       |                                                                       |                                                                             |          |       |         |         |         |      
|                                                         |                                                                                       |                                                                       | Net cash provided by (used in) financing
    activities                     |          |       | 36,019  |         |         |       | (2,724  | )      |         |       | 4,983   |  
|                                                         |                                                                                       |                                                                       |                                                                             |          |       |         |         |         |      
|Net increase (decrease) in cash and cash
    equivalents |                                                                                       |                                                                       | 19,974                                                                      |          |       |         | (12,340 | )       |       |         | (7,500 | )      
|Cash and cash equivalents, beginning of period           |                                                                                       |                                                                       | 98                                                                          |          |       |         | 20,072  |         |       |         | 7,732  |        
|                                                         |                                                                                       |                                                                       |                                                                             |          |       |         |         |         |      
|Cash and cash equivalents, end of period                 |                                                                                       | $                                                                     | 20,072                                                                      |          |       | $       | 7,732   |         |       | $       | 232    |        
|                                                         |                                                                                       |                                                                       |                                                                             |          |       |         |         |         |      
|Supplemental Cash Flow Information                       |                                                                                       |                                                                       |                                                                             |          |       |         |         |         |       |         |        |        
|                                                         | Cash interest paid                                                                    |                                                                       | $                                                                           | 2,698    |       |         | $       | 341     |       |         | $      | 125     |      
|                                                         | Income taxes paid                                                                     |                                                                       | $                                                                           | 2,526    |       |         | $       | 13,353  |       |         | $      | 11,513  |      

See accompanying notes.

F-6



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##### Table of Contents



ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

Years Ended December 31, 2001, 2002 and
2003




|   |                                                                
|-- | ---------------------------------------------------------------
|1. | Organization and Summary of Significant
    Accounting Policies

Organization

Odyssey HealthCare, Inc. and its subsidiaries
(the Company) provide hospice care, with a goal of
improving the quality of life of terminally ill patients and
their families. Hospice services focus on palliative care for
patients with life-limiting illnesses, which is care directed at
managing pain and other discomforting symptoms and addressing
the psychosocial and spiritual needs of patients and their
families. The Company provides for all medical, psychosocial
care and certain other support services associated with the
patients terminal illness.

The Company was incorporated on August 29,
1995 in the state of Delaware and, as of February 29, 2004,
had 68 Medicare-certified hospice providers serving patients and
their families in 29 states, with significant operations in
Texas, California and Arizona.

Principles of
Consolidation

The consolidated financial statements include the
accounts of Odyssey HealthCare, Inc. and its subsidiaries. All
significant intercompany accounts and transactions have been
eliminated in consolidation.



| |                                                         
| | --------------------------------------------------------
| | Cash and Cash Equivalents and Short-Term
    Investments

Cash and cash equivalents include currency,
checks on hand and overnight repurchase agreements of government
securities. Short-term investments primarily include money
market funds and debt securities with initial maturities between
180 days and one year.



| |                                        
| | ---------------------------------------
| | Fair Value of Financial
    Instruments

The fair value of financial instruments is the
amount at which the instrument could be exchanged in a current
transaction between willing parties. Management estimates that
the carrying amounts of the Companys financial instruments
included in the accompanying consolidated balance sheets are not
materially different from their fair values.



| |                    
| | -------------------
| | Accounts Receivable

Accounts receivable represents amounts due from
patients, third-party payors (principally the Medicare and
Medicaid programs), and others for services rendered based on
payment arrangements specific to each payor. Approximately 90.6%
and 91.4% of the accounts receivable at December 31, 2002
and 2003, respectively, represent amounts due from the Medicare
and Medicaid programs. The Company maintains a policy for
reserving for uncollectible accounts. The Company calculates the
allowance for uncollectible accounts based on a formula tied to
the aging of accounts receivable by payor class. The Company
reserves for specific accounts that are determined to be
uncollectible when such determinations are made. Accounts are
written off when all collection efforts are exhausted.

Medicare fiscal intermediaries and other payors
periodically conduct pre-payment or post-payment medical reviews
or other audits of the Companys reimbursement claims. In
order to conduct these reviews, the payor requests documentation
from the Company 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. The Company cannot
predict whether medical reviews or similar audits by federal or
state agencies or commercial payors of the Companys
hospice programs reimbursement claims will result in
material recoupments or

F-7



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##### Table of Contents



ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

denials, which could have a material adverse
effect on the Companys financial condition and results of
operations.



| |                                              
| | ---------------------------------------------
| | Goodwill and Other Non-Amortizable
    Assets

The Company adopted Statement of Financial
Accounting Standards No. 142 Goodwill and Other
Intangible Assets (SFAS 142) on
January 1, 2002. Goodwill is the excess of the purchase
price over the fair value of identifiable assets acquired. Under
SFAS 142, goodwill and intangible assets with indefinite
lives are not amortized but reviewed for impairment annually
(during the fourth quarter) or more frequently if certain
indicators arise. Goodwill is reviewed at the reporting unit
level, which is defined in SFAS 142 as an operating segment
or one level below an operating segment. The Company has defined
their reporting units at the operating segment level. The
Company determines the fair value of the reporting units using
multiples of revenue. If the fair value of a reporting unit is
less than the carrying value, then an indication of impairment
exists. The amount of the impairment would be determined by
estimating the fair values of the tangible and intangible assets
and liabilities, with the remaining fair value assigned to
goodwill. The amount of the impairment would be the difference
between the carrying amount of the goodwill and the fair value
of the goodwill. No impairment charges have been recorded.

Net Patient
Service Revenue

Net patient service revenue is reported at the
estimated net realizable amounts from patients, Medicare,
Medicaid, commercial insurance and managed care payors and
others for services rendered. Payors may determine that the
services provided are not covered and do not qualify for payment
or, for commercial payors, that payments are subject to usual
and customary rates. To determine net patient service revenue,
management adjusts gross patient service revenue for estimated
payment denials and contractual adjustments based on historical
experience. Changes in the estimate are adjusted in future
periods as the payments are determined. The percentage of net
patient service revenue derived under the Medicare and Medicaid
programs was 97.2%, 97.5% and 97.0% for the years ended
December 31, 2001, 2002 and 2003, respectively.

The Company is subject to limits for payments.
For inpatient services, which represented about 8.7% of gross
patient service revenue in 2003, the limit is based on inpatient
care days. If inpatient care days provided to patients at a
hospice exceeded 20% of the total days of hospice care provided
for the year, then payment for days in excess of this limit are
paid for at the routine home care rate. None of the
Companys hospice programs exceeded the payment limits on
inpatient services in 2001, 2002, or 2003.

Overall payments made by Medicare to the Company
are also subject to a cap amount calculated by the Medicare
fiscal intermediary at the end of the hospice cap period. The
hospice cap period runs from November 1st of each year through
October 31st of the following year. Total Medicare payments
to the Company during this period are compared to the cap amount
for this period. Payments in excess of the cap amount must be
returned by the Company to Medicare. The cap amount is
calculated by multiplying the number of beneficiaries electing
hospice care during the period by a statutory amount that is
indexed for inflation. The per-beneficiary cap amount was
$18,661 for the twelve-month period ending October 31,
2003. The per beneficiary cap amount for the twelve month period
ending October 31, 2004 has not been published. Once
published, the new cap amount will become effective
retroactively for all services performed since November 1,
2003. The hospice cap amount is computed on a hospice-by-hospice
basis. Our net patient service revenue for 2003 was reduced by
$1.2 million as a result of six hospice programs exceeding
the Medicare cap. The Company cannot assure that additional
hospices will not exceed the cap amount in the future.

Laws and regulations governing the Medicare and
Medicaid programs are complex and subject to interpretation. The
Company 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. While no

F-8



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##### Table of Contents



ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

such regulatory inquiries have been made,
compliance with 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

The Company provides charity care to patients
without charge when management of the hospice has determined
that the patient does not have the financial capability to pay,
which is determined at or near the time of admission. Because
the Company does not pursue collection of amounts determined to
qualify as charity care, they are not reported as revenue.

Charity care, based on established charges,
amounted to $0.9 million, $2.0 million and
$2.9 million for the years ended December 31, 2001,
2002 and 2003, respectively.

Direct
Hospice Care Expenses

Direct hospice care expenses consist primarily of
salaries, benefits, payroll taxes, and travel costs associated
with hospice care providers. Direct hospice care expenses also
include the cost of pharmaceuticals, durable medical equipment,
medical supplies, inpatient arrangements, net nursing home costs
and purchase services such as ambulance, infusion and radiology.

Property and
Equipment and Other Intangible Assets

Property and equipment, including improvements to
existing facilities, are recorded at cost. Depreciation and
amortization are calculated principally using the straight-line
method over the estimated useful lives of the assets. Estimated
useful lives for major asset categories are three years for
leasehold improvements, three to five years for equipment and
computer software, and five years for office furniture.

Other intangible assets are comprised of licenses
and non-compete agreements. The non-compete agreements are being
amortized based on the terms of the respective contracts.

When events, circumstances and operating results
indicate that the carrying value of certain property, equipment,
and other intangible assets might be impaired, the Company
prepares projections of the undiscounted future cash flows
expected to result from the use of the assets and their eventual
disposition. If the projections indicate that the recorded
amounts are not expected to be recoverable, such amounts are
reduced to estimated fair value. Indicators of potential
impairment are typically beyond the control of management. If
market conditions become less favorable than those projected by
management, impairments may be required.

On January 1, 2002 the Company adopted
Statement of Financial Accounting Standards No. 144
Accounting for the Impairment or Disposal of Long-Lived
Assets (SFAS 144). SFAS 144
supercedes Statement of Financial Accounting Standards
No. 121 Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed of
(SFAS 121) and the accounting and reporting
provisions of Accounting Principles Board Opinion No. 30
Reporting the Results of Operations-Reporting the Effects
of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions
(APB 30) for the disposal of a segment of a
business. SFAS 144 establishes a single accounting model,
based on the framework established in SFAS 121, for
long-lived assets to be disposed of by sale and resolves
implementation issues related to SFAS 121 by removing
goodwill from its scope. The adoption of SFAS 144 would
impact the results of operations and the financial position of
the Company if a component of the Companys business is
designated as held for sale after adoption of SFAS 144.
Components designated as held for sale would be reported
separately as discontinued operations with prior periods
restated. Currently, the Company has not designated any
components as held for sale under SFAS 144, but could do so
in the future.

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ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Stock-Based
Compensation

The Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 148
Accounting for Stock-Based Compensation 
Transition and Disclosures (SFAS 148) in
December 2002. SFAS 148 amends the disclosure provisions
and transition alternatives of Statement of Financial Accounting
Standards No. 123 Accounting for Stock-Based
Compensation (SFAS 123) and is effective
for fiscal years ending after December 15, 2002. The
Company adopted the disclosure provisions of SFAS 148
effective December 31, 2002.

Prior to 2001, the Company had two stock-based
compensation plans which are described more fully in
Note 7. The Company accounts for those plans under the
recognition and measurement principles of APB Opinion
No. 25, Accounting for Stock Issued to
Employees (APB 25) and related
interpretations. APB 25 uses the intrinsic value method to
account for options granted to employees. Stock-based
compensation is generally not recognized since the option price
is typically equal the market value of the underlying common
stock on the date of grant. During the years ended
December 31, 2000 and 2001, the Company recorded aggregate
deferred compensation for employees of $2.1 million and
$1.5 million, respectively, representing the difference
between the exercise prices of the stock options granted in
fiscal year 2000 and 2001 under the Odyssey HealthCare, Inc.
Stock Option Plan and 2001 Equity-Based Compensation Plan and
the then deemed fair value of the common stock prior to the
initial public offering (the Offering). These
amounts are being amortized to operations using the graded
method. Under the graded method, approximately 46%, 26%, 15%, 9%
and 4%, respectively of each options compensation expense
is recognized in each of the five years following the date of
the grant. For the years ended December 31, 2001, 2002 and
2003, the Company amortized deferred compensation in the amount
of $1.1 million, $0.7 million and

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ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

$0.4 million, respectively. The following
table illustrates the effect on net income and earnings per
share if the Company had applied the fair value recognition
provisions of SFAS 123 to all stock-based compensation.

|                                                                             |  |                        |        |   |      |   |        |      |  |   |        |  
|---------------------------------------------------------------------------- |  | ---------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                             |  |                       
|                                                                             |  | Year Ended December 31 |       
|                                                                             |  |                        |       
|                                                                             |  | 2001                   |        |   | 2002 |   |        | 2003 | 
|                                                                             |  |                        |        |   |      |   |        |      | 
|                                                                             |  |                       
|                                                                             |  | (In thousands)         |       
|Net income available to common stockholders, as
    reported                 |  | $                      | 17,554 |   |      | $ | 21,140 |      |  | $ | 31,207 |  
|Add: Stock-based employee compensation expense
    recorded, net of tax      |  |                        | 901    |   |      |   | 425    |      |  |   | 249    |  
|Deduct: Fair value stock-based employee
    compensation expense, net of tax |  |                        | (440   | ) |      |   | (1,285 | )    |  |   | (2,366 | )
|                                                                             |  |                        |        |   |      |   |        |      | 
|Pro forma net income available to common
    stockholders                    |  | $                      | 18,015 |   |      | $ | 20,280 |      |  | $ | 29,090 |  
|                                                                             |  |                        |        |   |      |   |        |      | 
|Earnings per share:                                                          |  |                        |        |   |      |   |        |      |  |   |        |  
|Basic  as reported                                                          |  | $                      | 1.83   |   |      | $ | 0.61   |      |  | $ | 0.87   |  
|Add: Stock-based employee compensation expense
    recorded, net of tax      |  |                        | 0.09   |   |      |   | 0.01   |      |  |   | 0.01   |  
|Deduct: Fair value stock-based employee
    compensation expense, net of tax |  |                        | (0.04  | ) |      |   | (0.04  | )    |  |   | (0.07  | )
|                                                                             |  |                        |        |   |      |   |        |      | 
|Basic  pro forma                                                            |  | $                      | 1.88   |   |      | $ | 0.58   |      |  | $ | 0.81   |  
|                                                                             |  |                        |        |   |      |   |        |      | 
|Diluted  as reported                                                        |  | $                      | 0.45   |   |      | $ | 0.58   |      |  | $ | 0.84   |  
|Add: Stock-based employee compensation expense
    recorded, net of tax      |  |                        | 0.03   |   |      |   | 0.01   |      |  |   | 0.00   |  
|Deduct: Fair value stock-based employee
    compensation expense, net of tax |  |                        | (0.01  | ) |      |   | (0.04  | )    |  |   | (0.06  | )
|                                                                             |  |                        |        |   |      |   |        |      | 
|Diluted  pro forma                                                          |  | $                      | 0.47   |   |      | $ | 0.55   |      |  | $ | 0.78   |  
|                                                                             |  |                        |        |   |      |   |        |      | 

The deemed fair value for options granted prior
to the offering was estimated at the date of grant using the
minimum value option valuation model, which assumes the stock
price has no volatility since the common stock was not publicly
traded at the time of grant. The deemed fair value for options
granted after the offering was estimated at the date of grant
using the Black-Scholes Model, which considers volatility. The
following table illustrates the weighted average assumptions for
the years ended December 31:

|                        |  |      |             |  |      |  |             |      |  |  |         | 
|----------------------- |  | ---- | ----------- |  | ---- |  | ----------- | ---- |  |  | ------- | 
|                        |  | 2001 |             |  | 2002 |  |             | 2003 | 
|                        |  |      |             |  |      |  |             |      | 
|Risk free interest rate |  |      | 4.50%5.19% |  |      |  | 3.44%4.55% |      |  |  | 3.50%   | 
|Expected life           |  |      | 6 years     |  |      |  | 5 years     |      |  |  | 5 years | 
|Expected volatility     |  |      | 0.590       |  |      |  | 0.715       |      |  |  | 1.558   | 
|Expected dividend yield |  |      |            |  |      |  |            |      |  |  |        | 

The weighted average deemed fair value of the
options granted was $6.32, $11.46 and $16.63 in the years ended
December 31, 2001, 2002 and 2003, respectively.

Net Income
Per Common Share

Basic net income per common share is computed by
dividing net income less the annual Series A, Series B
and Series C Convertible Preferred Stock dividends, where
applicable, by the weighted average number of common shares
outstanding during the period. Diluted net income per common
share is computed by dividing the net income by the weighted
average number of common shares outstanding during the period
plus the effect of dilutive securities, giving effect to the
conversion of the convertible preferred stock (using the

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##### Table of Contents



ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

if-converted method), where applicable, and
employee stock options and outstanding warrants (using the
treasury stock method and considering the effect of unrecognized
deferred compensation charges). Also see Note 5.

The accumulated dividends on the Series A,
Series B and Series C Convertible Preferred Stock were
reversed in 2001 as they were no longer payable due to the
mandatory conversion of the convertible preferred stock in
connection with the Companys Offering. The Company has
accounted for the reversal in accordance with Emerging Issues
Task Force Topic No. D-42 The Effect on the
Calculation of Earnings per Share for the Redemption or Induced
Conversion of Preferred Stock and recognized a gain to
common stockholders in 2001 totaling $5.8 million. This
gain was used in the computation of basic net income per common
share.

Income
Taxes

The Company accounts for income taxes using the
liability method as required by Statement of Financial
Accounting Standards Board Statement No. 109,
Accounting for Income Taxes
(SFAS 109). Under the liability method,
deferred taxes are determined based on differences between
financial reporting and tax bases of assets and liabilities and
are measured using the enacted tax laws that will be in effect
when the differences are expected to reverse.

General and
Professional Liability Insurance

The Company maintains general liability and
professional liability insurance coverage on a claims-made basis
in fiscal 2001, 2002 and 2003, with limits of liability of
$1.0 million per occurrence and $3.0 million in the
aggregate. The Company also maintains general liability and
umbrella coverage with a limit of $20.0 million.

Nursing Home
Costs

For patients receiving nursing home care under a
state Medicaid program who elect hospice care under Medicare or
Medicaid, the Company contracts with nursing homes for the
nursing homes provision to patients of room and board
services. The state must pay the Company, in addition to the
applicable Medicare or Medicaid hospice daily or hourly rate, an
amount equal to at least 95% of the Medicaid daily nursing home
rate for room and board furnished to the patient by the nursing
home. Under the Companys standard nursing home contracts,
the Company pays the nursing home for these room and board
services at the Medicaid daily nursing home rate. Nursing home
costs are offset by nursing home revenue, and the net amount is
included in direct hospice care expenses. Nursing home costs
totaled $25.6 million, $38.4 million and
$55.5 million for the years ended December 31, 2001,
2002 and 2003, respectively. Nursing home revenue totaled
$25.1 million, $38.2 million and $56.7 million
for the years ended December 31, 2001, 2002 and 2003,
respectively. During 2003, the Company conducted a review of the
nursing home accrual and determined certain amounts were not
payable and reduced nursing home expense by $1.0 million.

Advertising
Costs

The Company expenses all advertising costs as
incurred, which totaled $0.2 million for the year ended
December 31, 2001 and totaled $0.3 million for each of
the years ended December 31, 2002 and 2003.

Deferred Rent
Liability

Payments under operating leases are recognized as
rent expense on a straight-line basis over the term of the
related lease. The difference between the rent expense
recognized for financial reporting purposes and the actual
payments made in accordance with the lease agreements is
recognized as a deferred rent liability. Rent

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ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

expense charged to operations exceeded actual
rent payments by $0.3 million and $0.7 million for the
years ended December 31, 2002 and 2003, respectively.

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 consolidated
financial statements and accompanying notes. Actual results
could differ from those estimates.

Reclassification

Certain amounts have been reclassified to conform
to the current presentation.

Recent
Accounting Pronouncements

In April 2002, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards
No. 145 Rescission of FASB Statements No. 4, 44,
and 64, Amendment of FASB Statement No. 13, and Technical
Corrections (SFAS 145), which is required
to be applied in fiscal years beginning after May 15, 2002,
with early application encouraged. SFAS 145 rescinds
Statement of Financial Accounting Standards No. 4
Reporting Gains and Losses From Extinguishment of
Debt. SFAS 145 requires any gains or losses on
extinguishment of debt that were classified as an extraordinary
item in prior periods that do not meet the criteria in APB 30
for classification as an extraordinary item be reclassified into
income from operations. We adopted the provisions of
SFAS 145 on January 1, 2003. The impact of adoption of
SFAS 145 reduced income from operations by
$0.6 million for the year ended December 31, 2001
through the reclassification of the loss on extinguishment of
debt.

In April 2003, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards
No. 149 Amendment of SFAS 133 on Derivative
Instruments and Hedging Activities
(SFAS 149). SFAS 149 amends and clarifies
financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other
contracts and for hedging activities under Statement of
Financial Accounting Standards No. 133 Accounting for
Derivative Instruments and Hedging Activities.
SFAS 149 is effective for contracts entered into or
modified after June 30, 2003. The adoption of SFAS 149
did not have a material impact on the results of operations or
financial position of the Company.

In May 2003, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards
No. 150 Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity
(SFAS 150). SFAS 150 establishes standards
for how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity.
SFAS 150 is effective for financial instruments entered
into or modified after May 31, 2003, and otherwise is
effective beginning after July 1, 2003. On October 29,
2003, the Financial Accounting Standards Board voted to defer
for an indefinite period the application of SFAS 150 to
classification of non-controlling interests of limited-life
subsidiaries. The adoption of SFAS 150 did not have a
material impact on the results of operations or financial
position of the Company.

2.     Initial Public
Offering

On November 5, 2001, the Company completed
its Offering at $15.00 (pre-splits) per share. The Company sold
4.1 million shares (including 0.5 million shares
issued upon the exercise of the underwriters option to
purchase such shares to cover overallotments). The Company
received $56.0 million in net proceeds from the Offering,
of which $7.1 million was used to repay the Companys
outstanding borrowings under its revolving line of credit,
including unpaid interest thereon, and $10.6 million was
used to repay the Companys

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ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

12% senior subordinated notes. The Company
incurred debt extinguishments costs of $0.6 million, or
$0.4 million, net of tax. The remaining proceeds were used
to finance acquisitions of hospices, to develop new hospice
locations and for other general corporate purposes. Upon
completion of the Offering, the Company forgave the repayment of
promissory notes payable to it by Richard R. Burnham and
David C. Gasmire, who at the time of our initial public
offering were Chairman and Chief Executive Officer and President
and Chief Operating Officer, respectively. The Company recorded
a compensation charge of $0.2 million in connection with
the forgiveness of these notes in 2001. Upon the closing of the
Offering, the Companys preferred stock was mandatorily
converted into 8.1 million shares of common stock. The
accumulated dividends, which were not payable in the event of a
mandatory conversion, were reversed and no additional dividends
were accrued or recorded subsequent to the Offering. In November
2001 and in connection with the Offering, 1.0 million
shares of common stock were issued upon exercise of warrants
originally issued by the Company in connection with the original
issuance of its 12% senior subordinated notes.

3.     Acquisitions

2001

In February 2001, the Company purchased all the
assets and business of the Comforter of Colorado, LLC, a hospice
program in Colorado Springs, Colorado. The purchase price,
including transaction costs, totaled $0.7 million. Assets
acquired include goodwill of $0.7 million and certain
furniture and fixtures.

In April 2001, the Company purchased all the
assets and business of Hospice Health Services, Inc., a hospice
program in Charleston, South Carolina. The purchase price,
including transaction costs, totaled $0.7 million, which
included a note payable of $0.3 million and assumed
liabilities of $0.1 million. Assets acquired include
goodwill of $0.6 million and certain furniture and fixtures.

In April 2001, the Company purchased all the
assets and business of Crossroads Hospice of Arkansas, LLC, a
hospice program in Little Rock, Arkansas. The purchase price,
including transaction costs, totaled $2.8 million, which
included a note payable of $1.0 million. Assets acquired
include goodwill of $2.7 million and certain furniture and
fixtures.

In June 2001, the Company purchased all the
assets and business of Viator Healthcare, LP, a hospice program
in Pittsburgh, Pennsylvania. The purchase price, including
transaction costs, totaled $2.5 million, which included a
note payable of $0.5 million. Assets acquired include
goodwill of $2.5 million.

In July 2001, the Company purchased certain
assets of Alternative Healthcare System, Inc., a hospice program
in Beaumont, Texas. The purchase price, including transaction
costs, totaled $1.5 million, which included a note payable
of $0.6 million. Assets acquired include goodwill of
$1.5 million.

In September 2001, the Company purchased all the
assets and business of Trinity Health Ventures, Inc., a hospice
program in San Bernardino, California. The purchase price,
including transaction costs, totaled $1.5 million, which
included a note payable of $0.2 million. Assets acquired
include goodwill of $1.5 million and certain furniture and
fixtures.

In December 2001, the Company purchased all the
stock of Community Care Hospice, a hospice program in Odessa,
Texas. The purchase price, including transaction costs, totaled
$1.7 million, which included a note payable of
$0.5 million. Assets and liabilities acquired included cash
and short-term investments of $0.4 million, accounts
receivable of $0.3 million, goodwill of $1.6 million,
liabilities of $0.3 million and notes payable of
$0.2 million.

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ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

2002

In April 2002, the Company purchased all the
assets and business of Heart of Ohio Community Health Services
Corporation, a hospice program in Columbus, Ohio. The purchase
price, including transaction costs, totaled $0.6 million
and was accounted for as goodwill.

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

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

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

In August 2002, the Company purchased all the
assets and business of HospiCare, Inc., a hospice program
located in Biloxi, Mississippi. The purchase price, including
transaction costs, totaled $1.1 million. Assets acquired
include licenses of $0.2 million, a non-compete agreement
of $0.1 million and goodwill of $0.8 million.

In August 2002, the Company purchased all the
assets and business of Delta Hospice, Inc., a hospice program
located in Albuquerque, New Mexico, including an alternate
delivery site located in Los Alamos, New Mexico. The purchase
price, including transaction costs, totaled $2.0 million.
Assets acquired include licenses of $0.2 million, a
non-compete agreement of $0.1 million and goodwill of
$1.7 million. The purchase agreement included an earnout
provision, whereby, in December 2002, the Company paid
$0.2 million to the seller in response to certain revenue
targets being met. The earnout was treated as part of the
purchase price.

In September 2002, the Company purchased all the
assets and business of The Lutheran Home, Inc., a hospice
program located in Omaha, Nebraska. The purchase price,
including transaction costs, totaled $0.1 million. Assets
acquired include licenses and a non-compete agreement of
$0.1 million.

In October 2002, the Company purchased certain
assets of Alternative Healthcare Systems, Inc., a hospice
program located in Lake Charles, Louisiana. The purchase price,
including transaction costs, totaled $3.2 million. Assets
acquired include goodwill of $2.8 million, licenses of
$0.2 million and a non-compete agreement and fixed assets
of $0.2 million.

In December 2002, the Company purchased two
hospice programs from Circle of Life Hospice, LLP, located in La
Grange and Round Rock, Texas. The purchase price, including
transaction costs, totaled $2.5 million. Assets acquired
include goodwill of $2.1 million, licenses of
$0.2 million, and a non-compete agreement and fixed assets
of $0.2 million.

2003

In February 2003, the Company purchased
substantially all the assets and business of Good Shepherd
Hospice and Palliative Care Center, LLC, a hospice program
located in Waxahachie, Texas. The purchase price, including
transaction costs, totaled $3.0 million. Assets acquired
include licenses of $0.2 million, a non-compete agreement
of $0.1 million, goodwill of $2.7 million and certain
furniture and fixtures.

In May 2003, the Company purchased substantially
all the assets and business of Mahogany Hospice Care, Inc., a
hospice program located in Memphis, Tennessee. The purchase
price, including transaction costs,

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ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

totaled $1.3 million. Assets acquired
include licenses of $0.3 million, a non-compete agreement
of $0.2 million, and goodwill of $0.8 million and
certain furniture and fixtures.

Also in May 2003, the Company purchased
substantially all the assets and business of Homecare Hospice,
Inc., a hospice program located in Valdosta, Georgia. The
purchase price, including transaction costs, totaled
$0.5 million. Assets acquired include licenses of
$0.1 million, a non-compete agreement of $0.1 million,
and furniture and fixtures and goodwill of $0.3 million.

In August 2003, the Company purchased
substantially all the assets and business of Omega Hospice,
Ltd., a hospice program located in Brownsville, Texas. The
purchase price, including transaction costs, totaled
$1.7 million. Assets acquired include licenses of
$0.1 million, a non-compete agreement of $0.2 million,
and goodwill of $1.4 million and certain furniture and
fixtures.

Also in August 2003, the Company purchased
substantially all the assets and business of First State
Hospice, L.L.C., a hospice program located in Wilmington,
Delaware. The purchase price, including transaction costs,
totaled $0.5 million. Assets acquired include licenses of
$0.1 million, a non-compete agreement of $0.1 million,
and goodwill of $0.3 million and certain furniture and
fixtures.

In September 2003, the Company purchased
substantially all the assets and business of Utahs
Heritage Hospice, L.L.C., a hospice program located in Salt Lake
City, Utah. The purchase price, including transaction costs,
totaled $11.8 million. Assets acquired include licenses of
$0.2 million, a non-compete agreement of $0.2 million,
and goodwill of $11.4 million and certain furniture and
fixtures.

Also in September 2003, the Company purchased
certain assets of Grace, Inc, a hospice program located in
Omaha, Nebraska, with a patient census of approximately 35. The
purchase price, including transaction costs, totaled
$0.3 million. Assets acquired include a non-compete
agreement of $0.1 million and goodwill of $0.2 million.

In November 2003, the Company purchased certain
assets of Palliative Care, Inc., a hospice program located in
San Antonio, Texas, with a patient census of approximately 100.
The purchase price, including transaction costs, totaled
$3.3 million. Assets acquired include a non-compete
agreement of $0.2 million. and goodwill of
$3.1 million and certain furniture and fixtures.

2004

In January 2004, the Company purchased
substantially all the assets and business of Crown of Texas,
Ltd., a hospice program with operations located in Amarillo,
Texas and Conroe, Texas. The purchase price totaled
$22.5 million.

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

Unaudited pro forma consolidated results of
operations of the Company for the years ended December 31,
2001, 2002 and 2003 are presented below. Such pro forma
presentation has been prepared assuming

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ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

that the acquisitions described above have been
made as of January 1 of the year preceding the year of
acquisition:

|                                       |                                                         |                                          |         |      |      |   |         |      |  |   |         |      | 
|-------------------------------------- | ------------------------------------------------------- | ---------------------------------------- | ------- | ---- | ---- | - | ------- | ---- |  | - | ------- | ---- | 
|                                       |                                                         |                                         
|                                       |                                                         | Year Ended December 31,                  |        
|                                       |                                                         |                                          |        
|                                       |                                                         | 2001                                     |         |      | 2002 |   |         | 2003 | 
|                                       |                                                         |                                          |         |      |      |   |         |      | 
|                                       |                                                         |                                         
|                                       |                                                         | (In thousands, except per share amounts) |        
|Pro forma net patient service revenue  |                                                         | $                                        | 160,336 |      |      | $ | 231,611 |      |  | $ | 289,513 |     
|Pro forma net income                   |                                                         |                                          | 15,486  |      |      |   | 23,441  |      |  |   | 31,716  |     
|Pro forma net income per common share: |                                                         |                                          |         |      |      |   |         |      |  |   |         |     
|                                       | Basic net income available to common stockholders       |                                          | $       | 2.11 |      |   | $       | 0.67 |  |   | $       | 0.88 | 
|                                       |                                                         |                                          |         |      |      |   |         |      | 
|                                       | Diluted net income available to common
    stockholders |                                          | $       | 0.54 |      |   | $       | 0.64 |  |   | $       | 0.85 | 
|                                       |                                                         |                                          |         |      |      |   |         |      | 

4.     Intangible
Assets

Goodwill allocated to the Companys
reportable segments at December 31, 2002 and 2003 is as
follows (in thousands):

|                  |  |           |       |  |           |   |     |         |  |   |       |  |  |         |        |  |       |   |       |          |  |   |        |  |  |           |        |  |       |   |       |  |  |   |     |  |  |   |        | 
|----------------- |  | --------- | ----- |  | --------- | - | --- | ------- |  | - | ----- |  |  | ------- | ------ |  | ----- | - | ----- | -------- |  | - | ------ |  |  | --------- | ------ |  | ----- | - | ----- |  |  | - | --- |  |  | - | ------ | 
|                  |  | Northeast |       |  | Southeast |   |     | Central |  |   | South |  |  | Midwest |        |  | Texas |   |       | Mountain |  |   | West   |  |  | Corporate |        |  | Total |  
|                  |  |           |       |  |           |   |     |         |  |   |       |  |  |         |        |  |       |   |       |          |  |   |        |  |  |           |        |  |       |  
|January 1, 2003   |  | $         | 2,379 |  |           | $ | 703 |         |  | $ | 3,916 |  |  | $       | 14,970 |  |       | $ | 2,590 |          |  | $ | 7,814  |  |  | $         | 8,739  |  |       | $ | 5,296 |  |  | $ | 120 |  |  | $ | 46,527 | 
|Acquisitions      |  |           | 316   |  |           |   | 290 |         |  |   | 237   |  |  |         | 741    |  |       |   |      |          |  |   | 7,270  |  |  |           | 11,297 |  |       |   |      |  |  |   |    |  |  |   | 20,151 | 
|Disposals         |  |           |      |  |           |   |    |         |  |   |      |  |  |         |       |  |       |   |      |          |  |   |       |  |  |           |       |  |       |   |      |  |  |   |    |  |  |   |       | 
|                  |  |           |       |  |           |   |     |         |  |   |       |  |  |         |        |  |       |   |       |          |  |   |        |  |  |           |        |  |       |  
|December 31, 2003 |  | $         | 2,695 |  |           | $ | 993 |         |  | $ | 4,153 |  |  | $       | 15,711 |  |       | $ | 2,590 |          |  | $ | 15,084 |  |  | $         | 20,036 |  |       | $ | 5,296 |  |  | $ | 120 |  |  | $ | 66,678 | 
|                  |  |           |       |  |           |   |     |         |  |   |       |  |  |         |        |  |       |   |       |          |  |   |        |  |  |           |        |  |       |  

Other indefinite lived assets are comprised of
license agreements, which totaled $0.9 and $1.9 million at
December 31, 2002 and 2003, respectively, and are included
in intangibles in the accompanying consolidated balance sheets.
The Company does not believe there is any indication that the
carrying value of the license agreements exceeds their fair
value.

Intangible assets subject to amortization relate
primarily to non-compete agreements that are being amortized
based on the terms of the respective contracts and totaled $0.4
and $1.1 million (net of accumulated amortization of
$41,000 and $0.4 million) at December 31, 2002 and
2003, respectively, and are included in intangibles in the
accompanying consolidated balance sheets. Amortization expense
of the assets that still require amortization under
SFAS 142 was $0, $41,000 and $0.4 million for the
years ended December 31, 2001, 2002 and 2003, respectively.
Amortization expense relating to these intangible assets will be
approximately $0.5 million, $0.4 million and
$0.2 million in 2004, 2005 and 2006, respectively.

F-17



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##### Table of Contents



ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following table sets forth the effect on net
income and earnings per share excluding goodwill amortization
which was recognized in the year ended December 31, 2001.
Consistent with SFAS 142, the results of operations for the
year ended December 31, 2001 has not been restated for the
change in goodwill amortization, which was recognized in the
year ended December 31, 2001.

|                                                          |                                     |                                       |        |      |      |   |        |      |  |   |        |      | 
|--------------------------------------------------------- | ----------------------------------- | ------------------------------------- | ------ | ---- | ---- | - | ------ | ---- |  | - | ------ | ---- | 
|                                                          |                                     |                                      
|                                                          |                                     | Year Ended December 31,               |       
|                                                          |                                     |                                       |       
|                                                          |                                     | 2001                                  |        |      | 2002 |   |        | 2003 | 
|                                                          |                                     |                                       |        |      |      |   |        |      | 
|                                                          |                                     |                                      
|                                                          |                                     | (In thousands, except per share data) |       
|Reported net income applicable to common
    stockholders |                                     | $                                     | 17,554 |      |      | $ | 21,140 |      |  | $ | 31,207 |     
|Add back goodwill amortization, net of income tax         |                                     |                                       | 1,228  |      |      |   |       |      |  |   |       |     
|                                                          |                                     |                                       |        |      |      |   |        |      | 
|Adjusted net income                                       |                                     | $                                     | 18,782 |      |      | $ | 21,140 |      |  | $ | 31,207 |     
|                                                          |                                     |                                       |        |      |      |   |        |      | 
|Basic earnings per share:                                 |                                     |                                       |        |      |      |   |        |      |  |   |        |     
|                                                          | As reported                         |                                       | $      | 1.83 |      |   | $      | 0.61 |  |   | $      | 0.87 | 
|                                                          | Goodwill amortization               |                                       |        | 0.13 |      |   |        |     |  |   |        |     | 
|                                                          |                                     |                                       |        |      |      |   |        |      | 
|                                                          | Adjusted basic earnings per share   |                                       | $      | 1.96 |      |   | $      | 0.61 |  |   | $      | 0.87 | 
|                                                          |                                     |                                       |        |      |      |   |        |      | 
|Diluted earnings per share:                               |                                     |                                       |        |      |      |   |        |      |  |   |        |     
|                                                          | As reported                         |                                       | $      | 0.45 |      |   | $      | 0.58 |  |   | $      | 0.84 | 
|                                                          | Goodwill amortization               |                                       |        | 0.04 |      |   |        |     |  |   |        |     | 
|                                                          |                                     |                                       |        |      |      |   |        |      | 
|                                                          | Adjusted diluted earnings per share |                                       | $      | 0.49 |      |   | $      | 0.58 |  |   | $      | 0.84 | 
|                                                          |                                     |                                       |        |      |      |   |        |      | 

5.     Common
Stock

On February 24, 2003 and August 12,
2003, the Company completed two separate three-for-two stock
splits, each payable in the form of a fifty percent stock
dividend. The accompanying consolidated financial statements and
notes thereto have been restated for all periods presented to
reflect these stock dividends.

6.     Series B
Convertible Preferred Stock Warrants

In connection with the issuance of the
$1.5 million convertible promissory notes on May 22,
1998, the Company issued Series B warrants to the lenders
to purchase 0.2 million shares of Series B Convertible
Preferred Stock for consideration of $0.017 per share. The
warrants were valued at fair value, as determined by the
Company, at $0.2 million. This was recorded as a discount
on the convertible promissory notes as of December 31,
1998. The exercise price of the stock warrants was $0.83 and was
adjusted from time to time as provided in the warrant purchase
agreement. In December 2000, the warrants were amended such that
upon completion of an initial public offering where the
aggregate price paid for such shares by the public is equal to
or greater than $20.0 million at a per share price of at
least $4.00, the warrants were exercisable to purchase
0.2 million shares of the Companys common stock at an
exercise price of $1.67 per share. This amendment eliminated the
possibility of any additional shares of Series B
Convertible Preferred Stock becoming outstanding after the
completion of an initial public offering and did not provide the
holders of the warrants any additional rights and, accordingly,
no additional expense was recorded. Series B Convertible
Preferred Stock warrants to purchase 30,587 shares of common
stock remained outstanding as of December 31, 2003.

7.     Stock
Options

The Company no longer grants options under the
Odyssey HealthCare, Inc. Stock Option Plan (Stock Option
Plan). During 2001, the Company adopted the 2001
Equity-Based Compensation Plan (Compensation Plan).
Awards of stock options under the Compensation Plan shall not
exceed the lesser of 150,000,000 shares, or 10% of the total
number of shares of common stock then outstanding, assuming the
exercise of all

F-18



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##### Table of Contents



ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

outstanding options, warrants and the conversion
or exchange or exercise of all securities convertible into or
exchangeable or exercisable for common stock.

At December 31, 2003 there were 2,124,857
options and 617,220 options outstanding under the Stock Option
Plan and the Compensation Plan, respectively, with exercise
prices ranging from $0.04 to $28.48 per share. All options
granted have five to ten-year terms and vest over a four- and
five-year period.

There were 1,611,185 shares and 1,745,401 shares
available for issuance under the Compensation Plan at
December 31, 2002 and 2003, respectively.

A summary of stock option activity follows:

|                                         |           |                        |       |       |         |  |       |        |  
|---------------------------------------- | --------- | ---------------------- | ----- | ----- | ------- |  | ----- | ------ | -
|                                         |           | Weighted Average       |       |       |        
|                                         |           | Exercise Price         |       |       | Options | 
|                                         |           |                        |       |       |         | 
|                                         |           |                       
|                                         |           | (In thousands,         |      
|                                         |           | except dollar amounts) |      
|Options outstanding at January 1, 2001   |           | $                      | 0.51  |       |         |  | 2,145 |       
|                                         | Granted   |                        |       | 5.69  |         |  |       | 1,197  |  
|                                         | Canceled  |                        |       | 1.81  |         |  |       | (72    | )
|                                         | Exercised |                        |       | 0.30  |         |  |       | (123   | )
|                                         |           |                        |       |       |         | 
|Options outstanding at December 31, 2001 |           |                        | 2.43  |       |         |  | 3,147 |       
|                                         | Granted   |                        |       | 12.39 |         |  |       | 597    |  
|                                         | Canceled  |                        |       | 6.19  |         |  |       | (210   | )
|                                         | Exercised |                        |       | 0.79  |         |  |       | (676   | )
|                                         |           |                        |       |       |         | 
|Options outstanding at December 31, 2002 |           |                        | 4.51  |       |         |  | 2,858 |       
|                                         | Granted   |                        |       | 19.81 |         |  |       | 1,528  |  
|                                         | Cancelled |                        |       | 13.42 |         |  |       | (194   | )
|                                         | Exercised |                        |       | 3.04  |         |  |       | (1,450 | )
|                                         |           |                        |       |       |         | 
|Options outstanding at December 31, 2003 |           |                        | 12.85 |       |         |  | 2,742 |       
|                                         |           |                        |       |       |         | 

F-19



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##### Table of Contents



ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following table summarizes the stock options
outstanding as of December 31, 2003:

|               |       |                                               |       |                  |                  |  |        |             |      |        |                 |    |    |  |       |     |     | 
|-------------- | ----- | --------------------------------------------- | ----- | ---------------- | ---------------- |  | ------ | ----------- | ---- | ------ | --------------- | -- | -- |  | ----- | --- | --- | 
|               |       |                                               |       | Weighted Average |                  |  |        |             |     
|               |       |                                               |       | Remaining        |                  |  | Number |             |      | Number |                
|               |       | Number                                        |       |                  | Contractual Life |  |        | Vested and  |      |        | Unvested and    |   
|Exercise Price |       | Outstanding                                   |       |                  | (Years)          |  |        | Exercisable |      |        | Not Exercisable |   
|               |       |                                               |       |                  |                  |  |        |             |      |        |                 |   
|               |       |                                              
|               |       | (Amounts in thousands, except dollar amounts) |      
|$ 0.04         |       |                                               | 1     |                  |                  |  | 2.91   |             |      |        | 1               |    |    |  |      |    
|               |       | 0.44                                          |       |                  | 286              |  |        |             | 4.77 |        |                 |    |   |  |       |     | 286 | 
|               |       | 1.38                                          |       |                  | 240              |  |        |             | 6.86 |        |                 |    | 95 |  |       |     | 145 | 
|               |       | 3.11                                          |       |                  | 33               |  |        |             | 7.33 |        |                 |    | 9  |  |       |     | 24  | 
|               |       | 5.78                                          |       |                  | 57               |  |        |             | 7.67 |        |                 |    | 10 |  |       |     | 47  | 
|               |       | 7.19                                          |       |                  | 443              |  |        |             | 7.92 |        |                 |    | 2  |  |       |     | 441 | 
|               | 11.28 |                                               |       | 124              |                  |  |        | 8.58        |      |        |                 | 43 |    |  |       | 81  |    
|               | 11.69 |                                               |       | 145              |                  |  |        | 8.08        |      |        |                 | 15 |    |  |       | 130 |    
|               | 15.15 |                                               |       | 411              |                  |  |        | 8.92        |      |        |                 | 46 |    |  |       | 365 |    
|               | 15.25 |                                               |       | 159              |                  |  |        | 9.08        |      |        |                 |   |    |  |       | 159 |    
|               | 15.53 |                                               |       | 103              |                  |  |        | 8.92        |      |        |                 | 22 |    |  |       | 81  |    
|               | 18.76 |                                               |       | 13               |                  |  |        | 9.42        |      |        |                 |   |    |  |       | 13  |    
|               | 20.00 |                                               |       | 45               |                  |  |        | 9.42        |      |        |                 |   |    |  |       | 45  |    
|               | 22.33 |                                               |       | 443              |                  |  |        | 9.50        |      |        |                 |   |    |  |       | 443 |    
|               | 27.96 |                                               |       | 16               |                  |  |        | 9.50        |      |        |                 |   |    |  |       | 16  |    
|               | 28.48 |                                               |       | 223              |                  |  |        | 9.50        |      |        |                 |   |    |  |       | 223 |    
|               |       |                                               |       |                  |                  |  |        |             |      |        |                 |   
|               |       |                                               | 2,742 |                  |                  |  | 7.01   |             |      |        | 243             |    |    |  | 2,499 |    
|               |       |                                               |       |                  |                  |  |        |             |      |        |                 |   

F-20



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##### Table of Contents



ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

8. Net Income Per Common Share

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

|                             |                                                                                                                           |                                                                   |   |        |        |   |   |        |       |  |   |        |       | 
|---------------------------- | ------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------- | - | ------ | ------ | - | - | ------ | ----- |  | - | ------ | ----- | 
|                             |                                                                                                                           |                                                                  
|                             |                                                                                                                           | Year Ended December 31,                                           |  
|                             |                                                                                                                           |                                                                   |  
|                             |                                                                                                                           | 2001                                                              |   |        | 2002   |   |   | 2003   |      
|                             |                                                                                                                           |                                                                   |   |        |        |   |   |        |      
|                             |                                                                                                                           |                                                                  
|                             |                                                                                                                           | (In thousands, except per share amounts)                          |  
|Numerator                    |                                                                                                                           |                                                                   |   |        |        |   |   |        |       |  |   |       
|                             | Net income                                                                                                                |                                                                   | $ | 12,896 |        |   | $ | 21,140 |       |  | $ | 31,207 |      
|                             | Series A, B and C Preferred Stock Dividends                                                                               |                                                                   |   | (1,097 | )      |   |   |       |       |  |   |       |      
|                             | Gain on conversion of preferred securities                                                                                |                                                                   |   | 5,755  |        |   |   |       |       |  |   |       |      
|                             |                                                                                                                           |                                                                   |   |        |        |   |   |        |      
|                             | Numerator for basic earnings per
    share  income available to common stockholders                                      |                                                                   |   | 17,554 |        |   |   | 21,140 |       |  |   | 31,207 |      
|                             | Effect of dilutive securities:                                                                                            |                                                                   |   |        |        |   |   |        |       |  |   |        |      
|                             |                                                                                                                           | Series A, B and C Preferred Stock dividends                       |   |        | 1,097  |   |   |        |      |  |   |        |      | 
|                             |                                                                                                                           | Gain on conversion of preferred securities                        |   |        | (5,755 | ) |   |        |      |  |   |        |      | 
|                             |                                                                                                                           |                                                                   |   |        |        |   |   |        |      
|                             | Numerator for diluted net income per
    share  net income available to common stockholders
    after actual conversions |                                                                   | $ | 12,896 |        |   | $ | 21,140 |       |  | $ | 31,207 |      
|                             |                                                                                                                           |                                                                   |   |        |        |   |   |        |      
|Denominator                  |                                                                                                                           |                                                                   |   |        |        |   |   |        |       |  |   |       
|                             | Denominator for basic net income per
    share  weighted average shares                                                  |                                                                   |   | 9,552  |        |   |   | 34,782 |       |  |   | 35,945 |      
|                             | Effect of dilutive securities:                                                                                            |                                                                   |   |        |        |   |   |        |       |  |   |        |      
|                             |                                                                                                                           | Employee stock options                                            |   |        | 1,875  |   |   |        | 1,881 |  |   |        | 1,281 | 
|                             |                                                                                                                           | Series A, B and C Preferred Stock                                 |   |        | 15,107 |   |   |        |      |  |   |        |      | 
|                             |                                                                                                                           | Series B Preferred Stock Warrants
    convertible to common stock |   |        | 238    |   |   |        | 28    |  |   |        | 30    | 
|                             |                                                                                                                           | Common stock warrants                                             |   |        | 1,848  |   |   |        |      |  |   |        |      | 
|                             |                                                                                                                           |                                                                   |   |        |        |   |   |        |      
|                             | Denominator for diluted net income per
    share  adjusted weighted average shares and actual
    conversions            |                                                                   |   | 28,620 |        |   |   | 36,691 |       |  |   | 37,256 |      
|                             |                                                                                                                           |                                                                   |   |        |        |   |   |        |      
|Net income per common share: |                                                                                                                           |                                                                   |   |        |        |   |   |        |       |  |   |       
|                             | Basic net income available to common stockholders                                                                         |                                                                   | $ | 1.83   |        |   | $ | 0.61   |       |  | $ | 0.87   |      
|                             |                                                                                                                           |                                                                   |   |        |        |   |   |        |      
|                             | Diluted net income available to common
    stockholders                                                                   |                                                                   | $ | 0.45   |        |   | $ | 0.58   |       |  | $ | 0.84   |      
|                             |                                                                                                                           |                                                                   |   |        |        |   |   |        |      

9. Allowance for Uncollectible
Accounts

The allowance for uncollectible accounts for
patient accounts receivable is as follows:

|                             |  |                |       |  |               |   |       |             |  |   |             |   |  |   |       | 
|---------------------------- |  | -------------- | ----- |  | ------------- | - | ----- | ----------- |  | - | ----------- | - |  | - | ----- | 
|                             |  | Balance at     |       |  | Provision for |   |       | Write-Offs, |  |   |            
|                             |  | Beginning of   |       |  | Uncollectible |   |       | Net of      |  |   | Balance at  |  
|                             |  | Year           |       |  | Accounts      |   |       | Recoveries  |  |   | End of Year |  
|                             |  |                |       |  |               |   |       |             |  |   |             |  
|                             |  |               
|                             |  | (In thousands) |      
|Year ended December 31, 2001 |  | $              | 3,140 |  |               | $ | 3,207 |             |  | $ | (2,953      | ) |  | $ | 3,394 | 
|Year ended December 31, 2002 |  | $              | 3,394 |  |               | $ | 2,952 |             |  | $ | (3,384      | ) |  | $ | 2,962 | 
|Year ended December 31, 2003 |  | $              | 2,962 |  |               | $ | 4,015 |             |  | $ | (3,064      | ) |  | $ | 3,913 | 

F-21



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##### Table of Contents



ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

10. Property and Equipment

Property and equipment is as follows:

|                                               |  |                |       |  |      |   |        | 
|---------------------------------------------- |  | -------------- | ----- |  | ---- | - | ------ | 
|                                               |  |               
|                                               |  | December 31,   |      
|                                               |  |                |      
|                                               |  | 2002           |       |  | 2003 |  
|                                               |  |                |       |  |      |  
|                                               |  |               
|                                               |  | (In thousands) |      
|Office furniture                               |  | $              | 1,432 |  |      | $ | 2,504  | 
|Computer hardware                              |  |                | 2,022 |  |      |   | 3,310  | 
|Computer software                              |  |                | 1,041 |  |      |   | 2,365  | 
|Equipment                                      |  |                | 526   |  |      |   | 802    | 
|Motor vehicles                                 |  |                | 93    |  |      |   | 97     | 
|Buildings                                      |  |                | 25    |  |      |   |       | 
|Leasehold improvements                         |  |                | 1,803 |  |      |   | 2,691  | 
|                                               |  |                |       |  |      |  
|                                               |  |                | 6,942 |  |      |   | 11,769 | 
|Less accumulated depreciation and amortization |  |                | 3,272 |  |      |   | 5,334  | 
|                                               |  |                |       |  |      |  
|                                               |  | $              | 3,670 |  |      | $ | 6,435  | 
|                                               |  |                |       |  |      |  

11. Line of Credit, Long-Term Debt and Capital
Lease Obligations

Line of credit, long-term debt and capital lease
obligations consists of the following:

|                                                                                                                        |  |                |     |  |      |   |    | 
|----------------------------------------------------------------------------------------------------------------------- |  | -------------- | --- |  | ---- | - | -- | 
|                                                                                                                        |  |               
|                                                                                                                        |  | December 31,   |    
|                                                                                                                        |  |                |    
|                                                                                                                        |  | 2002           |     |  | 2003 |  
|                                                                                                                        |  |                |     |  |      |  
|                                                                                                                        |  |               
|                                                                                                                        |  | (In thousands) |    
|Acquisition notes payable, due in 2003; bearing
    interest at 7% to 8%, all of which are unsecured                    |  | $              | 248 |  |      | $ |   | 
|Leasehold improvement loans due between 2004 and
    2008; interest at 6.50% and 10.37%                                 |  |                | 13  |  |      |   | 17 | 
|Various capital leases covering equipment, due in
    2003; interest rates ranging from 7% to 15%; secured by equipment |  |                | 13  |  |      |   |   | 
|                                                                                                                        |  |                |     |  |      |  
|                                                                                                                        |  |                | 274 |  |      |   | 17 | 
|Less current maturities                                                                                                 |  |                | 274 |  |      |   | 4  | 
|                                                                                                                        |  |                |     |  |      |  
|                                                                                                                        |  | $              |    |  |      | $ | 13 | 
|                                                                                                                        |  |                |     |  |      |  

The Company had a $20.0 million revolving
line of credit that bore interest at prime, as defined in the
agreement, plus 1%, not to fall below 10%, and matured on
October 2, 2003. No amounts were drawn on the line of
credit at December 31, 2002 or October 2, 2003, the
maturity date.

F-22



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##### Table of Contents



ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Scheduled principal repayments on debt for the
next five years are as follows:

|     |  |                   |    | 
|---- |  | ----------------- | -- | 
|     |  | December 31, 2003 |   
|     |  |                   |   
|     |  | Debt              |   
|     |  |                   |   
|     |  | (In thousands)    |   
|2004 |  | $                 | 4  | 
|2005 |  |                   | 5  | 
|2006 |  |                   | 5  | 
|2007 |  |                   | 2  | 
|2008 |  |                   | 1  | 
|     |  |                   |   
|     |  | $                 | 17 | 
|     |  |                   |   

12. Income Taxes

Significant components of the Companys
deferred tax assets and liabilities are as follows:

|                          |                                    |                                       |        |        |      |   |        |        |        |  
|------------------------- | ---------------------------------- | ------------------------------------- | ------ | ------ | ---- | - | ------ | ------ | ------ | -
|                          |                                    |                                      
|                          |                                    | December 31,                          |       
|                          |                                    |                                       |       
|                          |                                    | 2002                                  |        |        | 2003 |  
|                          |                                    |                                       |        |        |      |  
|                          |                                    |                                      
|                          |                                    | (In thousands)                        |       
|Deferred tax assets:      |                                    |                                       |        |        |      |   |        |       
|                          | Accounts receivable                |                                       | $      | 889    |      |   | $      |       |       
|                          | Accrued compensation               |                                       |        | 622    |      |   |        | 808    |       
|                          | Workers compensation              |                                       |        | 241    |      |   |        | 638    |       
|                          |                                    |                                       |        |        |      |  
|                          |                                    |                                       | 1,752  |        |      |   | 1,446  |       
|                          |                                    |                                       |        |        |      |  
|Deferred tax liabilities: |                                    |                                       |        |        |      |   |        |       
|                          | Accounts receivable                |                                       |        |       |      |   |        | (220   | )     
|                          | Amortizable and depreciable assets |                                       |        | (1,767 | )    |   |        | (3,871 | )     
|                          | Other                              |                                       |        | (12    | )    |   |        | (471   | )     
|                          |                                    |                                       |        |        |      |  
|                          |                                    |                                       | (1,779 | )      |      |   | (4,562 | )     
|                          |                                    |                                       |        |        |      |  
|                          |                                    | Net deferred tax assets (liabilities) |        | $      | (27  | ) |        | $      | (3,116 | )
|                          |                                    |                                       |        |        |      |  

The components of the Companys income tax
expense are as follows:

|          |         |                         |       |       |      |   |        |        |  |   |        |        | 
|--------- | ------- | ----------------------- | ----- | ----- | ---- | - | ------ | ------ |  | - | ------ | ------ | 
|          |         |                        
|          |         | Year Ended December 31, |      
|          |         |                         |      
|          |         | 2001                    |       |       | 2002 |   |        | 2003   | 
|          |         |                         |       |       |      |   |        |        | 
|          |         |                        
|          |         | (Dollars in thousands)  |      
|Current:  |         |                         |       |       |      |   |        |        |  |   |        |       
|          | Federal |                         | $     | 2,698 |      |   | $      | 10,704 |  |   | $      | 14,914 | 
|          | State   |                         |       | 645   |      |   |        | 2,086  |  |   |        | 1,836  | 
|          |         |                         |       |       |      |   |        |        | 
|          |         |                         | 3,343 |       |      |   | 12,790 |        |  |   | 16,750 |       
|Deferred: |         |                         |       |       |      |   |        |        |  |   |        |       
|          | Federal |                         |       | (306  | )    |   |        | 298    |  |   |        | 2,629  | 
|          | State   |                         |       | (17   | )    |   |        | 52     |  |   |        | 460    | 
|          |         |                         |       |       |      |   |        |        | 
|          |         | $                       | 3,020 |       |      | $ | 13,140 |        |  | $ | 19,839 |       
|          |         |                         |       |       |      |   |        |        | 

F-23



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##### Table of Contents



ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The reconciliation of income tax expense computed
at the federal statutory tax rate to income tax expense is as
follows:

|                                         |  |                         |        |   |         |  |     |        |  |   |         |   |  |        |    |   |         |   |        |   |  |  |    |  
|---------------------------------------- |  | ----------------------- | ------ | - | ------- |  | --- | ------ |  | - | ------- | - |  | ------ | -- | - | ------- | - | ------ | - |  |  | -- | -
|                                         |  |                        
|                                         |  | Year Ended December 31, |       
|                                         |  |                         |       
|                                         |  |                         |        |   |         | 
|                                         |  | 2001                    |        |   | 2002    |  |     | 2003   | 
|                                         |  |                         |        |   |         |  |     |        | 
|                                         |  | Amount                  |        |   | Percent |  |     | Amount |  |   | Percent |   |  | Amount |    |   | Percent |  
|                                         |  |                         |        |   |         |  |     |        |  |   |         |   |  |        |    |   |         |  
|                                         |  |                        
|                                         |  | (Dollars in thousands)  |       
|Tax at federal statutory rate            |  | $                       | 5,571  |   |         |  | 35  | %      |  | $ | 11,998  |   |  |        | 35 | % |         | $ | 17,866 |   |  |  | 35 | %
|State income tax, net of federal benefit |  |                         | 628    |   |         |  | 4   |        |  |   | 1,064   |   |  |        | 3  |   |         |   | 1,452  |   |  |  | 3  |  
|Stock-based compensation charges         |  |                         | 389    |   |         |  | 2   |        |  |   | 142     |   |  |        | 1  |   |         |   | (94    | ) |  |  |   |  
|Non-deductible expenses and other        |  |                         | 151    |   |         |  | 1   |        |  |   | (64     | ) |  |        | (1 | ) |         |   | 615    |   |  |  | 1  |  
|Decrease in valuation allowance          |  |                         | (3,719 | ) |         |  | (23 | )      |  |   |        |   |  |        |   |   |         |   |       |   |  |  |   |  
|                                         |  |                         |        |   |         |  |     |        |  |   |         |   |  |        |    |   |         |  
|                                         |  | $                       | 3,020  |   |         |  | 19  | %      |  | $ | 13,140  |   |  |        | 38 | % |         | $ | 19,839 |   |  |  | 39 | %
|                                         |  |                         |        |   |         |  |     |        |  |   |         |   |  |        |    |   |         |  

The decrease in the valuation allowance in 2001
was due to the consistent profitability of the Companys
operations and the Companys ability to generate taxable
income and utilize its remaining net operating loss
carryforwards.

13. Retirement Plan

The Company sponsors a 401(k) plan, which is
available to substantially all employees after meeting certain
eligibility requirements. The plan provides for contributions by
the employees based on a percentage of their income. The Company
at its discretion may make contributions. Matching contributions
totaled $0.2 million, $0.3 million and
$0.6 million for the years ended December 31, 2001,
2002 and 2003, respectively.

14. Commitments and Contingencies

Leases

The Company leases office space and equipment at
its various locations. Total rental expense was approximately
$4.1 million, $5.2 million, and $7.0 million for
the years ended December 31, 2001, 2002 and 2003,
respectively.

Future minimum rental commitments under
noncancelable operating leases for the years subsequent to
December 31, 2003, are as follows (in thousands):

|           |  |   |        | 
|---------- |  | - | ------ | 
|2004       |  | $ | 6,872  | 
|2005       |  |   | 6,476  | 
|2006       |  |   | 5,630  | 
|2007       |  |   | 4,089  | 
|2008       |  |   | 2,466  | 
|Thereafter |  |   | 6,635  | 
|           |  |   |       
|           |  | $ | 32,168 | 
|           |  |   |       

Contingencies

The Company is involved in various legal
proceedings arising in the ordinary course of business. Although
the results of litigation cannot be predicted with certainty,
management believes the outcome of pending

F-24



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##### Table of Contents



ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

litigation will not have a material adverse
effect, after considering the effect of the Companys
insurance coverage, on the Companys consolidated financial
statements.

The Companys current general and
professional liability policy does not provide coverage for
claims that arise from acts that occurred prior to the
policys start date of April 12, 2000. From
March 12, 1999 to April 12, 2000, Reliance National
Insurance Company provided the Companys insurance
coverage. Since April 12, 2000, Lexington Insurance
Company, a subsidiary of American International Group, Inc., has
provided the Companys insurance coverage. During the
fourth quarter of 2001, the Insurance Commissioner of the
Commonwealth of Pennsylvania placed Reliance National Insurance
Company in liquidation. Based on the Companys estimation
of open claims, the Company is maintaining a reserve to cover
potential losses resulting from current and future litigation
claims covered by Reliance National Insurance Company to the
extent its assets are not sufficient to pay such claims.
Although the Company believes that the amount reserved is
adequate to cover its potential losses, there can be no
assurance that the Companys losses will not exceed the
amount reserved. The Companys profitability will be
negatively impacted to the extent its actual losses exceed the
amount reserved.

15. Segment Reporting

Prior to 2002, the Company evaluated the
performance of, and allocated resources to, its hospice programs
based on current operations and market assessments on a
hospice-by-hospice basis. The Companys continued growth in
2002 and 2003 reshaped these bases for evaluation and the
Company now has geographically defined operating segments which
to perform analysis and evaluate performance. The 2001 and 2002
amounts have been restated to reflect the change in operating
segments.

The Company currently evaluates performance and
allocates resources primarily on the basis of cost per day of
care and income from operations. The distribution of the
Companys net patient service revenue, direct hospice care
expenses, income (loss) from operations (which is used by
management for operating performance review), average daily
census and assets by geographic location are summarized in the
following tables.

|                             |           |                         |         |        |      |   |         |        |  |   |         |        | 
|---------------------------- | --------- | ----------------------- | ------- | ------ | ---- | - | ------- | ------ |  | - | ------- | ------ | 
|                             |           |                        
|                             |           | Year Ended December 31, |        
|                             |           |                         |        
|                             |           | 2001                    |         |        | 2002 |   |         | 2003   | 
|                             |           |                         |         |        |      |   |         |        | 
|                             |           |                        
|                             |           | (In thousands)          |        
|Net patient service revenue: |           |                         |         |        |      |   |         |        |  |   |         |       
|                             | Northeast |                         | $       | 8,234  |      |   | $       | 11,992 |  |   | $       | 15,730 | 
|                             | Southeast |                         |         | 5,976  |      |   |         | 8,862  |  |   |         | 12,426 | 
|                             | Central   |                         |         | 13,019 |      |   |         | 16,793 |  |   |         | 23,051 | 
|                             | South     |                         |         | 16,026 |      |   |         | 29,014 |  |   |         | 41,073 | 
|                             | Midwest   |                         |         | 14,990 |      |   |         | 20,376 |  |   |         | 25,345 | 
|                             | Texas     |                         |         | 23,239 |      |   |         | 41,626 |  |   |         | 61,193 | 
|                             | Mountain  |                         |         | 29,062 |      |   |         | 38,292 |  |   |         | 57,360 | 
|                             | West      |                         |         | 19,638 |      |   |         | 27,504 |  |   |         | 38,131 | 
|                             | Corporate |                         |         | (3     | )    |   |         |       |  |   |         |       | 
|                             |           |                         |         |        |      |   |         |        | 
|                             |           | $                       | 130,181 |        |      | $ | 194,459 |        |  | $ | 274,309 |       
|                             |           |                         |         |        |      |   |         |        | 

F-25



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##### Table of Contents



ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                               |           |                         |        |         |      |   |        |         |   |   |         |         |  
|------------------------------ | --------- | ----------------------- | ------ | ------- | ---- | - | ------ | ------- | - | - | ------- | ------- | -
|                               |           |                        
|                               |           | Year Ended December 31, |       
|                               |           |                         |       
|                               |           | 2001                    |        |         | 2002 |   |        | 2003    |  
|                               |           |                         |        |         |      |   |        |         |  
|                               |           |                        
|                               |           | (In thousands)          |       
|Direct hospice care expenses:  |           |                         |        |         |      |   |        |         |   |   |         |        
|                               | Northeast |                         | $      | 3,461   |      |   | $      | 5,398   |   |   | $       | 7,649   |  
|                               | Southeast |                         |        | 2,947   |      |   |        | 4,290   |   |   |         | 6,038   |  
|                               | Central   |                         |        | 5,739   |      |   |        | 7,652   |   |   |         | 11,100  |  
|                               | South     |                         |        | 7,535   |      |   |        | 14,193  |   |   |         | 20,155  |  
|                               | Midwest   |                         |        | 6,397   |      |   |        | 9,000   |   |   |         | 12,515  |  
|                               | Texas     |                         |        | 13,170  |      |   |        | 22,798  |   |   |         | 33,193  |  
|                               | Mountain  |                         |        | 13,903  |      |   |        | 18,380  |   |   |         | 27,719  |  
|                               | West      |                         |        | 9,025   |      |   |        | 13,160  |   |   |         | 18,592  |  
|                               | Corporate |                         |        | 92      |      |   |        | 73      |   |   |         | (595    | )
|                               |           |                         |        |         |      |   |        |         |  
|                               |           | $                       | 62,269 |         |      | $ | 94,944 |         |   | $ | 136,366 |        
|                               |           |                         |        |         |      |   |        |         |  
|Income (loss) from operations: |           |                         |        |         |      |   |        |         |   |   |         |        
|                               | Northeast |                         | $      | 3,093   |      |   | $      | 4,018   |   |   | $       | 4,496   |  
|                               | Southeast |                         |        | 1,845   |      |   |        | 2,911   |   |   |         | 3,942   |  
|                               | Central   |                         |        | 5,117   |      |   |        | 5,781   |   |   |         | 7,157   |  
|                               | South     |                         |        | 5,930   |      |   |        | 9,468   |   |   |         | 13,025  |  
|                               | Midwest   |                         |        | 5,467   |      |   |        | 7,181   |   |   |         | 6,842   |  
|                               | Texas     |                         |        | 5,394   |      |   |        | 11,341  |   |   |         | 17,009  |  
|                               | Mountain  |                         |        | 8,645   |      |   |        | 12,244  |   |   |         | 19,975  |  
|                               | West      |                         |        | 6,275   |      |   |        | 8,378   |   |   |         | 12,133  |  
|                               | Corporate |                         |        | (23,427 | )    |   |        | (27,367 | ) |   |         | (33,783 | )
|                               |           |                         |        |         |      |   |        |         |  
|                               |           | $                       | 18,339 |         |      | $ | 33,955 |         |   | $ | 50,796  |        
|                               |           |                         |        |         |      |   |        |         |  

|                      |           |                         |       |     |      |  |       |      |  |  |       |       | 
|--------------------- | --------- | ----------------------- | ----- | --- | ---- |  | ----- | ---- |  |  | ----- | ----- | 
|                      |           |                        
|                      |           | Year Ended December 31, |      
|                      |           |                         |      
|                      |           | 2001                    |       |     | 2002 |  |       | 2003 | 
|                      |           |                         |       |     |      |  |       |      | 
|Average Daily Census: |           |                         |       |     |      |  |       |      |  |  |       |      
|                      | Northeast |                         |       | 196 |      |  |       | 274  |  |  |       | 346   | 
|                      | Southeast |                         |       | 128 |      |  |       | 181  |  |  |       | 259   | 
|                      | Central   |                         |       | 347 |      |  |       | 431  |  |  |       | 566   | 
|                      | South     |                         |       | 418 |      |  |       | 749  |  |  |       | 1,019 | 
|                      | Midwest   |                         |       | 365 |      |  |       | 467  |  |  |       | 559   | 
|                      | Texas     |                         |       | 581 |      |  |       | 997  |  |  |       | 1,440 | 
|                      | Mountain  |                         |       | 591 |      |  |       | 745  |  |  |       | 1,094 | 
|                      | West      |                         |       | 418 |      |  |       | 563  |  |  |       | 736   | 
|                      |           |                         |       |     |      |  |       |      | 
|                      |           |                         | 3,044 |     |      |  | 4,407 |      |  |  | 6,019 |      
|                      |           |                         |       |     |      |  |       |      | 

F-26



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##### Table of Contents



ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|              |           |                         |         |        |      |   |         |        | 
|------------- | --------- | ----------------------- | ------- | ------ | ---- | - | ------- | ------ | 
|              |           |                        
|              |           | Year Ended December 31, |        
|              |           |                         |        
|              |           | 2002                    |         |        | 2003 |  
|              |           |                         |         |        |      |  
|              |           |                        
|              |           | (In thousands)          |        
|Total Assets: |           |                         |         |        |      |   |         |       
|              | Northeast |                         | $       | 3,748  |      |   | $       | 5,693  | 
|              | Southeast |                         |         | 2,052  |      |   |         | 4,458  | 
|              | Central   |                         |         | 6,955  |      |   |         | 9,145  | 
|              | South     |                         |         | 22,601 |      |   |         | 26,637 | 
|              | Midwest   |                         |         | 8,250  |      |   |         | 11,434 | 
|              | Texas     |                         |         | 14,751 |      |   |         | 28,341 | 
|              | Mountain  |                         |         | 17,993 |      |   |         | 34,538 | 
|              | West      |                         |         | 10,233 |      |   |         | 12,493 | 
|              | Corporate |                         |         | 38,831 |      |   |         | 46,819 | 
|              |           |                         |         |        |      |  
|              |           | $                       | 125,414 |        |      | $ | 179,558 |       
|              |           |                         |         |        |      |  

16. Related Party Transactions

A former member of the Companys board of
directors is a partner of the limited liability partnership from
which the Company had obtained the senior subordinated notes.
Interest paid on these notes was approximately $1.6 million
for the year ended December 31, 2001. These notes were paid
in full with proceeds from the Offering.

In January 1996, the Company accepted notes from
executive management totaling $0.2 million for the purchase
of Series A Convertible Preferred Stock. During 2000, a
former executive forfeited 0.1 million shares of
Series A Convertible Preferred Stock in exchange for
forgiveness of his note payable to the Company totaling
$0.1 million, including accumulated dividends. In 2001, the
Company forgave the remaining notes totaling $0.2 million.
Compensation expense was recorded totaling $0.2 million
representing note principal and accrued interest in 2001.

17. Fair Values of Financial
Instruments

Statement of Financial accounting Standards
No. 107 Disclosures about Fair Value of Financial
Instruments, (SFAS 107) requires disclosures
of fair value information about financial instruments, whether
or not recognized in the balance sheet, for which it is
practicable to estimate that value. In cases where quoted market
prices are not available, fair values are based on estimates
using present value or other valuation techniques. Those
techniques are significantly affected by assumptions used,
including the discount rate and estimates of future cash flows.
In that regard, the derived fair value estimates cannot be
substantiated by comparison to independent markets, and in many
cases, could not be realized in immediate settlement of the
instrument. SFAS 107 excludes certain financial instruments and
all nonfinancial instruments from its disclosure requirements.
Accordingly, the aggregate fair value amounts presented do not
represent the underlying value of the Company. The following
methods and assumptions used by the Company in estimating its
fair value disclosures for financial instruments:

Cash and Cash
Equivalents and Short-term Investments

The carrying amount reported in the consolidated
balance sheets for cash and cash equivalents and short-term
investments approximates its fair value.

F-27



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##### Table of Contents



ODYSSEY HEALTHCARE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Line of
Credit and Long-term Debt (Including Current
Maturities)

The fair values of the long-term debt are
estimated using discounted cash flow analyses, based on the
Companys incremental borrowing rates for similar types of
borrowing arrangements.

The carrying amounts and estimated fair values of
the Companys financial instruments at December 31,
2002 and 2003 are as follows (in thousands):

|                                                             |  |          |        |  |       |   |        |          |  |   |        |  |  |   |        | 
|------------------------------------------------------------ |  | -------- | ------ |  | ----- | - | ------ | -------- |  | - | ------ |  |  | - | ------ | 
|                                                             |  |          |        | 
|                                                             |  | 2002     |        |  | 2003  |  
|                                                             |  |          |        |  |       |  
|                                                             |  | Carrying |        |  | Fair  |   |        | Carrying |  |   | Fair   | 
|                                                             |  | Amount   |        |  | Value |   |        | Amount   |  |   | Value  | 
|                                                             |  |          |        |  |       |   |        |          |  |   |        | 
|Cash and cash equivalents                                    |  | $        | 7,732  |  |       | $ | 7,732  |          |  | $ | 232    |  |  | $ | 232    | 
|Short-term investments                                       |  | $        | 25,898 |  |       | $ | 25,898 |          |  | $ | 38,742 |  |  | $ | 38,742 | 
|Acquisition notes payable (including current
    maturities) |  | $        | 248    |  |       | $ | 248    |          |  | $ |       |  |  | $ |       | 
|Long-term debt (including current maturities)                |  | $        | 26     |  |       | $ | 26     |          |  | $ | 17     |  |  | $ | 17     | 

18. Unaudited Quarterly Financial
Information

The quarterly interim financial information shown
below has been prepared by the Companys management and is
unaudited. It should be read in conjunction with the audited
consolidated financial statements appearing herein:

|                                                  |  |                                          |        |  |        |   |        |       |  |   |        |  |  |   |        | 
|------------------------------------------------- |  | ---------------------------------------- | ------ |  | ------ | - | ------ | ----- |  | - | ------ |  |  | - | ------ | 
|                                                  |  |                                         
|                                                  |  | 2003 Calendar Quarters                   |       
|                                                  |  |                                          |       
|                                                  |  | First                                    |        |  | Second |   |        | Third |  |   | Fourth | 
|                                                  |  |                                          |        |  |        |   |        |       |  |   |        | 
|                                                  |  |                                         
|                                                  |  | (In thousands, except per share amounts) |       
|Total revenues                                    |  | $                                        | 60,060 |  |        | $ | 64,896 |       |  | $ | 71,049 |  |  | $ | 78,304 | 
|Net income                                        |  | $                                        | 7,208  |  |        | $ | 7,567  |       |  | $ | 7,847  |  |  | $ | 8,585  | 
|Net income per share  Basic                      |  | $                                        | 0.20   |  |        | $ | 0.21   |       |  | $ | 0.22   |  |  | $ | 0.24   | 
|Net income per share  Diluted                    |  | $                                        | 0.20   |  |        | $ | 0.20   |       |  | $ | 0.21   |  |  | $ | 0.23   | 
|Weighted average shares outstanding 
    Basic   |  |                                          | 35,423 |  |        |   | 35,643 |       |  |   | 36,063 |  |  |   | 36,392 | 
|Weighted average shares outstanding 
    Diluted |  |                                          | 36,869 |  |        |   | 37,194 |       |  |   | 37,791 |  |  |   | 37,990 | 

|                                                  |  |                                          |        |  |        |   |        |       |  |   |        |  |  |   |        | 
|------------------------------------------------- |  | ---------------------------------------- | ------ |  | ------ | - | ------ | ----- |  | - | ------ |  |  | - | ------ | 
|                                                  |  |                                         
|                                                  |  | 2002 Calendar Quarters                   |       
|                                                  |  |                                          |       
|                                                  |  | First                                    |        |  | Second |   |        | Third |  |   | Fourth | 
|                                                  |  |                                          |        |  |        |   |        |       |  |   |        | 
|                                                  |  |                                         
|                                                  |  | (In thousands, except per share amounts) |       
|Total revenues                                    |  | $                                        | 40,133 |  |        | $ | 46,636 |       |  | $ | 50,737 |  |  | $ | 56,953 | 
|Net income                                        |  | $                                        | 4,024  |  |        | $ | 4,732  |       |  | $ | 5,405  |  |  | $ | 6,978  | 
|Net income per share  Basic                      |  | $                                        | 0.12   |  |        | $ | 0.14   |       |  | $ | 0.15   |  |  | $ | 0.20   | 
|Net income per share  Diluted                    |  | $                                        | 0.11   |  |        | $ | 0.13   |       |  | $ | 0.15   |  |  | $ | 0.19   | 
|Weighted average shares outstanding 
    Basic   |  |                                          | 34,497 |  |        |   | 34,739 |       |  |   | 34,890 |  |  |   | 34,994 | 
|Weighted average shares outstanding 
    Diluted |  |                                          | 36,723 |  |        |   | 36,815 |       |  |   | 36,777 |  |  |   | 37,002 | 

F-28



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##### Table of Contents



EXHIBIT INDEX

|        |        |  |  |   |             |                                                                                                                                                                                                                                                                                                                                                                                                     
|------- | ------ |  |  | - | ----------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |        |  |  |   |            
|Number  |        |  |  |   | Description
|        |        |  |  |   |            
|        | 3.1    |  |  |  |             | Fifth Amended and Restated Certificate of
    Incorporation (incorporated by reference to Exhibit 3.1 to
    the Companys Amendment No. 2 to Registration
    Statement on Form S-1 (Registration No. 333-51522) as
    filed with the Commission on September 13, 2001)                                                                                                                           
|        | 3.2    |  |  |  |             | Second Amended and Restated Bylaws (incorporated
    by reference to Exhibit 3.2 to the Companys
    Registration Statement on Form S-1 (Registration
    No. 333-51522) as filed with the Commission on
    December 8, 2000)                                                                                                                                                                     
|        | 4.1    |  |  |  |             | Form of Common Stock Certificate (incorporated by
    reference to Exhibit 4.1 to the Companys Amendment
    No. 1 to Registration Statement on Form S-1
    (Registration No. 333-51522) as filed with the Commission on
    August 2, 2001)                                                                                                                                                      
|        | 4.2    |  |  |  |             | Second Amended and Restated Registration Rights
    Agreement, dated July 1, 1998, by and among Odyssey
    HealthCare, Inc. and the security holders named therein
    (incorporated by reference to Exhibit 4.3 to the
    Companys Registration Statement on Form S-1
    (Registration No. 333-51522) as filed with the Commission
    on December 8, 2000)                                    
|        | 4.3    |  |  |  |             | Rights Agreement (the Rights
    Agreement) dated November 5, 2001, between Odyssey
    HealthCare, Inc. and Rights Agent (incorporated by reference to
    Exhibit 4.1 to the Companys Registration Statement on
    Form 8-A as filed with the Commission on December 8,
    2001)                                                                                                             
|        | 4.4    |  |  |  |             | Form of Certificate of Designation of
    Series A Junior Participating Preferred Stock (included as
    Exhibit A to the Rights Agreement (Exhibit 4.3 hereto))                                                                                                                                                                                                                                    
|        | 10.1.1 |  |  |  |             | Amended and Restated Loan and Security Agreement,
    dated October 2, 2000 (the Credit Agreement),
    by and among Odyssey HealthCare, Inc. and subsidiaries and
    Heller Healthcare Finance, Inc. (incorporated by reference to
    Exhibit 10.1.1 to the Companys Registration Statement
    on Form S-1 (Registration No. 333-51522) as filed with
    the Commission on December 8, 2000)
|        | 10.1.2 |  |  |  |             | First Amendment to the Credit Agreement, dated
    March 29, 2001 (incorporated by reference to
    Exhibit 10.1.2 to the Companys Amendment No. 1
    to Registration Statement on Form S-1 (Registration
    No. 333-51522) as filed with the Commission on
    August 2, 2001)                                                                                                                  
|        | 10.1.3 |  |  |  |             | Second Amendment to Credit Agreement, dated
    May 8, 2001 (incorporated by reference to
    Exhibit 10.1.3 to the Companys Amendment No. 2
    to Registration Statement on Form S-1 (Registration
    No. 333-51522) as filed with the Commission on
    September 13, 2001)                                                                                                                    
|        | 10.2   |  |  |  |             | Amended and Restated Employment Agreement,
    effective as of February 28, 2002, by and between Odyssey
    HealthCare, Inc. and Richard R. Burnham (incorporated by
    reference to Exhibit 10.2 to the Companys Annual Report on
    Form 10-K as filed with the Commission on March 20,
    2002)                                                                                             
|        | 10.3   |  |  |  |             | Amended and Restated Employment Agreement,
    effective as of February 28, 2002, by and between Odyssey
    HealthCare, Inc. and David C. Gasmire (incorporated by reference
    to Exhibit 10.3 to the companys Annual Report on
    Form 10-K as filed with the Commission on March 20,
    2002)                                                                                               
|        | 10.4   |  |  |  |             | Amended and Restated Employment Agreement,
    effective as of February 28, 2002, by and between Odyssey
    HealthCare, Inc. and Douglas B. Cannon (incorporated by
    reference to Exhibit 10.4 to the Companys Annual report on
    Form 10-K as filed with the Commission on March 20,
    2002)                                                                                              
|        | 10.5.1 |  |  |  |             | Odyssey HealthCare, Inc. Stock Option Plan (the
    Stock Option Plan) (incorporated by reference to
    Exhibit 10.5 to the Companys Registration Statement
    on Form S-1 (Registration No. 333-51522) as filed with
    the Commission on December 8, 2000)                                                                                                                                  
|        | 10.5.2 |  |  |  |             | First Amendment to the Stock Option Plan, dated
    January 31, 2001 (incorporated by reference to
    Exhibit 10.5.2 to the Companys Amendment No. 2
    to Registration Statement on Form S-1 (Registration
    No. 333-51522) as filed with the Commission on
    September 13, 2001)                                                                                                           
|        | 10.6   |  |  |  |             | 2001 Equity-Based Compensation Plan (incorporated
    by reference to Exhibit 10.6 to the Companys
    Amendment No. 2 to Registration Statement on Form S-1
    (Registration No. 333-51522) as filed with the Commission on
    September 13, 2001)                                                                                                                                              
|        | 10.7.1 |  |  |  |             | Employee Stock Purchase Plan (incorporated by
    reference to Exhibit 10.7 to the Companys Amendment
    No. 2 to Registration Statement on Form S-1
    (Registration No. 333-51522) as filed with the Commission on
    September 13, 2001)                                                                                                                                                     



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##### Table of Contents



|        |        |  |  |   |             |                                                                                                                                                                                                                                                                                                                                             
|------- | ------ |  |  | - | ----------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |        |  |  |   |            
|Number  |        |  |  |   | Description
|        |        |  |  |   |            
|        | 10.7.2 |  |  |  |             | First Amendment to Employee Stock Purchase Plan,
    dated March 6, 2002 (incorporated by reference to
    Exhibit 10.7.2 to the Companys annual Report on
    Form 10-K as filed with the Commission on March 20,
    2002)                                                                                                               
|        | 10.8   |  |  |  |             | Form of Indemnification Agreement between Odyssey
    HealthCare, Inc. and its directors and officers (incorporated by
    reference to Exhibit 10.8 to the Companys
    Registration Statement on Form S-1 (Registration No.
    333-51522) as filed with the Commission on December 8, 2000)                                             
|        | 10.9.1 |  |  |  |             | Promissory Note and Warrant Purchase Agreement,
    dated May 22, 1998, by and among Odyssey HealthCare, Inc. and
    the other parties thereto (incorporated by reference to Exhibit
    10.10.1 to the Companys Registration Statement on
    Form S-1 (Registration No. 333-51522) as filed with
    the Commission on December 8, 2000)
|        | 10.9.2 |  |  |  |             | Form of Warrant, dated May 22, 1998
    (incorporated by reference to Exhibit 10.10.2 to the
    Companys Registration Statement on Form S-1
    (Registration No. 333-51522) as filed with the Commission
    on December 8, 2000)                                                                                                        
|        | 10.9.3 |  |  |  |             | First Amendment to Warrants, dated
    December 6, 2000 (incorporated by reference to
    Exhibit 10.10.3 to the Companys Amendment No. 1
    to Registration Statement on Form S-1 (Registration
    No. 333-51522) as filed with the Commission on
    August 2, 2001)                                                                   
|        | 21     |  |  |  |             | Subsidiaries of Odyssey HealthCare, Inc.*                                                                                                                                                                                                                                                                                                   
|        | 23.1   |  |  |  |             | Consent of Ernst & Young LLP*                                                                                                                                                                                                                                                                                                               
|        | 31.1   |  |  |  |             | Certification required by Rule 13a-14(a),
    dated March 11, 2004, by David C. Gasmire, Chief Executive
    Officer*                                                                                                                                                                                                                       
|        | 31.2   |  |  |  |             | Certification required by Rule 13a-14(a),
    dated March 11, 2004, by Douglas B. Cannon, Chief Financial
    Officer*                                                                                                                                                                                                                      
|        | 32     |  |  |  |             | Certification required by Rule 13a-14(a),
    dated March 11, 2004, by David C. Gasmire, Chief Executive
    Officer, and Douglas B. Cannon, Chief Financial Officer*                                                                                                                                                                       



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| |   |                
| | - | ---------------
| | * | Filed herewith.