• adverse changes in reimbursement levels under Medicare and Medicaid programs;

• our ability to successfully integrate and maintain the operations of the hospice programs acquired through our acquisition of VistaCare, Inc.;

• adverse changes in the Medicare payment cap limits and increases in our estimated Medicare cap contractual adjustments;

• decline in patient census growth;

• increases in inflation including inflationary increases in patient care costs;

• challenges inherent in and potential changes in our growth and development strategy;

• our ability to effectively implement our 2008 operations and development initiatives;

• our dependence on patient referral sources and potential adverse changes in patient referral practices of those referral sources;

• our ability to attract and retain healthcare professionals;

• increases in our bad debt expense due to various factors including an increase in the volume of pre-payment reviews by Medicare fiscal intermediaries;

• adverse changes in the state and federal licensure and certification laws and regulations;

• adverse results of regulatory surveys;

• delays in licensure and/or certification;

• government and private party legal proceedings and investigations;

• changes in state or federal income, franchise or similar tax laws and regulations;

• cost of complying with the terms and conditions of our corporate integrity agreement;

• adverse changes in the competitive environment in which we operate;

• our ability to liquidate our auction rate securities at their face value;

• adverse impact of natural disasters; and

• changes in our estimate of additional compensation costs under FASB Statement No. 123(R).

In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this Quarterly Report on Form 10-Q may not occur and actual results could differ materially from those anticipated or implied in the forward-looking statements. Many of these factors are beyond our ability to control or predict. Given these uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements, which reflect management's views only as of the date hereof. We undertake no obligation to revise or update any of the forward-looking statements or publicly announce any updates or revisions to any of the forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions, circumstances or assumptions underlying such statements. Reference is hereby made to the disclosures contained under the heading "Government Regulation and Payment Structure" in "Item 1. Business" and the disclosures contained under the heading "Item 1A. Risk Factors" in our 2007 Annual Report on Form 10-K filed with the Securities and Exchange Commission (the "SEC") on March 14, 2008.
The following discussion of our financial condition and results of operations should be read in conjunction with our unaudited consolidated financial statements and the related notes thereto included in Item 1 of this Quarterly Report on Form 10-Q.
OVERVIEW
On March 6, 2008, we completed our acquisition of VistaCare, Inc. Following the completion of the VistaCare acquisition, we now serve approximately 12,000 patients and their families each day through approximately 100 Medicare-certified hospice locations in 30 states. We are currently in the process of integrating the VistaCare hospice programs into our operations and the VistaCare corporate functions with our own corporate functions at our Support Center. Our primary goal during our integration of the VistaCare acquisition is to maintain the VistaCare patient census and site level profitability while implementing best practices. We anticipate that the VistaCare corporate support functions will be fully transitioned to our Support Center by the end of the fourth quarter of 2008. See Note 2 in the unaudited consolidated financial statements for a more detailed description of the transaction. The VistaCare acquisition significantly affects the comparability of our financial information as of June 30, 2008 and for the three and six month periods then ended.
We are one of the largest providers of hospice care in the United States in terms of both average daily patient census and number of Medicare-certified hospice programs. We operate all of our hospice programs through our operating subsidiaries. During the six months ended June 30, 2008, our average daily census was 10,668 patients, which represents a 39.7% increase over our average daily census of 7,636 patients for the six months ended June 30, 2007. Our average daily census increased by 4,435 patients due to the acquisition of the VistaCare operations. Our net patient service revenue of $283.5 million for the six months ended June 30, 2008 represents an increase of 44.5% over our net patient service revenue of $196.2 million for the six months ended June 30, 2007. We reported income from continuing operations of $7.6 million for the six months ended June 30, 2008, which represents a decrease of

22.3% from our income from continuing operations of $9.8 million for the six months ended June 30, 2007. We reported net income of $3.2 million, which includes a $4.4 million loss from discontinued operations, net of taxes, for the six months ended June 30, 2008 compared to net income of $7.8 million for the six months ended June 30, 2007, which includes a $2.0 million loss from discontinued operations, net of taxes.
On May 4, 2007, we announced the adoption of a stock repurchase program to repurchase up to $50.0 million of our common stock over the twelve month period beginning on May 4, 2007 either in the open market or through privately negotiated transactions, subject to market conditions and other factors. The repurchased shares were added to our treasury shares and may be used for employee stock plans and for other corporate purposes. The stock has been repurchased utilizing working capital and borrowings under our revolving line of credit. As of June 30, 2008 and since the adoption of this program we had repurchased 1,056,623 shares of our common stock for approximately $13.1 million (average cost of $12.42 per share). No shares were purchased during the six months ended June 30, 2008. The stock repurchase program expired on May 4, 2008. The terms of our credit agreement restrict our ability to repurchase any additional stock until our leverage ratio reaches a certain level, which is not expected to be reached within the next twelve months.
DEVELOPED HOSPICES
During the first quarter of 2007, our hospice program located in Boston, Massachusetts received its state licensure and received its Medicare certification in the second quarter of 2007. In addition, during the second quarter of 2007, we expanded the areas served by our Miami, Florida; Valdosta, Georgia; and Kansas City, Missouri hospice programs with the opening of Medicare certified alternate delivery sites in Monroe County, Florida; Douglas, Georgia; and Kearney, Missouri, respectively. During the first quarter of 2008, our hospice program located in Augusta, Georgia received its Medicare certification. During the second quarter of 2008, our hospice program located in Dayton, Ohio received its Medicare certification. During the second quarter of 2007 and 2008, we incurred pre-tax start-up losses of approximately $0.2 million and $0.3 million, respectively.
Once a hospice becomes Medicare certified, the process is started to obtain Medicaid certification. This process takes approximately six months and varies from state to state.
DISCONTINUED OPERATIONS
We conduct an ongoing strategic review of our hospice programs from which we evaluate hospice programs and decide to sell or close certain hospice programs.
On January 29, 2007, we announced that we would exit the Tulsa, Oklahoma hospice market, which was located in our Central region, and on February 22, 2007, we sold the Tulsa hospice program. As part of the sale, the purchaser assumed the office lease and purchased certain assets such as furniture/fixtures, equipment, deposits and licenses. We recognized a loss of $0.1 million related to the sale of the program during the first quarter of 2007.
We decided in the second quarter of 2007 to sell the Valdosta, Georgia; Columbia, South Carolina; St. George, Utah; Rockford, Illinois; and Allentown, Pennsylvania hospice programs and the Huntsville, Alabama alternate delivery site ("ADS"). We completed the sale of the Valdosta and Columbia programs, which were located in our Southeast region, on June 16, 2007 and recognized a pre-tax loss of $0.1 million in the second quarter on the sale of the programs. We completed the sale of the Huntsville ADS and our St. George and Allentown programs, which were located in our Southeast, Mountain and Midwest regions, respectively, during the third quarter of 2007 and no material amounts were recorded as a result. We completed the sale of the Rockford program, which was located in our Midwest region during the fourth quarter of 2007 and recognized a pre-tax gain of $0.1 million in the fourth quarter on the sale of the Rockford program.
We decided in the fourth quarter of 2007 to sell the Odessa, Texas; Big Spring, Texas; Cincinnati, Ohio; and Wichita, Kansas hospice programs. We completed the sale of the Odessa and Big Spring programs which were located in our Mountain region on January 1, 2008 and recognized a pre-tax loss of $17,000 during the fourth quarter of 2007 related to the sale of the Odessa and Big Spring programs. We completed the sale of the Cincinnati and Wichita programs, which were located in our Midwest and South Central regions, respectively, during the first quarter of 2008 and no material amounts were recorded as a result.
We decided in the first quarter of 2008 to sell the Baton Rouge, Louisiana; Ventura, California; Fort Wayne, Indiana; and Oklahoma City, Oklahoma hospice programs which are located in our Southeast, West, Midwest and South Central regions, repsectively. We also decided to close the Bryan/College Station, Texas hospice program and the Dallas, Texas inpatient unit. The

closures of the Bryan/College Station and Dallas inpatient unit programs which were located in our Texas and South Central regions, respectively, resulted in a pre-tax loss of $1.5 million during the first quarter of 2008, which included an accrual for the future lease costs of these closed programs of $1.2 million.
We decided in the second quarter of 2008 to close the Colorado Springs, Colorado inpatient unit and the Tucson, Arizona VistaCare program. The closures which were located in our Mountain and VistaCare West regions, respectively, resulted in a pre-tax loss of $2.3 million during the second quarter of 2008, which included an accrual for future lease costs of these closed programs of $2.1 million.
During the six months ended June 30, 2007 and 2008, we recorded a charge of approximately $2.0 million and $4.4 million, respectively, net of taxes, or $0.06 and $0.13 per diluted share, respectively, related to these entities in discontinued operations. These charges are included in discontinued operations for the respective periods.
Our results of operations and statistics for prior periods have been restated to reflect the reclassification of these entities to discontinued operations.
ACQUISITIONS
As discussed above, we completed the acquisition of VistaCare on March 6, 2008. We accounted for this acquisition as a purchase. As part of our ongoing acquisition strategy, we are continually evaluating potential acquisition opportunities.
Goodwill from our acquisitions was $207.6 million as of June 30, 2008, of which $109.3 million is a preliminary amount related to the VistaCare acquisition, representing 110.6% of stockholders' equity and 45.3% of total assets as of June 30, 2008. We account for goodwill and other intangible assets based on the provisions of Statement of Financial Accounting Standard No. 142 "Goodwill and Other Intangible Assets" ("SFAS 142"). Under SFAS 142, goodwill and intangible assets deemed to have indefinite lives are not amortized but are reviewed for impairment annually (during the fourth quarter) or more frequently if indicators arise. As of June 30, 2008, no impairment charges have been recorded by us. Other intangible assets continue to be amortized over their remaining useful lives.
NET PATIENT SERVICE REVENUE
Net patient service revenue is the estimated net realizable revenue from Medicare, Medicaid, commercial insurance, managed care payors, patients and others for services rendered to our patients. To determine net patient service revenue, we adjust gross patient service revenue for estimated contractual adjustments based on historical experience and estimated Medicare cap contractual adjustments. Net patient service revenue does not include charity care or the Medicaid room and board payments. We recognize net patient service revenue in the month in which our services are delivered. Services provided under the Medicare program represented approximately 92.6% and 92.7% of our net patient service revenue for the six months ended June 30, 2007 and 2008, respectively. Services provided under Medicaid programs represented approximately 4.5% and 4.0% of our net patient service revenue for the six months ended June 30, 2007 and 2008, respectively. The payments we receive from Medicare and Medicaid are calculated using daily or hourly rates for each of the four levels of care we deliver and are adjusted based on geographic location.
The four main levels of care we provide are routine home care, general inpatient care, continuous home care and inpatient respite care. We also receive reimbursement for physician services, self-pay and non-governmental room and board. Routine home care is the largest component of our gross patient service revenue, representing 88.4% and 89.2% of gross patient service revenue for the six months ended June 30, 2007 and 2008, respectively. General inpatient care represented 7.4% and 7.5% of gross patient service revenue for the six months ended June 30, 2007 and 2008, respectively. Continuous home care represented 3.3% and 2.3% of gross patient service revenue for the six months ended June 30, 2007 and 2008, respectively. Inpatient respite care and reimbursement for physician services, self-pay and non-governmental room and board represents the remaining 0.9% and 1.0% of gross patient service revenue for the six months ended June 30, 2007 and 2008, respectively.
The principal factors that impact net patient service revenue are our average daily census, levels of care, annual changes in Medicare and Medicaid payment rates due to adjustments for inflation and estimated Medicare cap contractual adjustments. Average daily census is affected by the number of patients referred and admitted into our hospice programs and the 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 is 84 and 85 days for the six months ended June 30, 2007 and 2008, respectively.

Payment rates under the Medicare and Medicaid programs are indexed for inflation annually; however, the increases have historically been less than actual inflation. On October 1, 2006 and 2007, the base Medicare payment rates for hospice care increased by approximately 3.4% and 3.5%, respectively, over the base rates previously in effect. These rates were further adjusted geographically by the hospice wage index. On July 31, 2008, the Centers for Medicare and Medicaid Services ("CMS") published the final rule that modifies the hospice wage index by phasing out over a three year period the budget neutrality adjustment factor. The phase out will occur over a three year period beginning on October 1, 2008, with 25% of the phase-out becoming effective on October 1, 2008, 50% becoming effective on October 1, 2009 and the balance on October 1, 2010. We have estimated that the final rule will reduce our net patient service revenue by approximately 1.2% in 2008 and 1.5% in 2009. CMS disclosed in the final rule that the market basket increase to Medicare base hospice payment rates will be 3.6%. This increase in the base hospice payment rates will become effective on October 1, 2008 and will be reduced in part by the estimated 1.1% negative impact from the elimination of the budget neutrality adjustment factor in the computation of the hospice wage index. We estimate that our hospice payment rates will increase by approximately 2.5% effective October 1, 2008 as a result of the market basket increase and the elimination of the budget neutrality adjustment factor. In the future, reductions in, or reductions in the rate of increase of, Medicare and Medicaid payments may have an adverse impact on our net patient service revenue and profitability and such impact could be material.
MEDICARE REGULATION
The Medicare Cap. Various provisions were included in the legislation creating the Medicare hospice benefit to manage the cost to the Medicare program for hospice, including the patient's waiver of curative care requirement, the six-month terminal prognosis requirement and the Medicare payment caps. The Medicare hospice benefit includes two fixed annual caps on payment, both of which are assessed on a program-by-program basis. One cap is an absolute dollar amount; the other limits the number of days of inpatient care. None of our hospice programs exceeded the payment limits on general inpatient care services for the six months ended June 30, 2007 and 2008. The caps are calculated from November 1 through October 31 of each year.
Dollar Amount Cap. The Medicare revenue paid to a hospice program from November 1 to October 31 of the following year may not exceed the annual cap amount, which is calculated by using the following formula: the product of the number of admissions to the program by patients who are electing to receive their Medicare hospice benefit for the first time, multiplied by the Medicare cap amount, which for the November 1, 2006 through October 31, 2007 Medicare fiscal year is $21,410. The Medicare cap amount is reduced proportionately for patients who transferred in or out of our hospice services. The Medicare cap amount is annually adjusted for inflation, but is not adjusted for geographic differences in wage levels, although hospice per diem payment rates are wage indexed. The Medicare cap amount for the November 1, 2007 through October 31, 2008 cap year is $22,386.
The following table shows the amounts accrued and paid for the Medicare cap contractual adjustments for the years ended December 31, 2006 and 2007 and for the six months ended June 30, 2008, respectively:

                                                                    Accrued Medicare Cap Contractual Adjustments
                                                               Year Ended December 31,                     Six Months Ended
                                                                                                               June 30,
                                                            2006                     2007                        2008
                                                                                   (in thousands)
Beginning balance - accrued Medicare cap
contractual adjustments                                 $     14,883             $      26,679            $           21,682
Medicare cap contractual adjustments                           8,853 (1)                 5,039 (2)                     2,435 (3)
Medicare cap contractual adjustments -
discontinued operations                                        7,611 (4)                 2,651 (4)                       372 (4)
Payments to Medicare fiscal intermediaries                    (1,983 )                 (12,687 )                      (4,352 )
Balances acquired from the VistaCare acquisition                   -                         -                         8,792
Reclassification to accounts payable                          (2,685 )(5)                    -                             -

Ending balance - accrued Medicare cap contractual
adjustments                                             $     26,679             $      21,682            $           28,929

(1) Includes additional accrual of $3.1 million related to the 2005 Medicare cap year.

(2) Includes additional accrual of $0.9 million related to the 2006 Medicare cap year.

(3) Includes additional accrual of $1.5 million related to the 2006 Medicare cap year.

(4) Medicare cap contractual adjustments reclassified to discontinued operations are related to all programs we have discontinued and sold during 2006, 2007 and 2008.

(5) Amounts were reclassified from accrued Medicare cap contractual adjustments to accounts payable in December 2006 and were paid in January 2007 to the Medicare fiscal intermediary.

Laws and regulations governing the Medicare and Medicaid programs are complex and subject to interpretation. 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.
EXPENSES
Because payments for hospice services are primarily paid on a per diem basis, our profitability is largely dependent on our ability to manage the expenses of providing hospice services. We recognize expenses as incurred and classify expenses as either direct hospice care expenses or general and administrative expenses. Direct hospice care expenses primarily include direct patient care salaries, payroll taxes, employee benefits, pharmaceuticals, medical equipment and supplies, inpatient costs and reimbursement of mileage for our patient caregivers. Length of stay impacts our direct hospice care expenses as a percentage of net patient service revenue, because if lengths of stay decline, direct hospice care expenses, which are often highest during the earliest and latter days of care for a patient, are spread against fewer days of care. Expenses are normally higher during the last days of care, because patients generally require greater hospice services, including drugs, medical equipment and nursing care at that time due to their deteriorating medical condition. In addition, cost pressures resulting from the use of more expensive forms of palliative care, including drugs and drug delivery systems, and increases in direct patient care salaries and employee benefits, could negatively impact our profitability.
For our patients receiving nursing home care under a state Medicaid program who elect hospice care under Medicare or Medicaid, we contract with nursing homes for room and board services. The state must pay us, in addition to the applicable Medicare or Medicaid hospice daily or hourly rate, an amount equal to at least 95% of the Medicaid daily nursing home rate for room and board furnished to the patient by the nursing home. Under our standard nursing home contracts, we pay the nursing home for these room and board services at 100% of the Medicaid daily nursing home rate. We refer to these costs, net of Medicaid payments, as "nursing home costs, net."
General and administrative expenses primarily include non-patient care salaries (including salaries for our executive directors, directors of patient services, patient care managers, community education representatives and other non-patient care staff), payroll taxes, employee benefits, office leases, professional fees and other operating costs.
The following table sets forth the percentage of net patient service revenue represented by the items included in direct hospice care expenses and general and administrative expenses for hospice care for the three and six months ended June 30, 2007 and 2008, respectively:

                                                 Three Months Ended                Six Months Ended
                                                      June 30,                         June 30,
                                                2007             2008            2007             2008
Direct hospice care expenses:
Salaries, benefits and payroll taxes               38.7 %          38.2 %           39.1 %         38.2 %
Pharmaceuticals                                     5.4             4.8              5.4            4.7
Medical equipment and supplies                      5.3             5.8              5.2            5.7
Inpatient costs                                     2.4             2.1              2.4            2.3
Other (including nursing home costs,
net, mileage, medical director fees and
contracted services)                                6.8             7.8              6.7            7.6

Total                                              58.6 %          58.7 %           58.8 %         58.5 %

General and administrative expenses -
hospice care:
Salaries, benefits and payroll taxes               14.3 %          14.9 %           14.3 %         14.7 %
Leases                                              2.9             2.8              2.9            2.8
Other (including insurance, recruiting,
travel, telephone and printing )                    3.9             3.9              3.9            4.3

Total                                              21.1 %          21.6 %           21.1 %         21.8 %

The following table sets forth the cost per day of care represented by the items included in direct hospice care expenses and general and administrative expenses for hospice care for the three and six months ended June 30, 2007 and 2008, respectively:

                                                  Three Months Ended                Six Months Ended
                                                       June 30,                         June 30,
                                                 2007             2008            2007            2008
Direct hospice care expenses:
. . .