UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended ~~June~~March 3031, ~~2005~~2007

¨	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 0-23946

PEDIATRIC SERVICES OF AMERICA, INC.

(Exact name of Registrant as specified in its charter)

Delaware

58-1873345

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

310 Technology Parkway, Norcross GA 30092-2929

(Address of principal executive offices, including zip code)

(770) 441-1580

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. ~~(as~~See ~~defined~~definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act). ~~Yes x No ¨~~ (Check one):

AsLarge ofaccelerated ~~August 2,~~filer ¨ Accelerated ~~2005,~~filer x Non-accelerated ~~the~~filer ¨ ~~Registrant had 7,255,813 shares of Common Stock, $0.01 par value, outstanding.~~

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x.

As of May 4, 2007, the Registrant had 7,575,913 shares of Common Stock, $0.01 par value, outstanding.

FORM 10-Q

PEDIATRIC SERVICES OF AMERICA, INC.

INDEX

		PageNumber
		Page Number
PART I – FINANCIAL INFORMATION
PART I FINANCIAL INFORMATION
ITEM 1:	Financial Statements
	Condensed Consolidated Balance Sheets as of June 30, 2005 and September 30, 2004	3
	Condensed Consolidated Balance Sheets as of March 31, 2007 and September 30, 2006	3
	Condensed Consolidated Statements of Operations for the three and nine months ended June 30, 2005 and 2004	5
	Condensed Consolidated Statements of Operations for the three and six months ended March 31, 2007 and 2006	5
	Condensed Consolidated Statements of Cash Flows for the nine months ended June 30, 2005 and 2004	6
	Condensed Consolidated Statements of Cash Flows for the six months ended March 31, 2007 and 2006	6
	Notes to Condensed Consolidated Financial Statements	7
ITEM 2:	Management’s Discussion and Analysis of Financial Condition and Results of Operations	1721
ITEM 3:	Quantitative and Qualitative Disclosures about Market Risk	2831
ITEM 4:	Controls and Procedures	2831
PART II – OTHER INFORMATION
PART II OTHER INFORMATION
ITEM 1:	Legal Proceedings	2931
ITEM 6:	Exhibits	29
ITEM 4:	Submission of Matters to a Vote of Security Holders	32
SIGNATURES		30
ITEM 6:	Exhibits	32
SIGNATURES		33

PART I – FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS

PEDIATRIC SERVICES OF AMERICA, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par value )

	June 30,2005			September 30,2004
	March 31,			September 30,
ASSETS	(Unaudited)
	2007			2006
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	1460,~~157~~748		$	848,~~159~~848
Accounts receivable, less allowances for doubtful accounts of $4,193 and $4,840, respectively		38,861			40,403
Accounts receivable, less allowances for doubtful accounts of $650 and $541, respectively		22,432			17,705
Prepaid expenses		2,~~029~~146			~~1,102~~944
Deferred income taxes		8,131			6,557
Income taxes receivable		1,618			875
Workers’ compensation loss fund		3,690			3,327
Deferred income taxes		2,323			3,197
Inventory		3,779			2,893
Workers’ compensation loss fund		4,667			4,529
Insurance recoveries		1,465			3,473
Insurance recoveries, less allowances for insurance recoveries of $1,246 and $1,327, respectively		964			618
Other current assets		239			630
Transition services		116			—
Total current assets		72,351			66,544
Other current assets		218			170
Assets held for sale		—			24,385
Total current assets		95,232			101,271
Property and equipment:
Home care equipment held for rental		33,887			32,438
Home care equipment		68			73
Furniture and fixtures		1310,~~272~~147			129,~~200~~912
Vehicles		500			505
Leasehold improvements		2,345			2,494
Leasehold improvements		3,185			3,102
		12,560			12,479
		50,844			48,245
Accumulated depreciation and amortization		(9,756	)		(9,605	)
Accumulated depreciation and amortization		(40,370	)		(38,207	)
		2,804			2,874
		10,474			10,038
Other assets:
Goodwill, less accumulated amortization of approximately $9,613		36,540			36,540
Goodwill, less accumulated amortization of approximately $3,721		25,378			20,019
Certificates of need, less accumulated amortization of approximately $644 and $627, respectively		29			46
Noncompete agreements, less accumulated amortization of approximately $894 and $868, respectively		516			127
Deferred financing fees, less accumulated amortization of approximately $775 and $594, respectively		596			777
Deferred income taxes		3,689			3,232
Noncompete agreements, less accumulated amortization of approximately $1,249 and $1,220, respectively		31			60
Workers’ compensation bond collateral		955			1,262
Deferred income taxes		—			1,301
Insurance cash surrender value and recoveries, less allowances for insurance recoveries of $800 and $1,104, respectively		4,737			4,454
Workers’ compensation bond collateral		1,514			2,311
Other		221			258
Insurance cash surrender value and recoveries		5,080			9,742
		35,496			29,352
Other		318			302
Total assets	$	133,532		$	133,497
		44,108			51,079
Total assets	$	126,933		$	127,661

See ~~accompanying notes~~Accompanying Notes.

PEDIATRIC SERVICES OF AMERICA, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS— – (Continued)

(In thousands), except par value )

	June 30,2005		September 30,2004
	March 31,		September 30,
LIABILITIES AND STOCKHOLDERS’ EQUITY	(Unaudited)
	2007		2006
	(Unaudited)
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	51,~~240~~174	$	43,~~672~~039
Accrued compensation		56,~~331~~145		65,~~029~~262
Income taxes payable		—		281
Accrued insurance		7,625		6,897
Accrued insurance		5,107		6,935
Refunds payable		2,334		2,116
Refunds payable		1,273		1,489
Accrued interest		42		42
Accrued interest		489		998
Professional service liabilities		988		866
Other accrued liabilities		3,295		3,032
Additional rent payable		1,211		1,484
Deferred revenue		796		800
Transition services		268		358
Current maturities of long-term obligations		43		157
Other accrued liabilities		262		406
Total current liabilities		21,574		24,393
Deferred revenue		—		902
Long-term accrued insurance		10,563		14,046
Total current liabilities		20,049		21,372
Deferred compensation		1,678		2,386
Long-term accrued insurance		12,110		12,375
Deferred income taxes		686		—
Long-term income taxes payable		88		88
Long-term obligations, net of current maturities		20,354		20,385
Deferred compensation		1,252		1,051
Total liabilities		5433,~~855~~499		6134,~~210~~886
Redeemable preferred stock, $.01 par value, 2,000 shares authorized, no shares issued and outstanding		—		—
Stockholders’ equity:
Common stock, $.01 par value, 80,000 shares authorized 7,254 and 7,031 shares issued and outstanding at June 30, 2005 and September 30, 2004, respectively		73		70
Common stock, $.01 par value, 80,000 shares authorized 7,556 and 7,533 shares issued and outstanding at March 31, 2007 and September 30, 2006, respectively		75		75
Additional paid-in capital		5256,~~139~~663		5055,~~621~~805
Retained earnings		1943,~~866~~295		1542,~~760~~731
Total stockholders’ equity		72100,~~078~~033		6698,~~451~~611
Total liabilities and stockholders’ equity	$	~~126~~133,~~933~~532	$	~~127~~133,~~661~~497

See ~~accompanying notes~~Accompanying Notes.

PEDIATRIC SERVICES OF AMERICA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

	Three Months EndedJune 30,						Nine Months EndedJune 30,
	Three Months Ended						Six Months Ended
	2005			2004			2005			2004
	March 31,						March 31,
	2007			2006			2007			2006
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Net revenue	$	6333,~~271~~644		$	5829,~~413~~203		$	~~191~~65,~~555~~702		$	~~179~~57,~~276~~136
Costs and expenses:
Costs of goods and services		35,989			33,236			110,669			100,854
Costs of goods and services (exclusive of depreciation shown separately below)		20,960			17,494			40,406			34,422
Other operating costs and expenses
Salaries, wages and benefits		105,~~777~~416			104,~~858~~910			3210,~~983~~640			319,~~685~~711
Business insurance		21,~~003~~495			1,~~613~~408			52,~~577~~790			52,~~891~~604
Overhead		41,~~487~~903			41,~~291~~841			123,~~809~~715			123,~~410~~699
Other operating costs and expenses		178,~~267~~814			168,~~762~~159			5117,~~369~~145			4916,~~986~~014
Corporate, general and administrative
Salaries, wages and benefits		32,~~533~~469			3,~~074~~329			105,~~211~~540			107,~~219~~079
Business insurance		6263			4059			~~152~~132			~~127~~123
Professional services		1,~~227~~196			~~605~~1,044			32,~~029~~128			1,~~759~~938
Overhead		~~745~~608			~~701~~675			21,~~214~~227			21,~~288~~394
Corporate, general and administrative		54,~~567~~336			45,~~420~~107			159,~~606~~027			1410,~~393~~534
Provision for doubtful accounts		~~794~~215			~~792~~60			~~2,436~~326			~~2,831~~65
Depreciation and amortization		1,098			958			3,242			2,762
Provision for insurance recoveries		(134	)		—			(384	)		—
Total costs and expenses		60,715			56,168			183,322			170,826
Depreciation and amortization		279			246			553			488
Operating income		2,556			2,245			8,233			8,450
Total costs and expenses		34,470			31,066			67,073			61,523
Other income		—			—			65			5
Operating loss		(826	)		(1,863	)		(1,371	)		(4,387	)
Interest income		56			63			149			112
Other income		—			5			58			8
Interest expense		(628	)		(604	)		(1,873	)		(1,719	)
Loss on early extinguishment of debt		—			—			—			(837	)
Income before income tax expense		1,984			1,704			6,574			6,848
Interest income		832			626			1,642			1,011
Income tax expense		510			661			2,468			2,656
Interest expense		—			(4	)		—			(564	)
Net income	$	1,474		$	1,043		$	4,106		$	4,192
Income (loss) from continuing operations, before income tax expense (benefit)		6			(1,236	)		329			(4,769	)
Net income per share data:
Income tax expense (benefit)		2			(446	)		190			(1,561	)
Basic	$	0.20		$	0.15		$	0.57		$	0.61
Income (loss) from continuing operations		4			(790	)		139			(3,208	)
Diluted	$	0.19		$	0.14		$	0.54		$	0.57
Discontinued operations:
Income from discontinued operations, net of tax		1			1,308			1,192			3,329
(Loss) gain on disposal of discontinued operations, net of tax		(8	)		80			(767	)		21,838
Net income	$	(3	)	$	598		$	564		$	21,959
Basic net income per share data:
Income (loss) from continuing operations	$	0.00		$	(0.11	)	$	0.02		$	(0.44	)
Income from discontinued operations, net of tax		0.00			0.18			0.16			0.46
(Loss) gain on disposal of discontinued operations, net of tax		(0.00	)		0.01			(0.10	)		2.98
Net income	$	(0.00	)	$	0.08		$	0.08		$	3.00
Diluted net income per share data:
Income (loss) from continuing operations	$	0.00		$	(0.11	)	$	0.02		$	(0.44	)
Income from discontinued operations, net of tax		0.00			0.18			0.15			0.46
(Loss) gain on disposal of discontinued operations, net of tax		(0.00	)		0.01			(0.10	)		2.98
Net income	$	(0.00	)	$	0.08		$	0.07		$	3.00
Weighted average shares outstanding:
Basic		7,~~252~~549			67,~~973~~372			7,~~185~~543			67,~~925~~321
Diluted		7,~~697~~734			7,~~488~~372			7,~~598~~723			7,~~389~~321

See ~~accompanying notes~~Accompanying Notes.

PEDIATRIC SERVICES OF AMERICA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

	Nine Months EndedJune 30,
	Six Months Ended
	2005			2004
	March 31,
	2007			2006
	(Unaudited)			(Unaudited)
Operating activities:
Net income	$	~~4,106~~564		$	421,~~192~~959
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Less income from discontinued operations, net of income tax expense		(1,192	)		(3,329	)
Depreciation and amortization		3,242			2,762
Less loss (gain) on disposal from discontinued operations, net of income tax expense		767			(21,838	)
Provision for doubtful accounts		2,436			2,831
Income (loss) from continuing operations, net of income tax expense (benefit)		139			(3,208	)
Amortization of deferred financing fees		181			125
Adjustments to reconcile income (loss) from continuing operations to net cash used in operating activities:
Nonqualified and disqualifying disposition of stock options		504			265
Depreciation and amortization		553			488
Changes in operating assets and liabilities:
Provision for doubtful accounts		326			65
Accounts receivable		(894	)		(7,825	)
Provision for insurance recoveries		(384	)		—
Prepaid expenses		(927	)		(1,286	)
Amortization of deferred financing fees		—			37
Inventory		(886	)		177
Loss on early extinguishment of debt		—			837
Other assets		310			4
Incentive stock option expense		176			200
Workers’ compensation loss fund		(363	)		(1,709	)
Nonqualified stock option expense		493			493
Workers’ compensation bond collateral		797			474
Deferred income taxes		417			2,482
Accounts payable		568			149
Changes in operating assets and liabilities
Income taxes payable		(281	)		(741	)
Accounts receivable		(5,054	)		(1,095	)
Accrued insurance, liabilities, refunds, interest and deferred taxes		(100	)		538
Prepaid expenses		(1,202	)		(1,025	)
Net cash provided by (used in) operating activities		8,693			(44	)
Other assets		(55	)		(103	)
Workers’ compensation loss fund		(138	)		(908	)
Workers’ compensation bond collateral		307			293
Accounts payable		(1,865	)		(3,334	)
Income taxes		(743	)		(219	)
Accrued compensation, insurance, liabilities, refunds and interest		(1,732	)		204
Net cash used in operating activities of continuing operations		(8,762	)		(4,793	)
Net cash used in operating activities of discontinued operations		(2,954	)		(8,267	)
Net cash used in operating activities		(11,716	)		(13,060	)
Investing activities:
Purchases of property and equipment		(~~3,567~~436	)		(~~3,908~~490	)
Net cash used in investing activities		(3,567	)		(3,908	)
Purchases of available for sale securities		(92,375	)		—
Sales of available for sale securities		92,375			—
Acquisitions of businesses		(5,789	)		—
Proceeds from the sale of discontinued operations		30,048			72,250
Net cash provided by investing activities of continuing operations		23,823			71,760
Net cash used in investing activities of discontinued operations		(396	)		(1,459	)
Net cash provided by investing activities		23,427			70,301
Financing activities:
Principal payments of long-term debt		(145	)		(146	)
Principal payments and extinguishment of long-term debt		—			(20,689	)
Deferred financing fees		—			(329	)
Disqualifying disposition of stock options		31			534
Proceeds from exercise of stock options		~~1,017~~158			~~576~~1,341
Net cash provided by financing activities		872			101
Net cash provided by (used in) financing activities of continuing operations		189			(18,814	)
Increase (decrease) in cash and cash equivalents		5,998			(3,851	)
Net cash used in financing activities of discontinued operations		—			(6	)
Cash and cash equivalents at beginning of period		8,159			9,171
Net cash provided by (used in) financing activities		189			(18,820	)
Cash and cash equivalents at end of period	$	14,157		$	5,320
Increase in cash and cash equivalents		11,900			38,421
Cash and cash equivalents at beginning of year		48,848			19,037
Cash and cash equivalents at end of period	$	60,748		$	57,458
Supplemental disclosure of cash flow information:
Cash paid for interest	$	~~2,234~~1		$	21,~~251~~505
Cash paid for taxes	$	12,~~850~~720		$	38,~~165~~219

See ~~accompanying notes~~Accompanying Notes.

PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of Pediatric Services of America, Inc. (the “Company”) and its majority-owned subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all information and notes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. Results of operations for the three and ~~nine~~six months ended ~~June~~March 3031, ~~2005~~2007 are not necessarily indicative of the results to be expected for the entire fiscal year ending September 30, ~~2005~~2007. These condensed consolidated financial statements should be read in conjunction with our audited consolidated financial statements for the year ended September 30, ~~2004~~2006, which are included in our Annual Report on Form 10-K/A for such year filed with the Securities and Exchange Commission. Principal accounting policies are set forth in our ~~2004~~2006 Annual Report.

2. Summary of Significant Accounting Policies

Description of Business

We provide a broad range of pediatric ~~health~~healthcare ~~care~~ services ~~and~~including ~~equipment~~private ~~including~~duty nursing, ~~respiratory therapy, rental and sale of durable medical equipment, pharmaceutical services and infusion therapy services. In addition, we provide~~ pediatric rehabilitation services, day treatment centers for medically fragile and chronically ill children and pediatric well care ~~and immunization services~~. We also provide case management services in order to assist the family and patient by coordinating the provision of services between the insurer or other payor, the physician, the hospital and other ~~health~~healthcare ~~care~~ providers. Our services are designed to provide a high quality, lower cost alternative to prolonged hospitalization for medically fragile children. ~~As a complement to our pediatric respiratory and infusion therapy services, we also provide respiratory and infusion therapy and related services for adults.~~ For financial reporting purposes, our branch offices are aggregated into ~~three~~two reportable segments based on ~~their~~the ~~predominant~~patient ~~line~~populations ofand ~~net~~relevant ~~revenue~~services provided in accordance with the Statement of Financial Accounting Standards No. 131 “Disclosures about Segments of an Enterprise and Related Information” (~~see~~See Note 76).

Discontinued Operations

On November 6, 2006, we completed the sale of substantially all of the assets of our Respiratory Therapy Equipment Services (“RTES”) business to Lincare, Inc. The aggregate purchase price was $35.2 million in cash of which $30.0 million was received at closing. The remainder of the purchase price is contingent upon the satisfaction of certain criteria, including the successful transition of certain patients and the collection of accounts receivable outstanding at closing (See Note 4). The agreement stipulates a preliminary measurement of the criteria to be performed at the six month anniversary with the final settlement at the twelve month anniversary of the agreement.

On November 18, 2005, we completed the sale of selected assets of our Pharmacy business to Accredo Health Group, Inc., a wholly-owned subsidiary of Medco Health Solutions, Inc. The aggregate purchase price was $72.3 million. We have recorded a gain of approximately $21.8 million, net of approximately $18.7 million for income taxes.

Use of Estimates

The preparation of the condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of net revenue and expenses during the reporting periods. Actual results could differ from those estimates and the differences could be material. ~~For~~Due ~~example, due~~ to the nature of the industry and the reimbursement environment in which we operate, certain estimates are required in recording net revenues and determining provisions for doubtful accounts. ~~Inherent~~In addition, FAS 123(R) requires estimations on stock option forfeitures. This estimate is reviewed and updated if necessary in the first quarter of each fiscal year unless there are indicators that require us to update more frequently. We also estimate the provision for insurance recoveries which is based upon an actuarial valuation of the open claims and a simultaneous assessment of the financial viability of the insurance carrier. Inherent in these estimates is the risk that they will have to be revised or updated as additional information becomes available to management.

Concentration of Credit Risk

Our principal financial instruments subject to potential concentration of credit risk are cash and cash equivalents and accounts receivable. Cash and cash equivalents are held primarily in one financial institution. We perform periodic evaluations of the relative credit standing of this financial institution. The concentration of credit risk with respect to accounts receivable, which are primarily health care industry related, represent a risk to us given the current health care environment. The risk is somewhat limited due to the large number of payors including Medicaid and Medicare, insurance companies and individuals, and the diversity of geographic locations in which we operate. However, we have substantial geographic density in the eastern United States, which we believe exposes us to payor initiated reimbursement changes. In addition, we are exposed to risk for a substantial amount of accounts receivable for a small number of hemophilia factor patients and disruptions to cash collections due to the inability of some payors to process claims.

PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited (Continued)

2. Summary of Significant Accounting Policies –- ~~continued~~Continued

Concentration of Credit Risk

Our principal financial instruments subject to potential concentration of credit risk are cash and cash equivalents and accounts receivable. Cash and cash equivalents are held in a limited number of financial institutions and with institutional investors. We perform periodic evaluations of the relative financial position and credit standing of these financial intermediaries. As part of our corporate cash management program we are investing the retained proceeds from the sale of the Pharmacy and RTES businesses in accordance with established investment policies. We have invested in a portfolio of highly liquid investment grade securities which are managed for us by institutional investors. The concentration of credit risk with respect to accounts receivable, which are primarily healthcare industry related, represent a risk to us given the current healthcare environment. The risk is somewhat limited due to the large number of payors including Medicaid, insurance companies and individuals, and the diversity of geographic locations in which we operate. However, we have substantial geographic density in the eastern United States, which we believe exposes us to payor initiated reimbursement changes.

Cash and Cash Equivalents

We consider all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents. Deposits with banks are federally insured in limited amounts.

Accounts Receivable

Accounts receivable are recorded based upon the amount of net revenue expected to be reimbursed by private and third party payors. Interest income is not recorded on trade accounts receivable. Accounts receivable include approximately $75.03 million and $4.2 million for which services have been rendered but the amounts were unbilled as of ~~June~~March 3031, ~~2005~~2007 and September 30, ~~2004.~~2006, respectively. Such unbilled amounts are primarily a result of the time required to process bills for services rendered.

Workers’ Compensation Loss Fund

Our workers’ compensation insurance carrier, Argonaut Insurance Company, rated A by AM Best Company, requires a twelve month estimated loss reserve to be funded entirely with cash each fiscal year which is then reduced by the monthly loss fund payments. The net balance at June 30, 2005 was $3.7 million. The insurance carrier has the right to increase this cash requirement at the end of each fiscal year if the claim experience is greater than anticipated, but to date has not indicated the need to do so. The policy for fiscal 2005 will be funded in a similar manner with the cash requirement estimated to be $1.0 million.

Identifiable Intangible Assets

Amortization expense on identifiable intangible assets was approximately $0.05 million and $0.04 million for the three months ~~ended~~ ~~June~~ended March 3031, ~~2005~~2007 and ~~2004~~March 31, 2006, respectively and $0.108 million and $0.07 million for the ~~nine~~six months ended ~~June~~March 3031, ~~2005~~2006 and ~~2004~~March 31, 2006, respectively. Estimated amortization expense of identifiable intangible assets for each of the fiscal years ending September 30, is presented below (in thousands):

	For The Year EndingSeptember 30,
2005	$	147,000
2007	$	170
2006	$	126,000
2008	$	176
2007	$	84,000
2009	$	176
2008	$	83,000
2010	$	176
2009	$	83,000
2011	$	167

Workers’ Compensation Bond Collateral

We have secured surety bonds of $1.7 million to satisfy our workers’ compensation program requirements for our former insurance carrier. As of June 30, 2005, the surety bonds were collateralized by $1.5 million cash posted to a third party escrow account.

Accrued Insurance/Insurance Recoveries

We retain the services of an independent actuary to prepare an actuarial analysis of our development of reported and incurred but not reported claims for workers’ compensation, medical malpractice and employee medical benefit plans. These estimates are updated ~~quarterly~~as determined necessary based on recent claims history and other events. Inherent in these estimates is the risk that they will need to be revised or updated, with the changes recorded in subsequent periods, as additional information becomes available to management. ~~Accrued workers’ compensation and medical malpractice losses have been discounted at 6%.~~

WeOn October 1, ~~renewed~~2006, we completed our ~~insurance~~ annual renewal of our risk management program. onWe ~~October 1,~~renewed ~~2004~~our insurance program for medical malpractice, commercial and general liability coverage with Arch Specialty Insurance Company, rated A- by AM Best Company. ~~Our~~Per claim self-insured retention amounts remained at $1.0 million with an annual aggregate self-insured retention amount of $7.3 million and an annual aggregate coverage limit of $15.0 million. We renewed our workers’ compensation policy ~~carrier,~~with ~~Argonaut~~Charter Oak Fire Insurance, ~~Company~~a subsidiary of St. Paul Travelers, is rated A+ by AM Best Company, with the deductible remaining at $0.35 million.

Lillie Axelrod, spouse of director Michael Axelrod, is an employee of Acordia Inc. Acordia provides insurance brokerage services to us. Mrs. Axelrod is paid a commission based on the fees paid to Acordia. The fees paid by us to Acordia during fiscal 2004 were approximately $0.156 million and are expected to be approximately $0.175 million for fiscal 2005.

PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited (Continued)

2. Summary of Significant Accounting Policies –- ~~continued~~Continued

Lillie Axelrod, spouse of director Michael Axelrod, is an employee of Wells Fargo Insurance Services, Inc. (“WFIS”). WFIS provides insurance brokerage services to us. Mrs. Axelrod is paid a commission based on the fees paid to WFIS. The fees paid by us to WFIS were approximately $0.198 million during fiscal year 2006 and are expected to be $0.208 million for fiscal 2007.

Allowance for Insurance Recoveries

Early in fiscal 2006, our former worker’s compensation insurance carrier, Atlantic Mutual, received a downgrade in their AM Best financial rating to a B-. On August 21, 2006, Standard & Poor’s downgraded Atlantic’s surplus note rating to D from CCC following Atlantic’s nonpayment of interest that was due on August 15, 2006. Subsequently, Atlantic Mutual requested a voluntary withdrawal of its AM Best rating. While we believe that our collateral remains secure, the potential for the carrier to default on claim payments due in the ordinary course has increased. Based upon information available to date, we believe the insurance carrier will not be able to meet its obligations. We established an allowance of $2.4 million on the full value of the insurance recoveries receivable at September 30, 2006. Based upon claim activity and carrier payments made during the six months ended March 31, 2007, we reduced our allowance by $0.4 million.

Workers’ Compensation Loss Fund

Our workers’ compensation insurance carrier, Charter Oak Fire Insurance, a subsidiary of St. Paul Travelers, rated A+ by AM Best Company requires a twelve month estimated loss reserve to be funded entirely with cash each fiscal year which is reduced by the monthly loss fund payments. For fiscal 2007, the annual cash requirement is estimated to be $1.6 million. Our previous workers’ compensation insurance carrier, Argonaut Insurance Company, rated A by AM Best Company, was funded in a similar manner. The net balance at March 31, 2007 and September 30, 2006 was $4.7 million and $4.5 million, respectively. The insurance carriers have the right to increase this cash requirement at the end of each fiscal year if the claim experience is greater than anticipated, but to date they have not indicated the need to do so.

Workers’ Compensation Bond Collateral

We have secured surety bonds of $1.0 million to satisfy our workers’ compensation program requirements for our former insurance carrier. In December, 2006, we received $0.3 million in cash from our former insurance carrier, which reduced the collateral and surety bond by the same amount. As of March 31, 2007, the surety bonds were collateralized by $1.0 million cash posted to a third party escrow account. We believe that our collateral remains secure despite the insurance carrier’s financial distress discussed above.

Income Taxes

The liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The tax provision for the nine months ended June 30, 2005 was increased by approximately $0.2 million due to a discrete event in the second quarter in a certain state jurisdiction disallowing certain deductions for state income tax purposes and decreased approximately $0.2 million in the third quarter due to the application of newly enacted rates to existing deferred balances.

~~Reclassifications~~Net Revenue

~~Certain~~We derive substantially all of our net revenue from patients who have a third party payor (insurance company or government) who either has contractually agreed to pay the patient’s account or is obligated to pay based on the patient’s participation in its program (i.e. Medicare or Medicaid). Revenues are recorded based on estimated net realizable amounts to be received for ~~prior~~products ~~periods~~or ~~have~~services ~~been~~rendered ~~reclassified~~during the period. The Company’s accounting system is programmed to ~~conform~~calculate the expected reimbursement to be received on a patient-by-patient basis based on the ~~current~~type ~~presentation~~of payor and the contractual terms of the payor or pre-negotiated reimbursement rates. The Company’s accounting system is updated as changes occur to reimbursement rates. In certain situations, the services and products are recorded separately. In other situations, the services and products are billed and reimbursed on a contract basis whereby the insurance carrier pays us one combined amount for treatment. Because the reimbursement arrangements in these situations are based on contract amounts, we do not maintain records that provide a breakdown between the service and product components. Substantially all of our revenue is fee for service.

Impact of Recently Issued Accounting Standards

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

Statement 123(R) must be adopted by us no later than the first fiscal year beginning after June 15, 2005. We expect to adopt Statement 123(R) on October 1, 2005.

Statement 123(R) permits public companies to adopt its requirements using one of two methods:

1. A “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of Statement 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of Statement 123(R) for all that remain unvested on the effective date.

2. A “modified retrospective” method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under Statement 123 for purposes of pro forma disclosures either (a) all prior periods presented or (b) prior interim periods of the year of adoption.

We plan to adopt Statement 123(R) using the modified prospective method.

As permitted by Statement 123, we currently account for share-based payments to employees using Opinion 25’s intrinsic value method and, as such, generally recognize no compensation cost for employee stock options. Accordingly, the adoption of Statement 123(R)’s fair value method will have a significant impact on our results of operations, although it will have no impact on our overall financial position. The impact of adoption of Statement 123(R) on our future financial statements cannot be predicted at this time because it will depend on levels of share-based payments granted in the future and the fluctuation in our share price. However, had we adopted Statement 123(R) in prior periods, the impact of that standard would have approximated the impact of Statement 123 as described in the disclosure of pro forma net income and earnings per share described below. Statement 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. While we cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options), the amount of operating cash flows recognized in the nine months ended June 30, 2005 and 2004 for such excess tax deductions were $0.5 million and $0.3 million, respectively.

Pro forma information regarding net income and earnings per share, required by SFAS 123 and as amended by SFAS 148, was determined as if we had accounted for our employee stock options granted subsequent to December 31, 1994 under the fair value method. The fair value of these options was estimated at the date of grant using a Black-Scholes option pricing model.

PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited (Continued)

2. Summary of Significant Accounting Policies –- ~~continued~~ Continued

~~For~~Our ~~purposes~~net ofrevenue ~~the~~may ~~pro~~vary ~~forma~~significantly ~~disclosures~~depending primarily on factors such as re-hospitalizations of patients, seasonality, the ~~estimated~~timing ~~fair~~of ~~value~~new branch office openings, acquisitions of ~~the~~businesses, ~~options~~public isschool ~~amortized~~calendars ~~over~~and ~~the~~pricing ~~options’ vesting~~pressures ~~period~~due to legislative and regulatory initiatives to contain healthcare costs. ~~Our~~Certain ~~pro~~RTES ~~forma~~equipment ~~information~~rentals ~~follows~~are billed (in ~~thousands,~~advance ~~except~~of ~~for~~our ~~net~~rendering ~~income~~the ~~per~~related ~~share~~services. ~~information~~Such amounts are deferred in the balance sheet until the related services are performed (See Note 4):.

	Three MonthsEnded June 30,						Nine Months EndedJune 30,
	2005			2004			2005			2004
Net Income
As reported	$	1,474		$	1,043		$	4,106		$	4,192
Fair value based method compensation expense, net of tax		(688	)		(292	)		(1,764	)		(851	)
Pro forma net income	$	786		$	751		$	2,342		$	3,341
Basic income per share
As reported	$	0.20		$	0.15		$	0.57		$	0.61
Pro forma	$	0.11		$	0.11		$	0.33		$	0.48
Diluted income per share
As reported	$	0.19		$	0.14		$	0.54		$	0.57
Pro forma	$	0.10		$	0.10		$	0.31		$	0.45

Due to the nature of the healthcare industry and the reimbursement environment in which we operate, certain estimates are required to record net revenues and accounts receivable at their net realizable values. Inherent in these estimates is the risk that they will need to be revised or updated, with the changes recorded in subsequent periods as additional information becomes available to us. Specifically, the complexity of many third party billing arrangements and the uncertainty of reimbursement amounts for services from certain payors may result in adjustments to amounts originally recorded. Such adjustments are typically identified and recorded at the point of cash application, claim denial or settlement of account review.

3In December, 2005 we received notice of a claim from one commercial payor primarily relating to our discontinued pharmacy operations. ~~Long-Term~~The ~~Borrowing~~payor ~~Arrangements~~claims overpayments of approximately $1.1 million. We have reviewed the basis for the claim and believe it is substantially without merit. We have submitted our response and are working towards resolution of these issues. At this time, we believe we are adequately reserved; however, there can be no assurance that ultimate resolution will not have a material adverse effect upon our future financial results. As of March 31, 2007, we had no material claims, disputes or unsettled matters with third party payors except as disclosed above, nor were there any material pending settlements with third party payors.

OnWe ~~January 27,~~have ~~2004,~~developed ~~we entered into~~ a ~~credit agreement~~methodology ~~with General Electric Capital Corporation (“Credit Agreement”). Subject~~ to ~~the~~record ~~terms and conditions of~~ the ~~Credit~~estimated ~~Agreement,~~net ~~the~~revenue ~~Lender~~as ~~made available~~ a ~~credit~~result ~~facility~~of ~~consisting~~the ofinherent atime ~~$10.0~~lag ~~million~~between ~~revolving~~certain ~~line~~RTES ofpatient ~~credit~~treatments and a ~~$10.0~~input ~~million line~~ of ~~credit~~the ~~for~~related ~~acquisitions.~~information ~~Availability~~into inour ~~both~~billing ~~components~~and iscollection ~~subject~~system. toThis amethodology ~~borrowing~~measures ~~base~~relative ~~calculation~~changes ~~against~~in ~~our~~the ~~accounts~~time ~~receivable.~~and ~~Borrowings~~overall ~~under~~activity ~~the~~level ~~revolving~~at ~~line~~each ofbranch ~~credit~~office ~~bear~~location ~~interest~~and ataggregates ~~LIBOR~~these ~~plus~~measurements ~~3.00%~~to orestimate the ~~Index~~impact to ~~Rate~~consolidated ~~plus~~net 1revenue.~~50%.~~ ~~Borrowings~~The ~~under~~estimated ~~the~~net ~~acquisition~~revenue ~~line~~from ofthe ~~credit~~inherent ~~bear~~time ~~interest~~lag atwas ~~LIBOR~~approximately ~~plus 3~~0.504%, ~~or the Index Rate plus 2~~0.005%. ~~The~~and ~~Credit Agreement provides for unused line fees of~~ 0.504% ~~for~~of ~~the~~net ~~revolving~~revenue ~~line~~for offiscal ~~credit~~years ~~and~~ended ~~0.75%~~2006, ~~for~~2005 ~~the acquisition~~and ~~line~~2004, ~~of credit~~respectively. ~~The~~Any ~~Credit~~unforeseen ~~Agreement~~volatility ~~contains~~to ~~several~~either ~~financial~~the ~~and~~time ~~non-financial~~or ~~covenants~~activity level ~~including,~~at ~~but~~specific ~~not~~branch ~~limited~~offices ~~to,~~had ~~certain~~the ~~leverage,~~potential ~~coverage,~~to ~~days~~significantly ~~sales~~impact ~~outstanding~~the ~~and~~estimate ~~maximum~~(See ~~capital~~Note ~~expenditures requirements~~4).

OnIn ~~May 12~~other select cases, ~~2004~~patient treatments may cease for a number of reasons including re-hospitalizations, wechanges ~~amended~~in ~~the~~treatment ~~Credit~~needs ~~Agreement~~or todeath, ~~clarify~~and a ~~definition and~~time ~~increase~~lag ~~the~~may ~~maximum~~exist ~~capital~~before ~~expenditures~~this ~~covenant~~information is reflected in our billing and collection system. We have ~~made~~developed noa ~~borrowings~~methodology which ~~under~~measures the historical experience of all patient net revenue adjustments over the trailing four quarters and applies this ~~agreement~~methodology ~~since~~to ~~its~~reduce ~~inception~~net revenues recognized in the current period. Included in this calculation is the reversal of revenue for patients without authorizations.

OnStock ~~April 16,~~Option ~~1998,~~Plans we issued, in a private placement, $75 million aggregate principal amount of 10% Senior Subordinated Notes due 2008, which were subsequently exchanged on May 12, 1998 for $75 million aggregate principal amount of 10% Senior Subordinated Notes due 2008, Series A, registered with the Securities and Exchange Commission (the “Notes”). The Indenture under which the Notes were issued allows us to repurchase the Notes at our discretion. All bids to repurchase have been based upon a number of factors including cash availability, interest rates on invested cash, other capital investment alternatives, and relative ask prices quoted by the market maker. Each decision to repurchase the Notes has been arrived at independently using the above criteria and we do not have a formal plan in place to repurchase the Notes. At June 30, 2005, approximately $20.4 million in aggregate principal amount of the Notes remained outstanding.

At March 31, 2007, we have two stock-based compensation plans, the Stock Option Plan and the Director’s Stock Option Plan (the “Directors’ Plan”). Our ~~Notes~~Stock ~~are~~Option ~~general~~Plan ~~unsecured~~(the ~~obligations~~“Option Plan”) provides for the granting of stock options covering up to 2,300,000 ~~subordinated~~shares inof ~~right~~Common Stock, of ~~payment~~which 810,950 options are outstanding to ~~all~~eligible ~~existing~~participants ~~and~~as of ~~future~~March 31, ~~senior~~2007. ~~debt~~Options may be issued as either incentive stock options or as nonqualified stock options. ~~The~~Options ~~Notes~~may be granted to those persons who are ~~fully~~officers ~~and~~or ~~unconditionally~~employees ~~guaranteed,~~of ~~jointly~~our company or to certain outside consultants. The terms and conditions ~~severally~~of options granted under the Option Plan, onincluding athe ~~senior~~number ~~subordinated basis~~of byshares, the ~~parent~~exercise price and ~~all~~the ~~existing~~time ~~and~~at ~~future~~which ~~restricted~~such ~~subsidiaries~~options ~~(as~~become ~~defined~~exercisable inare determined by the ~~Indenture~~Compensation Committee of the Board of Directors (the “Compensation Committee”). ~~Condensed~~The ~~consolidating~~vesting ~~financial~~period ~~information~~of ~~for~~the options is typically four years. Upon the ~~subsidiary~~occurrence ~~guarantors~~of ~~for~~certain events, the ~~three~~vesting ~~and~~period ~~nine~~of ~~months~~some ~~ended~~options ~~June 30,~~accelerate. ~~2005~~The isterm of options granted under the Option Plan may not ~~included~~exceed 10 ~~because~~years. We have the ~~parent~~right ~~and~~to ~~all~~repurchase ~~subsidiaries~~the ~~are~~Common ~~guarantors,~~Stock issued upon the ~~guarantees~~exercise ~~are~~of ~~full~~these ~~and~~options ~~unconditional~~at ~~and~~the ~~joint~~then ~~and~~fair ~~several~~market value of such shares, if either party terminates their employment relationship.

Under our Directors’ Plan, directors of our company who are not officers or employees may receive stock options annually to purchase shares of Common Stock, at an exercise price equal to the fair market value on the date of grant and expiring 10 years after issuance. The options vest on the first anniversary of their issuance, provided that the grantee is then a director of the Company. The Compensation Committee has the authority and sole discretion to make grants of options under the Directors’ Plan in addition to the annual grants described above. A total of 650,000 shares of Common Stock have been

PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited (Continued)

42. Summary ~~Commitments~~of ~~and~~Significant ~~Contingencies~~Accounting Policies - Continued

As reserved afor ~~result~~issuance ofpursuant ~~operating~~to inoptions ~~the~~granted ~~health~~under ~~care~~the ~~industry,~~Directors’ ~~our~~Plan ~~business entails an inherent risk~~ of ~~lawsuits alleging malpractice, product liability or related legal theories,~~ which ~~can involve large claims and significant defense costs. From time to time~~278,500 weoptions are ~~subject~~outstanding to ~~such~~eligible ~~suits~~participants ~~arising~~as ~~in the ordinary course~~ of March 31, ~~business~~2007. WeDuring ~~currently~~fiscal ~~maintain~~2006, ~~professional~~the ~~and~~Compensation ~~commercial~~Committee ~~liability~~agreed ~~insurance intended~~ to ~~cover~~eliminate ~~such~~the ~~claims.~~use As of ~~June 30,~~equity ~~2005,~~compensation ~~this~~in ~~insurance~~the ~~coverage~~form isof ~~provided~~Director ~~under~~Stock aOption ~~“claims-made”~~awards ~~policy~~and ~~which~~replace ~~provides,~~these ~~subject~~awards towith ~~the~~an ~~terms~~annual ~~and~~contribution ~~conditions~~ of ~~the~~approximately ~~policy~~$13,000 ~~coverage for certain types of claims made against us during~~on ~~the~~behalf ~~term~~ of ~~the~~each ~~policy~~Director ~~and~~into ~~does not provide coverage for losses occurring during~~ the ~~terms~~Company’s ofNon-qualified ~~the~~Deferred ~~policy~~Compensation ~~for~~Plan ~~which~~(“NQDCP”) aat ~~claim is made subsequent to~~ the ~~termination~~conclusion of ~~the~~each ~~policy~~fiscal year. ~~Should~~Such ~~the~~contributions ~~policy~~would ~~not~~ be ~~renewed~~eligible orfor ~~replaced~~a ~~with~~50% ~~equivalent~~match ~~insurance, claims~~funded ~~based~~by onthe ~~occurrences~~Company ~~during~~and ~~its term but asserted subsequently~~ would be ~~uninsured.~~subject ~~There~~to the ~~can~~existing berequirements ~~no assurance that our coverage limits~~ of ~~insurance~~the ~~will be adequate~~NQDCP.

InThe ~~addition,~~fair wevalue ~~are~~of ~~subject~~the tooptions ~~claims~~awarded ~~and~~under ~~lawsuits~~Statement ~~arising~~123(R) is estimated on the date of grant using the Black Scholes Merton option pricing formula that used the assumptions noted in the ~~ordinary~~following ~~course~~table. Expected volatilities are based on historical volatility of ~~business~~our stock and other factors. ~~Based~~We ~~upon~~use ~~information~~historical option exercise and employee ~~available~~termination dates to ~~date,~~estimate ~~management~~the ~~believes~~expected itterm. ~~has~~The ~~provided~~expected ~~adequate~~term ~~reserves~~represents ifthe ~~needed~~period ~~for~~of ~~any~~time ~~unfavorable~~that ~~settlement;~~options ~~however,~~granted ~~there~~are ~~can~~expected to be nooutstanding. ~~assurance~~We ~~that~~perform these calculations separately for each plan because the ~~ultimate~~participants ~~resolution~~exhibit different behavior. The estimate for forfeitures was reviewed and updated in the six months ended March 31, 2007 to reflect the impact of ~~such~~certain ~~current~~changes ~~pending~~to ~~legal~~our ~~proceedings~~long-term ~~would~~compensation ~~not~~strategies. ~~have~~This achange ~~material~~resulted in an increase to compensation ~~adverse~~expense ~~effect~~of approximately $0.2 million. The risk free rate for periods within the contractual life of the option is based on ~~our~~the ~~consolidated~~U.S. ~~financial~~Treasury oryield ~~liquidity~~curve ~~position~~in effect at the time of grant. We have elected to use the straightline method to recognize compensation expense under Statement 123(R).

We have entered into employment agreements with certain of our employees which provide, among other things, salary, benefits and perquisites, as well as additional compensation for certain changes in control of the Company or a failure of the Company to comply with any material terms of the agreements.


	Stock Option Plan
	March 31,
	2007		2006
Expected volatility	44	%	53	%
Expected dividends	0	%	0	%
Expected term (in years)	4		4
Risk-free rate	4.68	%	4.43	%

	Directors’ Plan
	March 31,
	2007		2006
Expected volatility	—		75	%
Expected dividends	—		0	%
Expected term (in years)	—		8
Risk-free rate	—		4.49	%

5. Stock Option Plans

During the three months ended June 30, 2005 and 2004, respectively 3,375 and 44,250 options to acquire our Common Stock were exercised. During the nine months ended June 30, 2005 and 2004, respectively 222,501 and 119,708 options to acquire Common Stock were exercised.

6. Basic and Diluted Income Per Share

Basic income per share is computed using the weighted average number of shares of Common Stock outstanding during the period. Diluted income per share is computed using the weighted average number of shares of Common Stock outstanding and the dilutive effect of common equivalent shares (calculated using the treasury stock method).

The following table sets forth the reconciliation of denominators used in the computation of the basic and diluted net income per share:

	Three Months EndedJune 30,		Nine Months EndedJune 30,
	2005	2004	2005	2004
Denominator for basic income per share-weighted average shares	7,252	6,973	7,185	6,925
Effect of dilutive securities:
Options	445	515	413	464
Denominator for diluted income per share—adjusted weighted average shares	7,697	7,488	7,598	7,389
Antidilutive securities:
Options	251	290	285	300

PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited (Continued)

72. Summary ~~Segments~~of Significant Accounting Policies - Continued

WeOption ~~have~~Plan three reportable segments: Nursing and PPEC; Pharmacy and Respiratory Therapy Equipment and Services (RTES). Our Nursing and PPEC division consists primarily of private duty home nursing care for predominately pediatric patients as well as Prescribed Pediatric Extended Care Centers which provide daily medical care for medically fragile children. Our Pharmacy division provides pharmaceutical products and services for our patients in the home or physician’s office. Our RTES division provides respiratory therapy equipment and services to patients in the home.

~~The~~A ~~accounting~~summary ~~policies~~ of ~~the~~option ~~operating~~activity ~~segments~~under ~~are~~ the ~~same~~Option Plan as ~~those described in the Summary~~ of ~~Significant Accounting Policies (see Note 2). We evaluate performance based on profit or loss from operating income~~March 31, ~~excluding corporate~~2007, ~~general~~ and ~~administrative~~changes ~~expenses.~~during ~~Asset~~the ~~information~~period bythen ~~segment,~~ended ~~including capital~~is ~~expenditures~~presented ~~and~~below: ~~net income (loss) beyond operating contribution margins are not provided to our Chief Operating Decision Maker (“CODM”). Inter-segment allocations have been eliminated.~~

Our reportable segments are defined based on the predominant line of net revenue which is reviewed by the CODM. The reportable segments are managed separately.


Options	Shares		Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term	Aggregate Intrinsic Value
Outstanding at October 1, 2006	767,550		$	10.67
Granted	91,000			12.61
Exercised	(23,100	)		6.88
Forfeited or expired	(24,500	)		10.94

Outstanding at March 31, 2007	810,950		$	10.98	7.12	$	2,867,270

Vested and exercisable at March 31, 2007	419,725		$	10.57	6.16	$	1,770,585

The weighted-average grant-date fair value of options granted during the six months ended March 31, 2007 and 2006, respectively was $5.06 and $6.70. The total intrinsic value of options exercised during the six months ended March 31, 2007 and 2006, respectively was $0.1 million and $1.3 million.

As of March 31, 2007 there was $1.1 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Option Plan. That cost is expected to be recognized over a weighted-average period of fifteen months.

Directors’ Plan

A summary of option activity under the Directors’ Plan as of March 31, 2007, and changes during the period then ended is presented below:


Options	Shares	Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term	Aggregate Intrinsic Value
Outstanding at October 1, 2006	278,500	$	8.68
Granted	—
Exercised	—
Forfeited or expired	—

Outstanding at March 31, 2007	278,500	$	8.68	4.87	$	1,759,240

Vested and exercisable at March 31, 2007	278,500	$	8.68	4.87	$	1,759,240

The weighted-average grant-date fair value of options granted during the six months ended March 31, 2006 was $11.31. There were no options granted under the Directors’ Plan during the six months ended March 31, 2007.

PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited (Continued)

~~Segments~~2. Summary of Significant Accounting Policies - ~~continued~~Continued

~~Our~~As ~~quarterly results may vary significantly depending primarily on factors such as re-hospitalizations~~ of ~~patients~~March 31, ~~seasonality~~2007 ~~and~~there ~~usage~~was ~~levels~~no ~~of pharmaceutical~~unrecognized ~~products~~compensation ~~and~~cost ~~respiratory~~related ~~services, the timing of new branch office openings and pricing pressures due~~ to ~~legislative and regulatory initiatives to contain health care costs. Because of these factors, our operating results for any~~non-vested ~~particular~~share-based ~~quarter~~compensation ~~may~~arrangements ~~not~~granted beunder ~~indicative of~~ the ~~results~~Directors’ ~~for the full fiscal year~~Plan. ~~The following table summarizes certain information for each of our company’s operating segments:~~

					RespiratoryTherapy,
	Nursing andPPEC		Pharmacy		Equipmentand Services		ConsolidatedTotal
Three Months Ended June 30, 2005
Net revenue	$	28,700	$	21,296	$	13,275	$	63,271
Costs of goods and services
Nursing and therapist salaries, wages, benefits and supplies		16,906		250		242		17,398
Pharmacy product and supplies		1		14,490		924		15,415
Disposables/supplies		17		100		3,059		3,176
Total cost of goods and services		16,924		14,840		4,225		35,989
Other operating costs and expenses
Administrative and marketing salaries, wages and benefits		4,822		2,341		3,614		10,777
Business insurance		1,117		255		631		2,003
Overhead		1,768		774		1,945		4,487
Total operating costs and expenses		7,707		3,370		6,190		17,267
Provision for doubtful accounts		188		116		490		794
Depreciation		88		95		758		941
Branch office contribution margin	$	3,793	$	2,875	$	1,612	$	8,280
Three Months Ended June 30, 2004
Net revenue	$	26,674	$	19,294	$	12,445	$	58,413
Costs of goods and services
Nursing and therapist salaries, wages, benefits and supplies		15,913		235		239		16,387
Pharmacy product and supplies		—		13,128		846		13,974
Disposables/supplies		17		148		2,710		2,875
Total cost of goods and services		15,930		13,511		3,795		33,236
Other operating costs and expenses
Administrative and marketing salaries, wages and benefits		4,835		2,110		3,913		10,858
Business insurance		1,093		158		362		1,613
Overhead		1,816		816		1,659		4,291
Total operating costs and expenses		7,744		3,084		5,934		16,762
Provision for doubtful accounts		189		239		364		792
Depreciation		94		58		665		817
Branch office contribution margin	$	2,717	$	2,402	$	1,687	$	6,806

During the six months ended March 31, 2007 and 2006, respectively, 23,100 and 208,050 options to acquire our Common Stock were exercised.

In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes by prescribing a recognition threshold and measurement attribute for the financial statement implications of tax positions taken or expected to be taken in a company’s tax return. The interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, and disclosure of such positions. FIN 48 is effective for fiscal years beginning after December 15, 2006, and is therefore effective for the Company in fiscal year 2008. We are in the process of evaluating the impact FIN 48 will have on our results of operations and financial position.

3. Acquisition of a Business

On January 6, 2007 we acquired certain of the pediatric assets of Americare At Home, Inc. a Massachusetts corporation (“Americare”). The acquisition included certain of Americare’s pediatric nursing locations in the Shrewsbury and Newton, Massachusetts markets. The purchase price was approximately $1.4 million in cash with $0.2 million held in escrow and Americare retaining its accounts receivable. The purchase price has been preliminarily allocated to identifiable intangible assets consisting of non-compete agreements of $0.25 million and goodwill of $1.2 million. Effective with the adoption of SFAS No. 142, the purchase price allocation of $1.2 million of goodwill is not being amortized; however, it is being deducted for tax purposes.

On February 4, 2007 we acquired substantially all of the pediatric assets of Wilko Enterprises, Inc., a Texas corporation (“Wilkerson”). The acquisition includes Wilkerson’s pediatric nursing business in the Temple, Texas market and will be consolidated into PSA’s existing branch in Austin, Texas. The purchase price is $0.3 million in cash with $0.1 million held in escrow and Wilkerson retaining its accounts receivable. The purchase price has been preliminarily allocated to identifiable intangible assets consisting of non-compete agreements of $0.04 million and goodwill of $0.2 million. Effective with the adoption of SFAS No. 142, the purchase price allocation of $0.2 million of goodwill is not being amortized; however, it is being deducted for tax purposes.

On February 17, 2007 we acquired select pediatric assets of Maternal Child Health, Inc. (“MCH”) a subsidiary of Deaconess Associations Inc. an Ohio corporation. The acquisition includes MCH’s pediatric nursing business in the Illinois, Texas and Pennsylvania markets. The MCH operations located in the Corpus Christi and McAllen, Texas markets will be operated on a stand alone basis. The purchase price is approximately $4.1 million in cash with MCH retaining its accounts receivable. The purchase price has been preliminarily allocated to identifiable intangible assets consisting of non-compete agreements of $0.1 million and goodwill of $4.0 million. Effective with the adoption of SFAS No. 142, the purchase price allocation of $4.0 million of goodwill is not being amortized; however, it is being deducted for tax purposes.

The purchase method of accounting was used to record these acquisitions and the results of operations of the acquired companies are included in the accompanying condensed consolidated statements of operations from the date of the acquisitions.

PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited (Continued)

~~Segments~~4. –Discontinued ~~continued~~Operations

	Three Months Ended June 30,
	2005			2004
Total profit for reportable segments	$	8,280		$	6,806
Corporate, general and administrative		(5,567	)		(4,420	)
Corporate depreciation and amortization		(157	)		(141	)
Interest income		56			63
Interest expense		(628	)		(604	)
Income before income tax expense	$	1,984		$	1,704

On November 6, 2006, we completed the sale of substantially all of the assets of our RTES business (See Note 2). As a result, these operations are reflected as a discontinued operation. The condensed consolidated financial statements for all periods presented have been restated to reflect discontinued operations. The operating results of the discontinued operations are summarized as follows:


*In Thousands*	Three Months Ended March 31,					Six Months Ended March 31,
	2007			2006		2007			2006
RTES Business
Net revenue	$	—		$	14,299	$	5,963		$	28,599
Income before income tax (benefit) expense		—			2,145		1,708			4,196
Income tax (benefit) expense		(1	)		839		516			1,646

Net income	$	1		$	1,306	$	1,192		$	2,550

Net income per share
Basic	$	0.00		$	0.18	$	0.16		$	0.35

Diluted	$	0.00		$	0.18	$	0.15		$	0.35

Loss on Disposal of RTES Business
(Loss) gain on disposal of discontinued operations (1)	$	(17	)	$	—	$	953		$	—
Income tax (benefit) expense (2)		(9	)		—		1,720			—

Net loss	$	(8	)	$	—	$	(767	)	$	—

Net loss per share
Basic	$	(0.00	)	$	—	$	(0.10	)	$	—

Diluted	$	(0.00	)	$	—	$	(0.10	)	$	—

(1)	In connection with the sale of our RTES business, we incurred approximately $2.5 million in employee termination costs which have been offset against the gain on disposal of discontinued operations.

(2)	Income tax expense for the gain on discontinued operations includes the permanent item of $4.7 million non-deductible goodwill specifically related to the sale of the RTES business.

PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited (Continued)

~~Segments~~4. –Discontinued ~~continued~~Operations - Continued

	Nursing andPPEC		Pharmacy		RespiratoryTherapy,Equipmentand Services		ConsolidatedTotal
Nine Months Ended June 30, 2005
Net revenue	$	86,043	$	65,796	$	39,716	$	191,555
Costs of goods and services
Nursing and therapist salaries, wages, benefits and supplies		51,209		920		808		52,937
Pharmacy product and supplies		1		45,772		2,633		48,406
Disposables/supplies		58		399		8,869		9,326
Total cost of goods and services		51,268		47,091		12,310		110,669
Other operating costs and expenses
Administrative and marketing salaries, wages and benefits		14,713		6,917		11,353		32,983
Business insurance		3,327		728		1,522		5,577
Overhead		5,224		2,441		5,144		12,809
Total operating costs and expenses		23,264		10,086		18,019		51,369
Provision for doubtful accounts		615		166		1,655		2,436
Depreciation		279		272		2,217		2,768
Branch office contribution margin	$	10,617	$	8,181	$	5,515	$	24,313
Nine Months Ended June 30, 2004
Net revenue	$	79,290	$	62,781	$	37,205	$	179,276
Costs of goods and services
Nursing and therapist salaries, wages, benefits and supplies		46,972		705		746		48,423
Pharmacy product and supplies		2		41,325		2,473		43,800
Disposables/supplies		55		461		8,115		8,631
Total cost of goods and services		47,029		42,491		11,334		100,854
Other operating costs and expenses
Administrative and marketing salaries, wages and benefits		14,184		5,993		11,508		31,685
Business insurance		3,851		669		1,371		5,891
Overhead		5,352		2,294		4,764		12,410
Total operating costs and expenses		23,387		8,956		17,643		49,986
Provision for doubtful accounts		704		759		1,368		2,831
Depreciation		282		158		1,896		2,336
Branch office contribution margin	$	7,888	$	10,417	$	4,964	$	23,269

On November 18, 2005, we completed the sale of selected assets of our Pharmacy business to Accredo Health Group, Inc., a wholly-owned subsidiary of Medco Health Solutions, Inc. The aggregate purchase price was $72.3 million (See Note 2). As a result, these operations are reflected as a discontinued operation. The condensed consolidated financial statements for all periods presented have been restated to reflect discontinued operations. The operating results of the discontinued operations are summarized as follows:


*In Thousands*	Three Months Ended March 31,					Six Months Ended March 31,
	2007		2006			2007		2006
Pharmacy Business
Net revenue	$	—	$	—		$	—	$	11,318
Income before income tax (benefit) expense		—		—			—		1,281
Income tax (benefit) expense		—		(2	)		—		502

Net income	$	—	$	2		$	—	$	779

Net income per share
Basic	$	—	$	0.00		$	—	$	0.11

Diluted	$	—	$	0.00		$	—	$	0.11

Gain on Disposal of Pharmacy Business
Gain on disposal of discontinued operations	$	—	$	38		$	—	$	40,562
Income tax (benefit) expense		—		(42	)		—		18,724

Net income	$	—	$	80		$	—	$	21,838

Net income per share
Basic	$	—	$	0.01		$	—	$	2.98

Diluted	$	—	$	0.01		$	—	$	2.98

PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited (Continued)

~~Segments~~4. Discontinued –Operations ~~continued~~- Continued

	Nine Months Ended June 30,
	2005			2004
Total profit for reportable segments	$	24,313		$	23,269
Corporate, general and administrative		(15,606	)		(14,393	)
Corporate depreciation and amortization		(474	)		(426	)
Other income		65			5
Interest income		149			112
Interest expense		(1,873	)		(1,719	)
Income before income tax expense	$	6,574		$	6,848

The operating results for total discontinued operations are summarized as follows:


*In Thousands*	Three Months Ended March 31,						Six Months Ended March 31,
	2007			2006			2007			2006
Total Discontinued Operations
Net revenue	$	—		$	14,299		$	5,963		$	39,917
Income before income tax (benefit) expense		—			2,145			1,708			5,477
Income tax (benefit) expense		(1	)		837			516			2,148

Net income	$	1		$	1,308		$	1,192		$	3,329

Net income per share
Basic	$	0.00		$	0.18		$	0.16		$	0.46

Diluted	$	0.00		$	0.18		$	0.15		$	0.46

(Loss) Gain on Disposal of Discontinued Operations	$	(17	)	$	38		$	953		$	40,562
Income tax (benefit) expense		(9	)		(42	)		1,720			18,724

Net (loss) income	$	(8	)	$	80		$	(767	)	$	21,838

Net (loss) income per share
Basic	$	(0.00	)	$	0.01		$	(0.10	)	$	2.98

Diluted	$	(0.00	)	$	0.01		$	(0.10	)	$	2.98

Assets of the RTES discontinued operations have been reflected in the consolidated balance sheet as of September 30, 2006 as current assets held for sale. The following is a summary of assets of RTES discontinued operations:


	September 30,
*In Thousands*	2006
RTES business
Accounts receivable, net	$	8,722
Prepaid expenses		158
Property, net		8,178
Goodwill, net		7,282
Other		45

Total assets of discontinued RTES operations	$	24,385

Accounts receivable for the RTES discontinued operations include approximately $2.1 million for which services have been rendered but the amounts were unbilled as of September 30, 2006. Such unbilled amounts are primarily a result of the time required to process bills for services rendered. Certain liabilities were not assumed by the purchaser in the sale of the RTES business. These include accounts payable, additional accrued compensation and other accrued liabilities.

PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited (Continued)

5. Basic and Diluted Income per Share

Basic income per share is computed using the weighted average number of shares of common stock outstanding during the period. Diluted income per share is computed using the weighted average number of shares of common stock outstanding and the dilutive effect of common equivalent shares (calculated using the treasury stock method).

For the three and six months ended March 31, 2006, the weighted average shares outstanding for continuing operations for basic and diluted computations are the same, as the impact of common equivalent shares on earnings per share is anti-dilutive.

The following table sets forth the reconciliation of denominators used in the computation of the basic and diluted income (loss) from continuing and discontinued operations per share:


	Three Months Ended		Six Months Ended
*(In thousands)*	March 31,		March 31,
	2007	2006	2007	2006
Denominator for basic income per share-weighted average shares	7,549	7,372	7,543	7,321
Effect of dilutive securities:
Options	185	—	180	—

Denominator for diluted income per share—adjusted weighted average shares	7,734	7,372	7,723	7,321

Antidilutive securities:
Options	208	275	253	221

6. Segments

We have two reportable segments: Nursing and PPEC. Our Nursing division consists primarily of private duty home nursing care for predominately pediatric patients. Our PPEC division contains Prescribed Pediatric Extended Care centers which provide daily medical care for medically fragile children.

The accounting policies of the operating segments are the same as those described in the Summary of Significant Accounting Policies (See Note 2). We evaluate performance based on profit or loss from operating income, excluding corporate, general and administrative expenses. Asset information by segment, including capital expenditures and net income (loss) beyond operating contribution margins are not provided to our Chief Operating Decision Maker (“CODM”). Inter-segment allocations have been eliminated.

Our reportable segments are defined based on the patient populations and relevant services provided which is reviewed by the CODM. All periods presented have been reclassified to conform to the current year presentation. The RTES and Pharmacy businesses have been reclassified to discontinued operations (See Note 2 and 4).

The following table summarizes goodwill for each of our Company’s operating segments (in thousands):


	Goodwill
	March 31,		September 30,
	2007		2006
Nursing	$	24,643	$	19,284
PPEC		735		735

Total	$	25,378	$	20,019

PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited (Continued)

6. Segments – Continued

The following tables summarize certain information for each of our Company’s operating segments (in thousands):


	Nursing		PPEC			Consolidated Total
Three Months Ended March 31, 2007
Net revenue	$	31,092	$	2,552		$	33,644
Costs of goods and services (exclusive of depreciation shown separately below)
Nursing and therapist salaries, wages, benefits and supplies		20,864		66			20,930
Disposables/Supplies		21		9			30

Total cost of goods and services		20,885		75			20,960
Other operating costs and expenses
Administrative and marketing salaries, wages and benefits		3,910		1,506			5,416
Business Insurance		1,377		118			1,495
Overhead		1,529		374			1,903

Total operating costs and expenses		6,816		1,998			8,814
Provision for doubtful accounts		199		16			215
Depreciation		59		69			128

Branch office contribution margin	$	3,133	$	394		$	3,527

Three Months Ended March 31, 2006
Net revenue	$	26,404	$	2,799		$	29,203
Costs of goods and services (exclusive of depreciation shown separately below)
Nursing and therapist salaries, wages, benefits and supplies		17,341		126			17,467
Disposables/Supplies		12		15			27

Total cost of goods and services		17,353		141			17,494
Other operating costs and expenses
Administrative and marketing salaries, wages and benefits		3,408		1,502			4,910
Business Insurance		1,302		106			1,408
Overhead		1,400		441			1,841

Total operating costs and expenses		6,110		2,049			8,159
Provision for doubtful accounts		106		(46	)		60
Depreciation		38		46			84

Branch office contribution margin	$	2,797	$	609		$	3,406


	Three Months Ended March 31,
	2007			2006
Total profit for reportable segments	$	3,527		$	3,406
Corporate, general and administrative		(4,336	)		(5,107	)
Corporate depreciation and amortization		(151	)		(162	)
Provision for insurance recoveries		134			—
Other income		—			5
Interest income		832			626
Interest expense		—			(4	)

Income (loss) from continuing operations, before income tax expense (benefit)	$	6		$	(1,236	)

PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited (Continued)

6. Segments – Continued


	Nursing		PPEC			Consolidated Total
Six Months Ended March 31, 2007
Net revenue	$	60,589	$	5,113		$	65,702
Costs of goods and services (exclusive of depreciation shown separately below)
Nursing and therapist salaries, wages, benefits and supplies		40,211		154			40,365
Disposables/Supplies		29		12			41

Total cost of goods and services		40,240		166			40,406
Other operating costs and expenses
Administrative and marketing salaries, wages and benefits		7,650		2,990			10,640
Business Insurance		2,553		237			2,790
Overhead		2,943		772			3,715

Total operating costs and expenses		13,146		3,999			17,145
Provision for doubtful accounts		316		10			326
Depreciation		112		137			249

Branch office contribution margin	$	6,775	$	801		$	7,576

Six Months Ended March 31, 2006
Net revenue	$	51,779	$	5,357		$	57,136
Costs of goods and services (exclusive of depreciation shown separately below)
Nursing and therapist salaries, wages, benefits and supplies		34,112		262			34,374
Disposables/Supplies		25		23			48

Total cost of goods and services		34,137		285			34,422
Other operating costs and expenses
Administrative and marketing salaries, wages and benefits		6,788		2,923			9,711
Business Insurance		2,405		199			2,604
Overhead		2,834		865			3,699

Total operating costs and expenses		12,027		3,987			16,014
Provision for doubtful accounts		68		(3	)		65
Depreciation		78		91			169

Branch office contribution margin	$	5,469	$	997		$	6,466


	Six Months Ended March 31,
	2007			2006
Total profit for reportable segments	$	7,576		$	6,466
Corporate, general and administrative		(9,027	)		(10,534	)
Corporate depreciation and amortization		(304	)		(319	)
Provision for insurance recoveries		384			—
Loss on early extinguishment of debt		—			(837	)
Other income		58			8
Interest income		1,642			1,011
Interest expense		—			(564	)

Income (loss) from continuing operations, before income tax expense (benefit)	$	329		$	(4,769	)

PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited (Continued)

6. Segments – Continued

Travel, auto, equipment leases and delivery charges which are included in other operating costs and expenses are not segregated between the portions related directly to patient care expenses and the portions related to overhead. The following table summarizes these expenses (in thousands):


	Three Months Ended March 31,				Six Months Ended March 31,
	2007		2006		2007		2006
Travel	$	80	$	51	$	163	$	118
Auto gas, mileage and repairs		183		207		336		418
Auto leases		67		46		154		96
Delivery charges		22		16		41		33

	$	352	$	320	$	694	$	665

7. Commitments and Contingencies

As a result of operating in the healthcare industry, our business entails an inherent risk of lawsuits alleging malpractice, product liability or related legal theories, which can involve large claims and significant defense costs. From time to time, we are subject to such suits arising in the ordinary course of business. Based upon information available to date, management believes it has provided adequate reserves, if needed, for any unfavorable resolutions; however, there can be no assurance that the ultimate resolution of such current pending legal proceedings will not have a material adverse effect on our financial condition or liquidity position.

Our former worker’s compensation carrier, Atlantic Mutual, received a downgrade in their AM Best financial rating following nonpayment of interest and subsequently requested a voluntary withdrawal of its AM Best rating (see Note 2 “Allowance for Insurance Recoveries”).

In December 2005, we received notice of a claim from one commercial payor primarily relating to our discontinued pharmacy operations. The payor claims overpayments of approximately $1.1 million. We have reviewed the basis for the claim and believe it is substantially without merit. We have submitted our response and are working towards resolution of these issues. At this time, we believe we are adequately reserved; however, there can be no assurance that ultimate resolution will not have a material adverse effect upon our future financial results. As of March 31, 2007, we had no material claims, disputes or unsettled matters with third party payors except as disclosed above, nor were there any material pending settlements with third party payors.

8. Subsequent Events

On April 25, 2007 we announced that we had entered into a definitive agreement with Portfolio Logic LLC pursuant to which we will become a privately owned company. Portfolio Logic will acquire all of our outstanding common shares not owned by Portfolio Logic at a price of $16.25 per share, paid in cash. As soon as possible, we will deliver to our shareholders a proxy statement for their consideration and approval of the transaction, and the two companies will file for regulatory approval under the Hart-Scott Rodino Antitrust Improvements Act of 1976, as amended.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

This Form 10-Q contains certain forward-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995) relating to future financial performance of our company. When used in this Form 10-Q, the words “may,” “hopes,” “targets,” “goal,” “could,” “should,” “would,” “believe,” “feel,” “expects,” “anticipate,” “~~confident”, “~~estimate,” “intend,” “plan,” “potential” and similar expressions may be indicative of forward-looking statements. These statements by their nature involve substantial risks and uncertainties, certain of which are beyond our control. We caution that various factors, including the factors described below and elsewhere in this report, ~~and including those set forth in Item 1 under the caption “Risk Factors” in our 2004 Annual Report on Form 10-K,~~ as well as those discussed in our other filings with the Securities and Exchange Commission, could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements made by us or on our behalf. The following are among the important factors that could cause actual results to differ materially from the results discussed herein:

•

Our failure to complete our proposed merger with Portfolio Logic LLC because of a number of factors, including the failure to obtain the requisite approval of our stockholders or the failure to satisfy other closing conditions;

•

the financial implications of the sale of our Pharmacy and RTES businesses;

•

our anticipated uses of the proceeds from the sale of our Pharmacy and RTES businesses;

•

changes in reimbursement rates or policies;

•

payor relationships;

• changes in ~~health~~healthcare ~~care~~ regulations, including changes resulting from the ~~recently enacted Medicare Prescription Drug Act of 2003 (“MMA”) and the~~ Health Insurance Portability and Accountability Act (“HIPAA”);

• ~~the~~performance ~~ability~~of toinvestments ~~collect~~in ~~for~~our ~~equipment~~corporate ~~sold~~cash ormanagement ~~rented~~program;

•

the ability to assimilate and manage previously acquired field operations;

•

the ability to collect accounts receivable for products and services we provide, including receivables related to acquired businesses and receivables under appeal;

•

the ability to comply with and respond to billing requirements issues, including those related to our billing and collection system;

•

reduced state funding levels and nursing hours authorized by Medicaid programs;

•

adverse litigation results;

•

competitive factors;

• ability to hire and retain qualified ~~health~~healthcare ~~care~~ professionals;

•

the availability and cost of medical malpractice, workers’ compensation and employee medical benefit insurance;

•

changes in industry practices; and

•

general economic condition and industry trends.

Any forward-looking statement speaks only as of the date on which such statement is made, and we undertake no obligation to update any forward-looking statement or statements to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of an unanticipated event. New factors emerge from time to time, and it is not possible for management to predict all of such factors. Further, management cannot assess the impact of each such factor on the business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

~~The~~21 ~~following discussion should be read in conjunction with the unaudited condensed consolidated financial statements included in this quarterly report.~~

The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements included in this quarterly report.

EXECUTIVE SUMMARY

Recent Developments

Home Healthcare Industry Events & Updates

~~Historically, Medicare reimbursement for covered drugs has been limited to 95 percent of the published average wholesale price (AWP) for the drug.~~ The ~~Medicare~~ ~~Prescription~~Deficit ~~Drug,~~Reduction ~~Improvement and Modernization~~ Act of ~~2003~~2005 (~~MMA~~“DRA”) ~~established new payment limits and procedures for drugs reimbursed under Medicare Part B~~, ~~including~~which ~~drugs~~was ~~used~~signed ~~for~~into ~~inhalation~~law ~~therapy.~~on ~~The final rule~~February 8, ~~as the MMA required~~2006, ~~provides that Medicare beneficiaries~~ will behave ~~reimbursed at~~ a ~~rate~~significant of 106 percent of the volume-weighted average selling price (the ASP). In addition, providers of inhalation therapy drugs, including our company, will receive a dispensing fee for supplying such drugs. The calendar year 2005 dispensing fee will be $57 for thirty (30) days of therapy or $80 for ninety (90) days. Within the Pharmacy segment, we are continuing to assess the impact of these changes to our unit dose respiratory products to determine the viability of our long term profitability. While the long term impact of the MMA reforms cannot yet be determined because the recently promulgated regulations are transitional in nature, these and other changes may have a material adverse effect on ~~our operations and financial results. For fiscal year 2005,~~ the ~~impact~~Medicaid ofservices ~~these regulations is expected to substantially reduce our profitability in the Pharmacy segment. There can be no assurance that~~ we ~~will not~~provide, ~~face~~including: ~~increased margin pressures from subsequent reimbursement changes beyond 2005.~~

A• ~~number~~Expanding ofaccess ~~other~~to ~~pilot~~home ~~programs~~ and ~~demonstrations which are mandated by the MMA signal the likelihood of continued re~~community-~~design~~based ofservices ~~certain aspects of the Medicare program. While the more immediately visible changes mandated~~ by ~~the~~establishing ~~MMA~~them ~~relate~~as toan ~~extension~~optional ofMedicaid ~~the Medicare~~ benefit tothat ~~prescription~~would ~~drug~~not ~~coverage,~~require ~~other aspects may impact the operations and profitability of health care providers, including our company. Among other things, the MMA mandates~~ a ~~phased-in~~ ~~competitive~~waiver ~~bidding process~~ for ~~Medicare~~individuals ~~procurement~~whose ofincome ~~certain~~does ~~durable~~not ~~medical~~exceed ~~equipment~~150% ~~(DME), commencing in the ten (10) largest Metropolitan Statistical Areas (MSAs) in 2007, followed by the next eighty (80) largest MSAs in 2009. Moreover, the Secretary~~ of the ~~United~~federal ~~States~~poverty ~~Department~~level of Health & Human Services has the authority to apply competitive bidding nationally for the highest cost, highest volume items and services and those items and services that the Secretary determines to have the (“~~largest savings potential.~~FPL” ~~There will also be at least a five (5~~) ~~year freeze in the Consumer Price Index update for reimbursement rates for DME where competitive bidding prices are not applicable~~. In addition, commencing in calendar year 2005, reimbursement for certain items and services (e.g., oxygen and oxygen equipment) that are not subject to competitive bidding will be capped at the 2002 rate or the “Median Federal Employee Health Plan Price” established in 2002, whichever is lower. For fiscal year 2005, the impact of these regulations will be to reduce our profitability in the RTES segment. There can be no assurance that we will not face increased margin pressures from subsequent reimbursement changes beyond 2005.

~~Under~~• ~~the~~Creating ~~MMA, there~~a ~~are~~new ~~major~~optional ~~changes~~Medicaid ineligibility ~~the~~group ~~Medicare payment rates~~ for ~~hemophilia~~children ~~products~~with ~~beginning~~disabilities inunder ~~calendar~~the ~~year~~age ~~2005. Currently, Medicare reimburses for blood clotting factor at 95 percent~~ of ~~AWP.~~19 ~~Effective~~who ~~January 1,~~meet ~~2005, we are reimbursed for blood clotting factor based on~~ the ~~new~~severity ~~ASP~~of ~~methodology.~~disability Werequired ~~expect~~under ~~that~~ the ~~resulting~~Supplemental ~~payment~~Security ~~rates~~Income ~~will be lower than the current rates for these products. In addition, the Centers for Medicare & Medicaid Services~~ (~~CMS~~“SSI”) ~~will~~program ~~make~~without aregard ~~separate payment~~ to ~~the~~any ~~entity~~income ~~that~~or ~~provides~~asset ~~blood~~requirements ~~clotting factor to a Medicare beneficiary for items and services related to the furnishing of such products. The amount of this separate payment is capped so~~ that ~~the~~apply ~~total~~under ofSSI ~~the~~where ~~ASP~~family ~~payment~~income ~~rate~~does ~~and~~not ~~the separate payment amount cannot~~ exceed 95300% ~~percent~~ of ~~AWP. It is possible that~~ the ~~proposed separate payment amount will be inadequate for the service level requirements of the Medicare beneficiary with hemophilia~~FPL. While our current census of Medicare beneficiary hemophilia patients is quite low, the potential for select state Medicaid programs to adopt changes to their payment rates based upon these Medicare changes exists. Such changes could result in a payment amount that would be inadequate for the required service level. We have addressed these proposed reductions, as well as the potential for further reimbursement reductions from selected commercial payors, by reducing administrative and overhead costs where possible and continuing to search for further opportunities to reduce our cost structure.

As• ~~described~~Establishing inFamily ~~our~~to ~~prior~~Family ~~SEC~~Health ~~filings,~~Information ~~Georgia~~Centers ~~Medicaid’s~~to ~~contractor~~provide ~~missed~~information ~~the~~and ~~original~~assistance ~~implementation~~to ~~date~~help families of ~~October 1,~~children ~~2002~~with ~~and~~special ~~delayed~~health ~~the~~care ~~“go~~needs ~~live”~~navigate ~~date~~the ~~until~~system ~~April 1,~~of ~~2003~~care ~~for~~and ~~its~~make ~~new~~decisions ~~Multi~~about ~~Health~~the ~~Network system.~~needs ~~Georgia~~and ~~Medicaid~~available issupport anmechanisms ~~important~~for ~~customer~~their ofchildren. ~~ours~~The ~~and~~DRA ~~represents~~increases ~~approximately~~funding 6%for ofthis ~~our~~initiative ~~annual~~under ~~billed~~Title ~~revenue.~~V ~~Some~~ of the Social Security Act.

18• Authorizing the Department of Health and Human Services’ Secretary (HHS Secretary) to conduct a demonstration project in states to increase the use of home and community-based services instead of institutions. States awarded a demonstration project will receive 90% of the costs of home and community-based long-term care services (under a HCBS waiver and/or the State Plan) for 12 months following a demonstration participant’s transition from an institution into the community.

~~Table~~Many of ~~Contents~~the states in which we operate are evaluating and implementing program reforms that could impact patient eligibility and increase managed care administration of benefits. To date, we have not experienced any reimbursement rate reductions in those certain states that have adopted these changes. In an effort to monitor and have an impact on these legislative issues, we have engaged consultants in selected markets to directly present our cost saving strategies and related rate requests to the Medicaid programs.

the continuing problems we are trying to resolve with Georgia Medicaid include: correcting conflicts between provider numbers, categories of service, membership identification, units of measure, authorized duration of service and corresponding procedure codes within its authorization module. Given the State’s continued delays in agreeing to a timely settlement on a large number of claims from our RTES segment, we are working with external legal counsel on the range of alternatives available to us, including initiating legal action. Nevertheless, we have been in communication with other contacts in the State’s government and have received somewhat limited assistance to date. Based upon the information available to date, we believe we have recorded an adequate allowance against these receivable balances.

While certain states are realizing relief from prior revenue shortfalls and some are reporting surpluses, concern over a reduction in the future level of Federal Medical Assistance Percentages dampens the likelihood that Medicaid payment limitations will be abated at any time in the near future. While many of the states in which we operate are discussing alternatives which could have the effect of restricting eligibility for Medicaid benefits or increasing the use of managed care organizations in the administration of benefits, we are not aware of any specific proposals being actively evaluated which would have a material adverse impact upon our operations or financial results. However, in an effort to impact these legislative issues, we have engaged consultants in selected markets to directly present our cost saving strategies and related rate requests to the Medicaid programs. During the third quarter of fiscal 2005, we received a rate increase for our Private Duty Nursing services from two states. In addition, our local market staff routinely collaborates with the appropriate community and regulatory authorities on our behalf as well as our patients.

The HIPAA transactions and code set standards, mandate that Covered Entities, including our company, transmit claims and certain related healthcare information in standardized formats and data sets. Compliance was required on October 16, 2003, but many payors, including most state Medicaid agencies, were not in compliance by that date. To date, many Medicaid agencies are running dual systems to accommodate HIPAA compliant transactions as well as non-compliant transactions. Some states, however, are running only HIPAA compliant systems and other states are not yet HIPAA compliant. There is uncertainty as to when those states using dual systems will discontinue their non-HIPAA compliant systems. These uncertainties surrounding claims processing as a result of HIPAA’s transactions and code set standards, which uncertainties are outside our control, have resulted in delayed reimbursement by some payors, including Medicaid agencies. We expect that the impact to our cash collections from non-HIPAA compliant payors should continue to decline throughout fiscal 2005.

Company Events & Updates

~~During~~On ~~the~~April 25, ~~second~~2007 ~~quarter~~we ofannounced ~~fiscal~~that ~~year~~we ~~2005,~~had weentered ~~performed~~into a ~~strategic review~~definitive ofagreement ~~our~~with ~~business.~~Portfolio ~~The~~Logic ~~purpose~~LLC ofpursuant ~~this~~to ~~review~~which ~~was~~we towill ~~conduct~~become a ~~rigorous~~privately ~~evaluation~~owned ofcompany. ~~all~~Portfolio ~~possible~~Logic ~~strategic~~will ~~alternatives;~~acquire ~~select~~all aof ~~strategic~~our outstanding ~~path~~common ~~that~~shares ~~maximizes~~not ~~long-term~~owned ~~shareholder~~by ~~value;~~Portfolio ~~assess~~Logic ~~the~~at ~~management~~a ~~team’s~~price ~~capabilities~~of ~~and identify~~$16.25 ~~any~~per ~~gaps~~share, paid in ~~needed~~cash. ~~talents~~As ~~and~~soon ~~skill~~as ~~sets;~~possible, ~~provide~~we ~~clarity~~will deliver to ~~the~~our ~~tactical~~shareholders ~~actions~~a ~~necessary~~proxy tostatement ~~maximize~~for ~~the~~their ~~value~~consideration ofand ~~each~~approval ~~segment~~ of the ~~business;~~transaction, and ~~implement a communication plan which supports~~ the ~~chosen strategic path. During the~~two ~~third~~companies ~~quarter~~will offile ~~fiscal~~for ~~2005,~~regulatory weapproval ~~continued~~under the ~~implementation~~Hart-Scott ofRodino ~~several~~Antitrust ofImprovements ~~the~~Act ~~critical elements~~ of ~~the~~1976, ~~agreed~~as ~~strategic path~~amended. InWe ~~addition,~~incurred ~~the~~costs ~~Vice President~~ of ~~PPEC~~approximately ~~Operations resigned~~$0.3 Amillion ~~decision~~in ~~was~~connection ~~made~~with ~~not to replace this position and to have these operations report to~~ the ~~Vice~~transaction ~~President~~as of ~~Nursing~~March 31, 2007.

~~With respect~~On toApril 1, ~~compliance~~2007, ~~with~~we ~~Section 404~~renewed ofour ~~the~~contract ~~Sarbanes-Oxley~~with ~~Act’s~~United Health Care (“~~SOX 404~~United”) ~~requirements~~for ~~related~~private toduty ~~internal~~nursing ~~controls~~services. ~~over~~This contract contains financial ~~reporting,~~incentives wecontingent ~~continue~~upon tosatisfaction ~~work~~of ~~with~~a ~~our~~broad ~~consultants~~range ~~and~~of ~~have~~criteria ~~substantially~~including: ~~completed~~volume ~~the documentation~~and ~~process~~accuracy ~~and~~of ~~are~~electronic ~~well~~claims, ~~underway~~patient ~~with~~satisfaction ~~the~~and ~~required~~nurse ~~testing~~staffing. ~~Although~~These ~~our~~incentives ~~estimated~~will ~~expense~~not ~~has~~be ~~increased,~~recorded as revenues until we ~~believe~~receive confirmation ~~that~~from ~~our~~United ~~project~~as isto ontheir ~~schedule~~achievement. ~~which~~The ~~allows~~Company ~~for~~hopes ~~adequate~~that ~~time~~this tocontract ~~perform~~will ~~the~~be ~~required~~a ~~testing~~model ~~and~~for ~~potential~~future ~~remediation tasks~~managed ~~prior~~care contract negotiations and will serve to ~~the~~differentiate ~~required~~us ~~testing~~from byour competitors and reinforce our ~~external~~value ~~auditors~~proposition.

On ~~December~~February 1617, ~~2004~~2007, ~~the~~we ~~Financial~~acquired ~~Accounting~~select ~~Standards~~pediatric ~~Board~~assets ~~(FASB)~~of ~~issued~~Maternal ~~FASB~~Child ~~Statement~~Health, NoInc. ~~123~~ (R“MCH”) ~~(revised~~a ~~2004),~~subsidiary ~~Share-Based~~of ~~Payment,~~Deaconess Associations ~~which~~Inc. isan aOhio ~~revision~~corporation. ofThe ~~FASB~~acquisition ~~Statement~~includes ~~No. 123,~~MCH’s ~~Accounting~~pediatric ~~for~~nursing ~~Stock-Based Compensation.~~business ~~Statement~~in ~~123(R)~~the ~~supersedes~~Illinois, ~~APB~~Texas ~~Opinion~~and NoPennsylvania markets. ~~25,~~ ~~Accounting~~The ~~for~~MCH ~~Stock~~operations ~~Issued~~located toin ~~Employees,~~the Corpus Christi and ~~amends~~McAllen ~~FASB~~Texas ~~Statement~~markets ~~No. 95,~~will ~~Statement~~be ofoperated ~~Cash~~on ~~Flows~~a stand alone basis. ~~Generally,~~The ~~the~~purchase ~~approach~~price inis ~~Statement~~approximately ~~123(R)~~$4.1 ismillion ~~similar~~in ~~to the~~cash ~~approach~~with ~~described~~MCH inretaining ~~Statement~~its ~~123~~accounts receivable. ~~However,~~The ~~Statement 123(R)~~purchase ~~requires~~price ~~all~~has ~~share-based~~been ~~payments~~preliminarily allocated to ~~employees,~~identifiable ~~including~~intangible ~~grants~~assets consisting of ~~employee~~non-compete ~~stock~~agreements ~~options,~~of $0.1 tomillion beand ~~recognized~~goodwill inof $4.0 million. Effective with the ~~income~~adoption ~~statement~~of ~~based~~SFAS onNo. 142, ~~their~~the ~~fair~~purchase ~~values~~price allocation of $4.0 ~~Pro~~million ~~forma disclosure~~of goodwill is nonot ~~longer~~being anamortized; ~~alternative~~however, it is being deducted for tax purposes.

Statement 123(R) must be adopted by us no later than the first fiscal year beginning after June 15, 2005. We expect to adopt Statement 123(R) on October 1, 2005.

Statement 123(R) permits public companies to adopt its requirements using one of two methods:

We plan to adopt Statement 123(R) using the modified prospective method.

Risk Management

We have spent significant time and resources to move towards a fully implemented Enterprise Risk Management Model. This approach to risk management emphasizes assessment of risk from a broader perspective and relies upon significant employee education initiatives and awareness of a variety of risk exposures. Our full time risk manager, who possesses extensive homecare and occupational medicine experience, has strengthened the initial incident reporting and investigation process and actively monitors claim adjustment activities. Our Risk Committee, which is comprised of members of the Compliance, Legal, Human Resources, Internal Audit and Risk Management Departments, continues to monitor incident reporting and claim adjustment activity, review existing patient census and discharge high-risk cases where legally permissible. Our Risk Committee employs a multi-functional approach to its decision making process. We continue to educate branch office staff on risk management procedures including appropriate nurse staffing decisions. In addition, our third party actuary analyzes our medical malpractice loss history and quantifies liability recognition under the policy terms. Under our medical malpractice policy, we have a $1.0 million per year per claim self-insured retention and an annual aggregate self-insured retention of $8.0 million. If our loss experience worsens it could have a material adverse effect on our financial results and liquidity position.

Operations

We have three reportable segments: (i) Nursing and PPEC, (ii) Pharmacy and (iii) RTES (see Notes to the Condensed Consolidated Financial Statements-Note 7).

In the Nursing and PPEC segment, we continue to see pressures on both reimbursement levels and wage rates in key markets. We have expanded our local market recruiting efforts and we are recruiting for one additional position for a total of ten recruiters.

In the Pharmacy segment, we experienced an increase in gross margin rates due to the seasonal decline of low margin Synagis product as well as improved payor mix within the hemophilia factor and growth hormone products. Within the hemophilia factor product, clinical changes in a patient’s condition can dictate rapid changes to the specific type and amount of drugs provided. These alternative drugs may have relatively higher or lower acquisition costs and reimbursement levels based on the payor. Given the expanded, though increasingly concentrated census, changes of this type expose the Pharmacy segment revenue and contribution margin to significant volatility. Payor initiated reductions to reimbursement levels with no corresponding reduction to acquisition costs pose a significant threat to future contribution margin levels. In response to these changing market conditions we have undertaken a series of initiatives including recruiting for a National Hemophilia Director to coordinate our existing programs and provide dedicated focus on expansion. In addition, we have increased development

of marketing materials that highlight our clinical and service expertise as integral components of our pharmacy programs. We have also explored potential business relationships with hemophilia treatment centers to manage their patient populations, and we continue to refine operational best practices to assure maximized clinical compliance and efficiency.

As anticipated, our unit dose pharmacy experienced a significant reduction in Medicare reimbursement. With the transition in the Vice President of Pharmacy Operations position, the planned operating cost reductions were delayed until late in the second quarter of fiscal 2005. During the third quarter, as expected, our contribution margin improved as the transition to manufactured products and operating cost reductions were in full effect.

Our start up pharmacy in the Orlando, Florida market received its required licenses late in the first quarter of fiscal 2005, later than we had anticipated. This delay contributed to start up losses of approximately $0.2 million in the nine months ended June 30, 2005. Start up losses attributable to the Denver, Colorado start up pharmacy were approximately $0.3 million in the nine months ended June 30, 2005. A decision was made to close the Denver, Colorado pharmacy effective in the fourth quarter of fiscal 2005. We determined that we have not made enough progress and the prospects for profitability were moving past a reasonable timeframe.

In the RTES segment, we are focusing our sales and marketing efforts on higher acuity respiratory patients to leverage our clinical competencies and more actively manage the core product mix. As a result, we have begun to see increases in target referrals from managed care payors in select markets. However, we have experienced an increased rate of capital expenditures in connection with the replacement of several equipment items in our core rental fleet. These increasing capital expenditures reflect growing market acceptance of improved versions of these core products. Many of those items have become smaller and more portable and are increasingly requested by patients and referring physicians. These items have higher acquisition costs and, to date, reimbursement levels have not increased. In addition, we are experiencing decreased reimbursement for certain disposable and supply items, as well as the elimination of reimbursement for other select items (see “Home Healthcare Industry Events & Updates” above for additional discussion). In order to address the continued margin pressures on our RTES segment, our Product Review Committee continues to standardize product selections, aggregate product volumes and decrease our number of vendors in an attempt to maximize purchasing power. With the Divisional Vice President position vacant, execution of these initiatives will be critical to achieving the desired objectives.

Source & Availability of Clinical Personnel

During the 13 weeks ending June 25, 2005, our case hours staffed increased to approximately 798,000 as compared to 795,000 in the 13 weeks ended March 26, 2005. We continue to aggressively compete for nurses to staff hours ordered, retain nurses with select wage and benefit improvements and implement employee satisfaction initiatives. To help reduce un-staffed hours, we have made additional investments in nine new local market nurse recruiters, with one open position remaining. We believe that case hours staffed is the most appropriate measurement of nursing activity. To date, we have seen inconsistent results in a number of markets and we will continue to assess and respond accordingly. We anticipate that over time, our nurse scheduling system, SHINE, will help to improve both un-staffed hours and gross margin levels; however, there can be no assurance that this will occur.

RESULTS OF OPERATIONS

The following table is derived from our unaudited condensed consolidated statements of operations for the periods indicated and presents results of operations as a percentage of net revenue and the percentage change in the dollar of each item from the comparative prior period:

									Period-to-Period Percentage
	Percentage of Net Revenue								Increase (Decrease)
	Three Months				Nine Months				Three Months		Nine Months
	ended June 30,				ended June 30,				ended June 30,		ended June 30,
	2005		2004		2005		2004		2005		2005
Net Revenue	100.0	%	100.0	%	100.0	%	100.0	%	8		7
Costs of goods and services	56.9		56.9		57.8		56.3		8		10
Other operating costs and expenses
Administrative and marketing salaries, wages and benefits	17.0		18.6		17.2		17.7		(1	)	4
Business insurance	3.2		2.8		2.9		3.3		24		(5	)
Overhead	7.1		7.3		6.7		6.9		5		3
Other operating costs and expenses	27.3		28.7		26.8		27.9		3		3
Corporate, general and administrative
Salaries, wages and benefits	5.6		5.3		5.3		5.7		15		(0	)
Business insurance	0.1		0.1		0.1		0.1		56		20
Professional services	1.9		1.0		1.6		1.0		103		72
Overhead	1.2		1.2		1.2		1.3		6		(3	)
Corporate, general and administrative	8.8		7.6		8.2		8.1		26		8
Provision for doubtful accounts	1.3		1.4		1.3		1.6		0		(14	)
Depreciation and amortization	1.7		1.6		1.7		1.5		15		17
Operating income	4.0		3.8		4.2		4.6		14		(3	)
Other income	—		—		—		—		—		1,061
Interest income	0.1		0.1		0.1		0.1		(11	)	34
Interest expense	(1.0	)	(1.0	)	(1.0	)	(1.0	)	4		9
Income before income tax expense	3.1	%	2.9	%	3.3	%	3.7	%	17		(4	)

WeOn ~~provide~~February 9, 2007, the Company received a ~~broad~~favorable ~~range~~verdict defending itself against a claim of tortious ~~health~~interference ~~care~~related ~~services~~to ~~and~~a ~~products~~1996 ~~principally~~acquisition. ~~for~~The ~~children~~Company ~~and~~incurred approximately $0.3 million of legal fees during the six months ended March 31, 2007. The verdict directs that the Company is entitled to arecover ~~lesser~~legal ~~extent,~~fees ~~young~~incurred since ~~adults~~the ~~and~~date ~~geriatric~~of ~~patients~~its most recent rejected settlement offer. ~~The~~Plaintiff ~~following~~has ~~table~~filed ~~summarizes~~a ~~both~~motion ~~services~~to ~~and~~appeal ~~products~~the ~~based~~verdict ~~upon~~and ~~estimated~~the ~~percentages~~recovery of ~~net~~fees, ~~billings~~if ofany, ~~each~~is ~~major~~pending ~~category~~resolution ~~for~~of the ~~periods~~appeal. ~~indicated:~~

	Three Months Ended				Nine Months Ended
	June 30,				June 30,
	2005		2004		2005		2004
	% Total		% Total		% Total		% Total
Pediatric Home Health Care
Nursing and PPEC	41.7	%	41.8	%	41.4	%	40.4	%
Respiratory Therapy Equipment and Services	8.5	%	8.5	%	8.2	%	8.2	%
Pharmacy	29.9	%	28.8	%	29.6	%	29.5	%
Total Pediatric Home Health Care	80.1	%	79.1	%	79.2	%	78.1	%
Adult Home Health Care
Nursing	4.5	%	4.7	%	4.5	%	4.6	%
Respiratory Therapy Equipment and Services	8.4	%	8.9	%	8.5	%	8.8	%
Pharmacy	7.0	%	7.3	%	7.8	%	8.5	%
Total Adult Home Health Care	19.9	%	20.9	%	20.8	%	21.9	%
Total	100.0	%	100.0	%	100.0	%	100.0	%

On February 4, 2007, we acquired substantially all of the pediatric assets of Wilko Enterprises, Inc.,a Texas corporation (“Wilkerson”). The acquisition includes Wilkerson’s pediatric nursing business in the Temple, Texas market and will be consolidated into PSA’s existing branch in Austin, Texas. The purchase price is $0.3 million in cash with $0.1 million held in escrow and Wilkerson retaining its accounts receivable. The purchase price has been preliminarily allocated to identifiable intangible assets consisting of non-compete agreements of $0.04 million and goodwill of $0.2 million. Effective with the adoption of SFAS No. 142, the purchase price allocation of $0.2 million of goodwill is not being amortized; however, it is being deducted for tax purposes.

On January 6, 2007, we acquired certain of the pediatric assets of Americare At Home, Inc. a Massachusetts corporation (“Americare”). The acquisition included certain of Americare’s pediatric nursing locations in the Shrewsbury and Newton, Massachusetts markets. The purchase price was approximately $1.4 million in cash with $0.2 million held in escrow and Americare retaining its accounts receivable. The purchase price has been preliminarily allocated to identifiable intangible assets consisting of non-compete agreements of $0.25 million and goodwill of $1.2 million. Effective with the adoption of SFAS No. 142, the purchase price allocation of $1.2 million of goodwill is not being amortized; however, it is being deducted for tax purposes.

On November 6, 2006, we completed the sale of substantially all of the assets of our RTES business to Lincare, Inc. The aggregate purchase price was $35.2 million of which $30.0 million was received at closing. The remainder of the purchase price is contingent upon the satisfaction of certain criteria, including the successful transition of certain patients and the collection of accounts receivable outstanding at closing (See Note 2 and 4).

During the second half of fiscal 2006, we implemented a program to approach our private duty nursing managed care payors with a request to increase reimbursement rates. In many cases we have not had a rate increase for a number of years and have incurred significant increases in nurse wage rates during that period. In select cases, we have negotiated and finalized rate increases, many of which become effective at the start of our fiscal year 2007. Negotiations are ongoing with a number of other payors and we are hopeful we will achieve some level of rate increase in most cases; however, there can be no assurance that these rate increases will be achieved.

Early in fiscal 2006, our former worker’s compensation insurance carrier, Atlantic Mutual, received a downgrade in its AM Best financial rating to a B-. On August 21, 2006, Standard & Poor’s downgraded Atlantic’s surplus note rating to D from CCC following Atlantic’s nonpayment of interest that was due on August 15, 2006. Subsequently, Atlantic Mutual requested a voluntary withdrawal of its AM Best rating. While we believe that our collateral remains secure, the potential for the carrier to default on claim payments due in the ordinary course has increased. Based upon information available to date, we believe the insurance carrier will not be able to meet its obligations. We established an allowance of $2.4 million on the full value of the insurance recoveries receivable at September 30, 2006. Based upon claim activity and carrier payments made during the six months ended March 31, 2007 we reduced our allowance by approximately $0.4 million.

Risk Management

We have spent significant time and resources to move towards a fully implemented Enterprise Risk Management Model. This approach to risk management emphasizes assessment of risk from a broader perspective and relies upon significant employee education initiatives and awareness of a variety of risk exposures. Our full time risk manager, who possesses extensive homecare and occupational medicine experience, has strengthened the initial incident reporting and investigation process and actively monitors claim adjustment activities. Our Risk Committee, which is comprised of members of the Compliance, Legal, Human Resources, Finance and Risk Management Departments, continues to monitor incident reporting and claim adjustment activity, review existing patient census and discharge high-risk cases where legally permissible. Our Risk Committee employs a multi-functional approach to its decision making process. We continue to educate branch office staff on risk management procedures including appropriate nurse staffing decisions. We have expanded our risk management staff in fiscal 2007 and intensified our efforts to pro-actively identify high risk patients and nurses, reinforce appropriate boundaries of care, strengthen our data collection efforts during incident reporting and continue to aggressively engage the third party administrator in the claim adjustment process. In addition, our third party actuary analyzes our medical malpractice loss history and quantifies liability recognition under the policy terms. Under our medical malpractice policy, we have a $1.0 million per year, per claim, self-insured retention, with an aggregate self-insured retention limit of $7.3 million and an annual aggregate coverage limit of $15.0 million. If our loss experience worsens, it could have a material adverse effect on our financial results and liquidity position.

~~Three~~Operations ~~Months Ended June 30, 2005 Compared to Three Months Ended June 30, 2004~~

~~Net~~We ~~revenue~~have ~~increased~~two ~~$4.9~~reportable ~~million,~~segments: ~~or 8%, to $63.3 million in the three months ended June~~(i) ~~30, 2005 from $58.4 million in the three months ended June 30, 2004. For the~~ Nursing and ~~PPEC segment net revenue increased $2.0 million, or 8%, to $28.7 million in the three months ended June~~(ii) ~~30, 2005 from $26.7 million in the three months ended June 30, 2004. Of this growth, $0.4 million was attributable to the Macon start up~~ PPEC ~~branch~~(see ~~office~~“Notes ~~and $0.3 million was from PPEC same store growth. The increase of $1.3 million in Nursing net revenue was broad based throughout our service areas. Pharmacy net revenue increased $2.0 million, or 10%,~~ to ~~$21.3~~Condensed ~~million~~Consolidated inFinancial ~~the~~Statements”—Note three months ended June 30, 2005 from $19.3 million in the three months ended June 30, 2004. This increase in Pharmacy net revenue is attributable to increased deliveries of hemophilia factor and growth hormone products. These increases were offset by net revenue declines in unit dose respiratory medications. RTES net revenue increased $0.8 million, or 7% to $13.3 million in the three months ended June 30, 2005 from $12.4 million in the three months ended June 30, 2004. The increase was across all core products. In the three months ended June 30, 2005, we derived approximately 51% of our net revenue from commercial insurers and other private payors, 43% from Medicaid and 6~~% from Medicare~~).

~~Costs~~In ofthe ~~goods~~Nursing ~~and services consist primarily of branch office nursing compensation and benefits~~segment, ~~medical~~we ~~equipment,~~are ~~pharmaceuticals~~focused ~~and~~on ~~related~~increasing ~~supplies. Costs~~our ofstaffed ~~goods~~hours and ~~services~~reimbursement ~~increased~~rates ~~$2.8~~to ~~million,~~drive orrevenue ~~8%, to $36~~growth.0 ~~million~~During in the ~~three~~six months ended ~~June~~ March 3031, ~~2005~~2007, ~~from~~we ~~$33.2~~continue ~~million~~to inbelieve ~~the~~our ~~three~~nurse ~~months~~recruiting ~~ended~~strategy ~~June 30,~~with ~~2004.~~its ~~Costs~~focus ofupon ~~goods~~weekly ~~and~~staffed ~~services~~hours oftargets, ~~the~~for ~~Nursing~~each ~~and~~branch ~~PPEC segment increased $1.0 million~~office, oras ~~6%,~~well toas ~~$16.9~~our ~~million~~incentive inprograms ~~the~~to ~~three~~reward ~~months~~achievement ~~ended~~of ~~June 30,~~these ~~2005~~targets ~~from~~best ~~$15.9~~positions ~~million~~us into ~~the~~achieve our ~~three~~growth ~~months ended June 30, 2004~~objectives. ~~Costs~~We ofhave ~~goods~~also ~~and~~instituted ~~services as~~ a ~~percentage~~variety of ~~the~~new ~~Nursing~~programs ~~and PPEC segment net revenue decreased~~ to ~~59%~~monetarily inreward ~~the~~our ~~three~~nurses ~~months ended June 30, 2005 compared~~ to ~~60%~~increase in the ~~three~~number ~~months ended June 30, 2004. The Pharmacy segment cost~~ of ~~goods~~hours ~~and~~that ~~services~~they ~~increased~~work $1for us.3 ~~million,~~We orcontinue ~~10%,~~ to ~~$14.8~~experience ~~million~~wage pressures in ~~the~~select ~~three months ended June 30, 2005 from $13~~markets.5 ~~million~~During in the ~~three~~six months ended ~~June~~ March 3031, ~~2004. The RTES segment cost of goods and services increased $0.4 million~~2007, orwe ~~11%,~~began to ~~$4.2~~see ~~million in~~ the ~~three~~impact ~~months~~of ~~ended~~increased ~~June 30,~~rates ~~2005~~ from ~~$3.8~~select ~~million~~managed incare ~~the three~~payors ~~months~~on ~~ended~~our ~~June 30,~~gross ~~2004~~margin rate. ~~Costs~~Our ofbranch ~~goods~~office ~~and~~directors’ ~~services~~focus asis aupon ~~percentage~~increasing ofgross ~~net~~margin ~~revenue~~dollars ~~increased~~which towill ~~32%~~improve in the ~~three~~branch ~~months~~office contribution ~~ended June 30, 2005 from 30% in the three months ended June 30, 2004~~margin.

Other operating costs and expenses include branch office administrative and marketing compensation and benefits, allocated business insurance costs, facility and overhead costs. Other operating costs and expenses increased $0.5 million, or 3%, to $17.3 million in the three months ended June 30, 2005 from $16.8 million in the three months ended June 30, 2004. In the ~~Nursing and~~ PPEC segment, ~~other~~we ~~operating~~continue ~~costs~~to ~~and~~be ~~expenses~~pleased ~~remained~~with ~~relatively~~the ~~constant~~financial atresults ~~$7.7~~of ~~million~~our inGeorgia ~~the~~centers. ~~three~~Our ~~months~~census ~~ended~~has continued ~~June 30, 2005 as compared~~ to ~~the three months ended June 30~~grow, ~~2004.~~community Asacceptance ~~a percentage~~ of ~~net~~our ~~revenue,~~business ~~the~~model ~~Nursing~~has expanded and ~~PPEC~~feedback ~~segment costs decreased to 27% in the three months ended June 30, 2005~~ from ~~29%~~state inofficials ~~the~~is ~~three months ended June 30, 2004~~positive. In ~~the~~North ~~Pharmacy~~Carolina ~~segment,~~our ~~other~~pilot ~~operating costs~~project ~~and~~continues ~~expenses increased $0.3 million, or 9%,~~ to ~~$3.4~~demonstrate ~~million in~~ the ~~three~~desired ~~months~~outcomes ~~ended~~and ~~June 30,~~we ~~2005~~are ~~from $3.1 million~~ in ~~the~~discussions ~~three~~with ~~months ended June 30, 2004. As a percentage of net revenue these costs remained relatively constant at~~the ~~16%~~appropriate inagency ~~the~~managers ~~three months ended June 30, 2005 as compared~~ to ~~the~~secure ~~three~~a ~~months~~permanent ~~ended~~source ~~June 30, 2004. This increase includes administrative salaries~~ of ~~approximately $0~~funding.1 ~~million~~We ~~attributable~~are tovery ~~start~~pleased upwith ~~operations~~our innew ~~the~~West ~~Orlando~~Palm ~~and~~Beach ~~Denver markets.~~PPEC Infacility ~~the RTES segment, costs and expenses increased $0~~expansion.3 ~~million,~~The orcenter ~~4%,~~is tonow ~~$6.2~~at ~~million~~full ~~in the three months ended June 30, 2005 compared to $5~~capacity.9 million in the three months ended June 30, 2004. As a percentage of net revenue these costs decreased to 47% in the three months ended June 30, 2005 from 48% in the three months ended June 30, 2004.

~~Corporate, general and administrative costs increased $1.1 million, or 26%, to $5.6 million in the three months ended June~~Source ~~30,~~& ~~2005~~Availability ~~from $4.4 million in the three months ended June 30, 2004. As a percentage~~ of ~~net~~Clinical ~~revenue,~~Personnel corporate, general and administrative costs increased to 9% in the three months ended June 30, 2005 compared to 8% in the three months ended June 30, 2004. Of the $1.1 million increase, $0.6 million was attributable to increased professional fees, specifically increased SOX 404 costs and increased audit fees.

~~Provision~~We ~~for~~believe ~~doubtful~~that ~~accounts~~case ~~remained~~hours ~~relatively~~staffed ~~constant~~is atthe ~~$0.8~~most ~~million~~appropriate inmeasurement of nursing activity. During the ~~three~~13 ~~months~~weeks ~~ended~~ending ~~June~~March 3031, ~~2005~~2007, our case hours staffed increased to approximately 928,000 as compared to 874,000 in the ~~three~~13 ~~months~~ weeks ended ~~June~~December 30, ~~2004~~2006. ~~Cash~~A ~~collections~~substantial asportion ~~a percentage~~ of ~~net~~the ~~revenue~~increase ~~were~~relates ~~106%~~to ~~and~~the ~~107%~~acquisitions completed in the ~~three~~second ~~months~~quarter ~~ended~~of ~~June 30~~fiscal 2007. We continue to aggressively compete for nurses to staff hours ordered, ~~2005~~retain nurses with select wage and ~~2004,~~benefit ~~respectively~~improvements and implement employee satisfaction initiatives. We have made investments in nine local market nurse recruiters to help reduce unstaffed hours.

~~Depreciation~~CRITICAL ~~and~~ACCOUNTING ~~amortization~~POLICIES ~~increased $0.1 million, or 15%, to $1.1 million in the three months ended June 30, 2005 as compared to $1.0 million in the three months ended June 30, 2004.~~

~~Interest~~This ~~expense~~Form ~~remained~~10-Q ~~relatively~~reflects ~~constant~~disclosure atupdates $0to our critical accounting policies.6 ~~million~~These critical accounting policies should be read in ~~the~~conjunction ~~three~~with ~~months~~our ~~ended~~audited ~~June 30,~~consolidated ~~2005~~financial ~~compared~~statements tofor the ~~three~~year ~~months~~ ended ~~June~~September 30, ~~2004.~~2006 ~~Our~~which ~~average~~are ~~debt~~included ~~outstanding~~in ~~remained~~our ~~constant.~~Annual Report on Form 10-K/A for such year filed with the Securities and Exchange Commission.

~~Income~~Billing ~~tax~~and ~~expense~~Collection decreased $0.2 million, or 23%, to $0.5 million in the three months ended June 30, 2005 from $0.7 million in the three months ended June 30, 2004. The tax provision for the quarter ended June 30, 2005 includes a reduction in provision of approximately $0.2 million due to the application of newly enacted rates to existing deferred balances.

We derive substantially all of our net revenue from patients who have a third party payor (insurance company or government) who either has contractually agreed to pay the patient’s account or is obligated to pay based on the patient’s participation in its program (i.e. Medicare or Medicaid). Net revenues from Medicaid and Medicare are generally based on reimbursement of the reasonable direct and indirect costs of providing services to program participants. Revenues are recorded based on estimated net realizable amounts to be received for products or services rendered during the period. Our accounting system is programmed to calculate the expected reimbursement to be received on a patient-by-patient basis based on the type of payor and the contractual terms of the payor or pre-negotiated reimbursement rates.

Our accounting system is updated as changes occur to reimbursement rates. The current reimbursement environment is complex, involving multiple payors with differing coverage and reimbursement policies. Our corporate reimbursement specialists work closely with the branch offices and the payors. Each specialist is responsible for ensuring the adequacy of the documentation, submitting the documentation and claims to third party payors and expediting payment.

In most cases, the third party payor will not pay the entire bill and the patient becomes responsible for the portion not paid by the third party (i.e. co-payment or deductible). Once the insurance company or other third party has paid its portion of such patient’s bill, the patient becomes responsible for the remainder of the bill. After payment has been received from the respective third party, a patient receives monthly statements from the Company. We assess collectability monthly of all our patients’ accounts receivable based on historical experience and emerging trends.

~~Nine~~Management ~~Months~~of ~~Ended~~accounts ~~June 30~~receivable, ~~2005~~through ~~Compared~~effective tobilling, ~~Nine~~collection ~~Months~~and ~~Ended~~reimbursement ~~June 30~~procedures, ~~2004~~is critical to the financial success of healthcare service providers due to lengthy reimbursement periods. Any significant delay in reimbursement could have a material adverse effect on our financial condition.

Net revenue increased $12.3 million, or 7%, to $191.6 million in the nine months ended June 30, 2005 from $179.3 million in the nine months ended June 30, 2004. For the Nursing and PPEC segment, net revenue increased $6.8 million, or 9%, to $86.0 million in the nine months ended June 30, 2005 from $79.3 million in the nine months ended June 30, 2004. Of this growth, $0.8 million was attributable to the Macon PPEC start-up branch office and $1.0 million was from PPEC same store growth. The ~~increase~~following oftable ~~$5.0~~summarizes ~~million in the nursing segment was broad based throughout~~ our ~~service~~days ~~areas.~~sales ~~Pharmacy~~outstanding ~~net~~as ~~revenue~~of ~~increased $3.0 million, or 5%, to $65.8 million in~~ the ~~nine~~dates ~~months~~indicated: ended June 30, 2005 from $62.8 million in the nine months ended June 30, 2004. RTES net revenue increased $2.5 million, or 7%, to $39.7 million in the nine months ended June 30, 2005 from $37.2 million in the nine months ended June 30, 2004. In the nine months ended June 30, 2005, we derived approximately 52% of our net revenue from commercial insurers and other private payors, 42% from Medicaid and 6% from Medicare.

Costs of goods and services consist primarily of branch office nursing compensation and benefits, medical equipment, pharmaceuticals and related supplies. Costs of goods and services increased $9.8 million, or 10%, to $110.7 million in the nine months ended June 30, 2005 from $100.9 million in the nine months ended June 30, 2004. Costs of goods and services of the Nursing and PPEC segment increased $4.2 million, or 9%, to $51.3 million in the nine months ended June 30, 2005 from $47.0 million in the nine months ended June 30, 2004. Costs of goods and services as a percentage of the Nursing and PPEC segment net revenue was relatively constant at 60% in the nine months ended June 30, 2005 as compared to the nine months ended June 30, 2004. For the Pharmacy segment, cost of goods and services increased $4.6 million, or 11%, to $47.1 million in the nine months ended June 30, 2005 from $42.5 million in the nine months ended June 30, 2004. Pharmacy costs of goods and services as a percentage of net revenue increased to 72% in the nine months ended June 30, 2005 from 68% in the nine months ended June 30, 2004. For the RTES segment, cost of goods and services increased $1.0 million, or 9%, to $12.3 million in the nine months ended June 30, 2005 from $11.3 million in the nine months ended June 30, 2004. Costs of goods and services as a percentage of net revenue increased to 31% in the nine months ended June 30, 2005 from 30% in the nine months ended June 30, 2004. This increase is primarily attributable to higher consumption of disposals and supplies.


	March 31,	September 30,
	2007	2006
Days sales outstanding (calculated on year to date revenue)	62	54

~~Other~~The ~~operating~~days ~~costs~~sales ~~and~~outstanding ~~expenses~~increase ~~include~~is ~~branch~~primarily ~~office~~due ~~administrative and marketing compensation and benefits, allocated business insurance costs, facility and overhead costs. Other operating costs and expenses increased $1.4 million, or 3%,~~ to ~~$51.4 million in~~ the ~~nine~~Melmedica ~~months~~acquisition ~~ended~~whose ~~June 30, 2005 from $50.0 million~~operations inare ~~the nine months ended June 30, 2004. In the Nursing and PPEC segment, other operating costs and expenses decreased $0.1 million, or 1%, to $23.3 million~~ in the ~~nine~~States ~~months ended June 30, 2005 from $23.4 million in the nine months ended June 30, 2004. As a percentage~~ of ~~net~~Illinois ~~revenue, the Nursing~~ and ~~PPEC~~Indiana. ~~segment~~Delays ~~costs decreased to 27%~~ in ~~the~~processing ~~nine~~ownership ~~months~~applications ~~ended~~resulted ~~June 30, 2005 from 29%~~ in ~~the~~an ~~nine~~inability ~~months ended June 30, 2004. The primary factor was decreased allocated business insurance costs. In the Pharmacy segment, other operating costs and expenses increased $1.1 million, or 13%,~~ to ~~$10.1~~tie ~~million~~physician inauthorizations ~~the nine months ended June 30, 2005 from $9.0 million in the nine months ended June 30, 2004. This increase includes administrative salaries of approximately $0.5 million attributable~~ to ~~start~~services ~~up operations in the Orlando and Denver markets~~provided. AsThe amajority ~~percentage~~ of ~~net revenue~~ these ~~costs~~claims ~~increased~~were toreleased ~~15%~~ in ~~the~~December ~~nine~~2006 ~~months~~and ~~ended~~January ~~June 30, 2005~~2007. ~~from~~Payment ~~14%~~ in ~~the~~full ~~nine~~for ~~months~~these ~~ended~~claims ~~June 30,~~is ~~2004~~expected. In ~~the RTES segment~~addition, ~~costs~~the ~~and~~operations ~~expenses~~acquired ~~increased~~during ~~$0.4 million, or 2%, to $18.0 million in~~ the ~~nine~~three months ended ~~June~~March 3031, ~~2005~~2007 ~~from~~encountered ~~$17.6~~routine ~~million~~delays in the ~~nine~~reauthorization ~~months~~of ~~ended~~patient ~~June 30, 2004~~services. As aThese ~~percentage~~delays ofare ~~net~~temporary ~~revenue~~and ~~these~~payment ~~costs~~for services ~~decreased~~rendered tois ~~45%~~expected induring the ~~nine~~third ~~months~~fiscal ~~ended~~quarter ~~June 30,~~of ~~2005~~fiscal ~~from 47% in the nine months ended June 30, 2004~~2007.

~~Corporate,~~Allowance ~~general~~for ~~and~~Doubtful ~~administrative~~Accounts costs increased $1.2 million, or 8%, to $15.6 million in the nine months ended June 30, 2005 as compared $14.4 million in the nine months ended June 30, 2004. As a percentage of net revenue, corporate, general and administrative costs remained relatively constant at 8% in the nine months ended June 30, 2005 compared to the nine months ended June 30, 2004. Of the $1.2 million increase, $1.3 million was attributable to increased professional fees, specifically increased SOX 404 costs and increased audit fees.

~~Provision~~In determining the adequacy of the allowance and related provision for doubtful accounts, ~~decreased~~we $0have developed a process that combines detailed analysis of historical collections and write-off activity with a detailed review of existing account balances meeting certain criteria and their likelihood of being collected at the amounts recorded.4 ~~million,~~This ordetailed ~~14%,~~review toinvolves $2both the assigned Corporate Reimbursement department personnel and the respective branch office location personnel assessing each patient claim that falls within prescribed age and amount criteria.4 ~~million~~Co-payments inare captured under the ~~nine~~private ~~months~~pay ~~ended~~category ~~June 30,~~and ~~2005~~a higher reserve ~~from~~percentage $2is applied to these balances based on historical collection patterns.8 ~~million~~These assessments are aggregated and compared to the results of the detailed analysis of historical collections to provide additional support to management in making the ~~nine~~estimate of the allowance for doubtful accounts. During the six months ended ~~June~~March 3031, ~~2004~~2007, we revised our methodology for assessing the collectibility of amounts due which have not yet been billed from a statistical percentage to a specific review. ~~Cash~~This ~~collections~~change was implemented due to the dramatic decline in the number of unbilled claims as a ~~percentage~~result of ~~net~~the ~~revenue~~sale ~~were~~of ~~101%~~the ~~and~~RTES ~~97%~~business. Inherent in this estimate is the ~~nine~~risk ~~months~~that ~~ended~~it ~~June 30~~will need to be revised or updated, ~~2005~~with ~~and~~the changes ~~2004~~recorded in subsequent periods, ~~respectively~~as additional information becomes available to management.

~~Depreciation~~The ~~and~~following ~~amortization~~table ~~increased~~provides ~~$0.5~~a comparison ~~million,~~of orapproximate ~~17%,~~percentages toof ~~$3.2~~our ~~million in~~aging ~~the~~of ~~nine~~net ~~months~~accounts ~~ended~~receivable ~~June 30,~~by ~~2005~~payor asfor ~~compared~~the toperiods ~~$2.8~~ended ~~million~~March 31, in2007 ~~the~~and ~~nine months ended June~~September 30, ~~2004.~~2006:

Interest expense increased $0.2 million, or 9%, to $1.9 million in the nine months ended June 30, 2005 from $1.7 million in the nine months ended June 30, 2004. Our average debt outstanding remained constant.


	March 31, 2007

	0-120 days		121-180 days		181-240 days		241-365 days		>365 days		Total
Commercial and contract insurance	30.5	%	2.6	%	1.2	%	0.5	%	0.2	%	35.0	%
Medicaid	32.0	%	3.1	%	1.9	%	1.9	%	0.5	%	39.4	%
Medicare	0.8	%	0.1	%	0.0	%	0.0	%	0.0	%	0.9	%
Private pay	0.6	%	0.1	%	0.1	%	0.1	%	0.1	%	1.0	%
Unbilled	23.7	%	0.0	%	0.0	%	0.0	%	0.0	%	23.7	%

Total net accounts receivable	87.6	%	5.9	%	3.2	%	2.5	%	0.8	%	100.0	%

	September 30, 2006

	0-120 days		121-180 days		181-240 days		241-365 days		>365 days		Total
Commercial and contract insurance	32.9	%	2.1	%	1.1	%	0.6	%	-1.6	%	35.1	%
Medicaid	35.1	%	1.3	%	0.8	%	1.5	%	0.7	%	39.4	%
Medicare	0.6	%	0.0	%	0.0	%	0.0	%	0.0	%	0.6	%
Private pay	0.7	%	0.1	%	0.1	%	0.2	%	0.0	%	1.1	%
Unbilled	23.8	%	0.0	%	0.0	%	0.0	%	0.0	%	23.8	%

Total net accounts receivable	93.1	%	3.5	%	2.0	%	2.3	%	-0.9	%	100.0	%

Income tax expense decreased $0.2 million, or 7%, to $2.5 million in the nine months ended June 30, 2005 from $2.7 million in the nine months ended June 30, 2004. The tax provision for the nine months ended June 30, 2005 was increased by

~~approximately~~RESULTS ~~$0.2~~OF ~~million~~OPERATIONS due to a discrete event in the second quarter in a certain state jurisdiction disallowing certain deductions for state income tax purposes and decreased approximately $0.2 million in the third quarter due to the application of newly enacted rates to existing deferred balances.


	Percentage of Net Revenue								Period-to-Period Percentage Increase (Decrease)
	Three Months Ended March 31,				Six Months Ended March 31,				Three Months Ended March 31,		Six Months Ended March 31,
	2007		2006		2007		2006		2007		2007
Net Revenue	100.0	%	100.0	%	100.0	%	100.0	%	15	%	15	%
Costs of goods and services (exclusive of depreciation shown separately below)	62.3		59.9		61.5		60.2		20		17
Other operating costs and expenses
Salaries, wages and benefits	16.1		16.8		16.2		17.0		10		10
Business insurance	4.4		4.8		4.2		4.6		6		7
Overhead	5.7		6.3		5.7		6.5		3		0

Other operating costs and expenses	26.2		27.9		26.1		28.1		8		7
Corporate, general and administrative
Salaries, wages and benefits	7.3		11.4		8.4		12.4		(26	)	(22	)
Business insurance	0.2		0.2		0.2		0.2		7		7
Professional services	3.6		3.6		3.2		3.4		15		10
Overhead	1.8		2.3		1.9		2.4		(10	)	(12	)

Corporate, general and administrative	12.9		17.5		13.7		18.4		(15	)	(14	)
Provision for doubtful accounts	0.6		0.2		0.5		0.1		258		402
Provision for insurance recoveries	(0.4	)	—		(0.6	)	—		100		100
Depreciation and amortization	0.8		0.8		0.8		0.9		13		13

Operating loss	(2.4	)	(6.3	)	(2.0	)	(7.7	)	(56	)	(69	)
Other income	—		—		0.1		—		(100	)	625
Loss on early extinguishment of debt	—		—		—		(1.5	)	—		(100	)
Interest income	2.5		2.1		2.5		1.8		33		62
Interest expense	—		—		—		(1.0	)	(100	)	(100	)

Income (loss) from continuing operations, before income tax expense (benefit)	0.1		(4.2	)	0.6		(8.4	)	(100	)	(107	)
Income tax expense (benefit)	—		(1.5	)	0.3		(2.7	)	(100	)	(112	)

Income (loss) from continuing operations	0.1	%	(2.7	)%	0.3	%	(5.7	)%	(101	)%	(104	)%

We provide a broad range of healthcare services and products principally for children and, to a lesser extent, young adult patients. We define pediatric as age eighteen and younger with the remainder defined as adult. Patients who began service with us as children and are still on service upon attaining the age of eighteen are classified as adults. The following table summarizes both products and services from continuing operations based upon estimated percentages of net billings of each major category for the periods indicated.


	Three Months Ended March 31,				Six Months Ended March 31,
	2007		2006		2007		2006
	% Total		% Total		% Total		% Total
Pediatric Home Health Care
Nursing	82.0	%	78.6	%	81.9	%	79.3	%
PPEC	7.6	%	9.6	%	7.8	%	9.4	%

Total Pediatric Home Health Care	89.6	%	88.2	%	89.7	%	88.7	%
Adult Home Health Care
Nursing	10.4	%	11.8	%	10.3	%	11.3	%

Total Adult Home Health Care	10.4	%	11.8	%	10.3	%	11.3	%

Total	100.0	%	100.0	%	100.0	%	100.0	%

Three Months Ended March 31, 2007 Compared to Three Months Ended March 31, 2006

Net revenue increased $4.4 million, or 15%, to $33.6 million in the three months ended March 31, 2007 from $29.2 million in the three months ended March 31, 2006. For the Nursing segment, net revenue increased $4.7 million, or 18%, to $31.1 million in the three months ended March 31, 2007 from $26.4 million in the three months ended March 31, 2006. For the PPEC segment, net revenue decreased $0.2 million, or 9%, to $2.6 million in the three months ended March 31, 2007 from $2.8 million in the three months ended March 31, 2006 primarily as a result of the closure of the Orlando and Jacksonville centers. In the three months ended March 31, 2007, we derived approximately 37% of our net revenue from commercial insurers and other private payors, 62% from Medicaid and 1% from Medicare.

Costs of goods and services consist primarily of branch office nursing compensation and benefits, medical equipment and related supplies. Costs of goods and services increased $3.5 million, or 20%, to $21.0 million in the three months ended March 31, 2007 from $17.5 million in the three months ended March 31, 2006. Costs of goods and services of the Nursing segment increased $3.5 million, or 20%, to $20.9 million in the three months ended March 31, 2007 from $17.4 million in the three months ended March 31, 2006. Costs of goods and services as a percentage of the Nursing segment net revenue increased to 67% in the three months ended March 31, 2007 as compared to 66% for the three months ended March 31, 2006 as a result of increased margin pressure in select markets. For the PPEC segment, cost of goods and services remained relatively constant at $0.1 million in the three months ended March 31, 2007 as compared to the three months ended March 31, 2006.

Corporate, general and administrative costs decreased $0.8 million, or 15% to $4.3 million in the three months ended March 31, 2007 as compared to $5.1 million in the three months ended March 31, 2006. This was primarily related to decreased salaries and benefit costs due to a lower headcount as a result of the actions taken with the sale of the RTES business. Our percentage of net revenue, corporate, general and administrative costs decreased to 13% in the three months ended March 31, 2007 compared to 18% in the three months ended March 31, 2006.

Provision for doubtful accounts increased $0.2 million, or 258%, to $0.2 million in the three months ended March 31, 2007 from $0.1 million in the three months ended March 31, 2006. During the three months ended March 31, 2007, we experienced delays in collecting from select state Medicaid programs due to temporary funding issues and authorization delays relating to the acquired operations. These delays are temporary and payment for services rendered is expected during the third fiscal quarter of fiscal 2007.

Depreciation and amortization remained relatively constant at $0.3 million in the three months ended March 31, 2007 as compared to the three months ended March 31, 2006.

Interest income increased $0.2 million, or 33%, to $0.8 million in the three months ended March 31, 2007, as compared to $0.6 million in the three months ended March 31, 2006 (See “Liquidity and Capital Resources” below for further discussion).

Income tax expense from continuing operations increased $0.4 million, or 100%, to an expense of $0.002 million in the three months ended March 31, 2007 from a benefit of $0.4 million in the three months ended March 31, 2006.

Six Months Ended March 31, 2007 Compared to Six Months Ended March 31, 2006

Net revenue increased $8.6 million, or 15%, to $65.7 million in the six months ended March 31, 2007 from $57.1 million in the six months ended March 31, 2006. For the Nursing segment, net revenue increased $8.8 million, or 17%, to $60.6 million in the six months ended March 31, 2007 from $51.8 million in the six months ended March 31, 2006. For the PPEC segment, net revenue decreased $0.2 million, or 5%, to $5.1 million in the six months ended March 31, 2007 from $5.4 million in the six months ended March 31, 2006 primarily as a result of the closures of our Orlando and Jacksonville centers. In the six months ended March 31, 2007, we derived approximately 36% of our net revenue from commercial insurers and other private payors, 63% from Medicaid and 1% from Medicare.

Costs of goods and services consist primarily of branch office nursing compensation and benefits, medical equipment and related supplies. Costs of goods and services increased $6.0 million, or 17%, to $40.4 million in the six months ended March 31, 2007 from $34.4 million in the six months ended March 31, 2006. Costs of goods and services of the Nursing segment increased $6.1 million or 18% to $40.2 million in the six months ended March 31, 2007 as compared to $34.1 million in the six months ended March 31, 2006. For the PPEC segment, cost of goods and services decreased $0.1 million or 42% to $0.2 million in the six months ended March 31, 2007 as compared to $0.3 million for the six months ended March 31, 2006.

ended March 31, 2006. In the PPEC segment, other operating costs and expenses remained relatively constant at $4.0 million in the six months ended March 31, 2007 as compared to the six months ended March 31, 2006. As a percentage of net revenue these costs increased to 78% in the six months ended March 31, 2007 from 74% in the six months ended March 31, 2006.

Corporate, general and administrative costs decreased $1.5 million, or 14% to $9.0 million in the six months ended March 31, 2007 as compared to $10.5 million in the six months ended March 31, 2006. This was primarily related to reduced corporate office headcount as a result of the actions taken with the sale of the RTES business in the six months ended March 31, 2007. The percentage of net revenue, corporate, general and administrative costs decreased to 14% in the six months ended March 31, 2007 as compared to 18% in the six months ended March 31, 2006.

Provision for doubtful accounts increased $0.3 million, or 402%, to $0.3 million in the six months ended March 31, 2007 from $0.1 million in the six months ended March 31, 2006. During the six months ended March 31, 2007 we experienced delays in collection from select state Medicaid programs due to temporary funding issues and authorizing delays relating to the acquired operations. These delays are temporary and payment for services rendered is expected during the third fiscal quarter of fiscal 2007.

Depreciation and amortization increased $0.1 million, or 13%, to $0.6 million in the six months ended March 31, 2007 as compared to $0.5 in the six months ended March 31, 2006.

Interest income increased $0.6 million, or 62%, to $1.6 million in the six months ended March 31, 2007, as compared to $1.0 million in the six months ended March 31, 2006 (See “Liquidity and Capital Resources” below for further discussion).

Income tax expense from continuing operations increased $1.8 million, or 112%, to an expense of $0.2 million in the six months ended March 31, 2007 as compared to a benefit of $1.6 million in the six months ended March 31, 2006.

LIQUIDITY AND CAPITAL RESOURCES

Operations

OnFor ~~January 27, 2004, we entered into a credit agreement with General Electric Capital Corporation (“Credit Agreement”). Subject to~~ the ~~terms~~ ~~and~~three ~~conditions~~months ofended ~~the~~March 31, ~~Credit Agreement~~2007, ~~the~~we ~~Lender~~ made ~~available~~routine apurchases ~~credit facility consisting~~ of acomputer ~~$10.0~~equipment ~~million~~and ~~revolving~~purchased, ~~line~~instead of ~~credit~~continuing ~~and~~to alease, ~~$10.0~~office copiers ~~million line of credit~~ for ~~acquisitions.~~our ~~Availability~~branch inoffices ~~both components is subject~~ to ~~a borrowing~~maintain ~~base~~and ~~calculation~~upgrade ~~against~~ our ~~accounts~~technology ~~receivable~~infrastructure. ~~Borrowings~~We ~~under~~anticipate ~~the~~future ~~revolving~~capital ~~line~~expenditures of credit bear interest at LIBOR plus 3.00% or the Index Rate plus 1.50%. Borrowings under the acquisition line of credit bear interest at LIBOR plus 3.50% or the Index Rate plus 2.00%. The Credit Agreement provides for ~~unused~~maintenance, ~~line~~support ~~fees~~and ofenhancements ~~0.50% for the revolving line~~ of ~~credit~~existing technology and ~~0.75%~~continued ~~for~~investments ~~the~~in ~~acquisition~~new ~~line~~start ofup ~~credit~~locations. ~~The Credit Agreement contains several financial and non-financial~~We ~~covenants~~anticipate ~~including,~~funding ~~but~~these ~~not~~capital ~~limited~~expenditures ~~to,~~with ~~certain~~cash ~~leverage,~~on ~~coverage,~~hand ~~DSO~~ and ~~maximum~~cash ~~capital~~flow ~~expenditures~~from ~~requirements~~operations.

OnAsset ~~May 12,~~Sales ~~2004, we amended the Credit Agreement to clarify a definition and increase the maximum capital expenditures covenant. We have made no borrowings under the Credit Agreement since its inception.~~

~~Cash~~On ~~collections~~November 6, as2006, awe ~~percentage~~completed the sale of ~~net~~substantially ~~revenue~~all ~~for~~of the ~~three~~assets ~~months~~of ~~ended~~our ~~June 30~~RTES business to Lincare, ~~2005~~Inc. ~~and~~The ~~2004~~aggregate purchase price was $35.2 ~~106%~~million ~~and~~in ~~107%,~~cash ~~respectively~~of which $30.0 ~~While~~million wewas ~~anticipate~~received ~~that~~at weclosing. ~~will~~The ~~continue~~remainder toof ~~achieve~~the ~~our~~purchase ~~cash~~price ~~collection~~is ~~targets~~contingent upon the satisfaction of certain criteria, ~~there~~including ~~can~~the besuccessful ~~no assurance~~transition ~~that~~of ~~disruptions~~certain topatients ~~cash~~and ~~flow~~the ~~will~~collection ~~not~~of outstanding ~~occur~~accounts receivable at closing (See Note 4).

~~During the~~Asset ~~nine~~Purchases months ended June 30, 2005, a significant portion of our purchases were for medical equipment to service existing patients and we made routine purchases of computer equipment to maintain and upgrade our technology infrastructure. We anticipate future capital expenditures for maintenance, support and enhancements of existing technology, continued investments in new start up locations and continued durable medical equipment purchases. We anticipate funding these capital expenditures with cash flow from operations.

~~HIPAA’s transactions~~On ~~and~~February 17, ~~code~~2007 ~~set~~we ~~standards~~acquired ~~mandate~~select ~~that~~pediatric ~~Covered~~assets ~~Entities~~of Maternal Child Health, ~~including~~Inc. ~~our~~(“MCH”) ~~company~~a subsidiary of Deaconess Associations Inc. an Ohio corporation. The acquisition includes MCH’s pediatric nursing business in the Illinois, ~~transmit~~Texas ~~claims~~and Pennsylvania markets. The MCH operations located in the Corpus Christi and ~~certain~~McAllen ~~related~~Texas ~~healthcare~~markets ~~information~~will be operated on a stand alone basis. The purchase price is approximately $4.1 million in ~~standardized~~cash ~~formats~~with MCH retaining its accounts receivable. The purchase price has been preliminarily allocated to identifiable intangible assets consisting of non-compete agreements of $0.1 million and goodwill ~~data~~of ~~sets~~$4.0 ~~(See~~million. ~~“Recent~~Effective ~~Developments”~~with ~~above~~the adoption of SFAS No.) 142, the purchase price allocation of $4.0 million of goodwill is not being amortized; however, it is being deducted for tax purposes.

Risk Management

Our workers’ compensation insurance carrier, ~~Argonaut~~Charter ~~Insurance~~Oak ~~Company~~Fire Insurance, a subsidiary of St. Paul Travelers rated A+ by AM Best Company, requires a ~~twelve~~ twelve month estimated loss reserve to be funded entirely with cash each fiscal year which is ~~then~~ reduced by the monthly loss fund payments. ~~This~~For fiscal 2007, the annual cash requirement is estimated to be $1.06 million. ~~for~~Our ~~fiscal~~previous ~~2005~~workers’ compensation insurance carrier, Argonaut Insurance Company, rated A by AM Best Company, was funded in a similar manner. The net balance at ~~June~~March 3031, ~~2005~~2007 and September 30, ~~2004~~2006 was $34.7 million and $34.35 million, respectively. The insurance carriers ~~carrier~~have ~~has~~ the right to increase this cash requirement at the end of each fiscal year if the claim experience is greater than anticipated, but to date ~~has~~they have not indicated the need to do so.

We have secured surety bonds of $1.70 million to satisfy our workers’ compensation program requirements for our former insurance carrier. In December, 2006, we received $0.3 million in cash from our former insurance carrier, which reduced the collateral and surety bond by the same amount. As of ~~June~~March 3031, ~~2005~~2007, the surety bonds were collateralized by $1.50 million cash posted to a third party escrow account. We believe that our collateral remains secure despite the insurance carriers financial distress discussed above.

WeOn ~~renewed our employee medical benefit plans effective~~ January 1, 2005. We determined it to be advantageous to continue to use a self insured model instead of a guaranteed minimum premium model. Claim history for calendar 2004 was positive and calendar 2005 pricing is within market inflation estimates. This plan ultimately exposes us to greater risk as compared to the guaranteed minimum premium model coverage2007, ~~although the self-insured model’s stop loss, aggregate loss and tail liability features provide sufficient protection such that it is more likely than not that~~ we ~~will~~renewed ~~realize~~our ~~cost savings. In addition, the~~ self-insured ~~model~~employee ~~carrier’s~~ medical ~~and~~benefit ~~disease~~plans. ~~management~~In ~~capabilities~~January ~~along~~2007, ~~with~~we ~~its~~made ~~pharmacy~~minor ~~formulary~~design ~~protocols~~changes ~~and wellness care programs should enable us~~ to ~~deliver to~~ our ~~employees~~benefit aplans ~~more effective~~ and ~~competitive~~analyzed ~~plan. We recognize that~~ the ~~features~~impact of ~~our medical benefit plan are important to~~ the ~~recruiting~~removal ~~and retention~~ of ~~clinical~~the ~~and~~employees ~~administrative~~who ~~staff~~transitioned ~~and we are committed~~ to ~~offering a plan that is fully~~Lincare, ~~competitive~~Inc. ~~with~~as ~~those~~part ~~offered~~of bythe ~~other~~sale ~~home~~of ~~care~~the ~~providers~~RTES business.

As a result of operating in the ~~health~~healthcare ~~care~~ industry, our business entails an inherent risk of lawsuits alleging malpractice, product liability or related legal issues, which can involve large claims and significant defense costs. From time to time, we are subject to such suits arising in the ordinary course of business. We currently maintain professional and commercial liability insurance intended to cover such claims. As of ~~June~~March 3031, ~~2005~~2007, this insurance coverage is provided under a “claims-made” policy which provides, subject to the terms and conditions of the policy, coverage for certain types of claims made against us during the term of the policy and does not provide coverage for losses occurring during the terms of the policy for which a claim is made subsequent to the termination of the policy. Should the policy not be renewed or replaced with equivalent insurance, claims based on occurrences during its term but asserted subsequently would be uninsured. There can be no assurance that the coverage limits of our insurance policy will be adequate.

26On October 1, 2006, we completed our annual renewal of our risk management program and implemented several changes. We renewed our insurance program for medical malpractice, commercial and general liability coverage with Arch Specialty Insurance Company, rated A by AM Best Company. Per claim self-insured retention amount remained at $1.0 million with an annual aggregate self-insured retention amount of $7.3 million and an annual aggregate coverage limit of $15.0 million. We renewed our workers’ compensation policy with Charter Oak Fire Insurance, a subsidiary of St. Paul Travelers rated A+ by AM Best Company, with the per claim deductible remaining at $0.35 million.

In addition, we are subject to accident claims arising out of the normal operation of our fleet of vans and small trucks for our sold RTES business and buses for our PPEC division, and we maintain insurance intended to cover such claims. A successful claim against us in excess of our insurance coverage could have a material adverse effect upon our business. Claims against us, regardless of their merits or eventual outcome, also may have a material adverse effect upon our reputation and business.

We are subject to claims and lawsuits arising in the ordinary course of business. Based upon information available to date, management believes it has provided adequate reserves if needed for any unfavorable settlements; however, there can be no assurance that the ultimate resolution of such current pending legal proceedings would not have a material adverse effect on our financial results.

a “claims-made” policy that provides, subject to the terms and conditions of the policy, coverage for certain types of claims made against us during the term of the policy and does not provide coverage for losses occurring during the terms of the policy for which a claim is made subsequent to the termination of the policy. Should the policy not be renewed or replaced with equivalent insurance, claims based on occurrences during its term but asserted subsequently would be uninsured. There can be no assurance that the coverage limits of our insurance policy will be adequate.

On October 1, 2004, we completed our annual renewal of our risk management program and implemented several changes. We renewed our insurance program for medical malpractice, commercial and general liability coverage with Arch Specialty Insurance Company, rated A- by AM Best Company. Per claim self-insured retention remained at $1.0 million with an annual aggregate self-insured retention of $8.0 million and an annual aggregate policy limit of $15.0 million. The premiums increased 16% for fiscal 2005 as compared to fiscal 2004.

In addition, we are subject to accident claims arising out of the normal operation of our fleet of vans and small trucks, and we maintain insurance intended to cover such claims. A successful claim against us in excess of our insurance coverage could have a material adverse effect upon our business. Claims against us, regardless of their merits or eventual outcome, also may have a material adverse effect upon our reputation and business.

We are, from time to time, subject to lawsuits arising in the ordinary course of business, some of which may allege damages that would not be covered under our existing insurance policies. We establish our reserves for these lawsuits based upon the information available to date and we believe our reserves are adequate; however there can be no assurance that the ultimate resolution of these lawsuits will not have a material adverse effect on our operations and financial results.

Capital Resources

We ~~currently~~ ~~believe~~have ~~that~~invested ~~our~~the ~~liquidity~~retained ~~position~~proceeds ~~will~~from bethe ~~adequate~~sale toof ~~satisfy~~the Pharmacy and RTES businesses in accordance with the terms of our ~~working~~Investment ~~capital~~Policy ~~requirements,~~which ~~professional~~has ~~and~~been ~~commercial~~approved ~~liability~~by ~~insurance~~the ~~loss~~Board ~~funding,~~of ~~workers’~~Directors. ~~compensation~~This ~~collateral~~policy ~~requirements~~provides for the establishment of short-term, ~~and~~highly ~~income~~liquid ~~tax~~investments ~~payments~~within prescribed parameters. ~~Our~~ ~~current~~Some ~~source~~of these investments have maturities which range from 7 days to approximately 40 days. In accordance with FASB 115, the purchase and redemption of these ~~liquidity~~particular issecurities are classified as investing activities in the condensed consolidated statements of cash onflows. ~~hand~~As of the balance sheet date, ~~cash~~all ~~flow~~funds ~~from~~were ~~operations~~held in a money market fund and ~~availability~~classified ~~under~~as a cash equivalent on the ~~Credit~~condensed consolidated ~~Agreement~~balance sheet. WeThe dividends and interest earned from some of these securities are ~~exposed~~not subject to ~~fluctuations~~Federal income taxes and will result in ~~cash~~a ~~collection~~permanent ~~results~~difference between book and tax income.

We currently believe that our liquidity position will be adequate to satisfy our working capital requirements, professional and commercial liability insurance loss funding, workers’ compensation collateral requirements, income tax payments and potential acquisitions and start-up branch offices. Our current sources of liquidity are cash on hand, investment income and cash flow from operations. We are exposed to fluctuations in cash collection results.

CONTINGENT LIABILITIES AND COMMITMENTS

Our former workers’ compensation carrier requires the estimated loss reserve to be secured by surety bonds (see “Liquidity and Capital Resources”).

On October 1, ~~2004~~2006, we completed our annual renewal of our risk management programs and implemented several changes (see “Liquidity and Capital Resources”).

We ~~have~~received ~~entered~~notification into employment agreements with certain employees that provide, among other things, salary, benefits and perquisites, as well as additional compensation for certain changes in control or a failure to comply with any material terms of ~~the agreements. We have~~ a ~~Non-Qualified~~claim ~~Deferred~~from ~~Compensation~~one ~~Plan~~commercial ~~for~~payor ~~certain~~primarily ofrelating ~~our~~to ~~employees. The Plan’s~~our ~~deferred~~discontinued ~~compensation~~pharmacy ~~liability~~operation as(see ofNote ~~June 30, 2005 was approximately $1~~7).3 ~~million.~~

~~The~~We ~~following~~have ~~table~~entered ~~represents~~into employment agreements with certain employees which provide, among other things, salary, benefits and perquisites, as well as additional compensation, for certain changes in control or a ~~schedule~~failure to comply with any material terms of the agreements. We have a Non-Qualified Deferred Compensation Plan for certain of our employees. ~~contractual~~The ~~obligations~~deferred ~~and~~compensation ~~commitments~~liability as of ~~June~~March 31, 2007 and September 30, ~~2005:~~2006 was approximately $1.5 million and $1.4 million, respectively. On April 6, 2006, we adopted a Long-Term Incentive Compensation Plan (“LTIP”) for the Senior Management team. Under the LTIP, cash awards may be granted based upon the achievement of certain Performance Goals which are established at the outset of each three year Performance Period and adjusted as appropriate. The LTIP will become the primary component of our long term compensation strategies and the future use of existing equity compensation programs is expected to decline.

	Payments Due by Period (In thousands)
	Total		Less Than 1 Year		1-3 Years		3-5 Years		After 5 Years
Contractual Obligations:
Long-term debt
Subordinated Notes	$	20,350	$	—	$	20,350	$	—	$	—
Other notes payable		47		43		4		—		—
Operating leases		14,819		4,162		5,207		2,922		2,528
	$	35,216	$	4,205	$	25,561	$	2,922	$	2,528

The following table represents a schedule of our contractual obligations and commitments as of March 31, 2007:


	Payments Due by Period (In thousands)
			Less Than						More than
	Total		1 Year		1-3 Years		3-5 Years		5 Years
Contractual Obligations:
Operating leases	$	9,552	$	2,340	$	4,021	$	2,542	$	649

	$	9,552	$	2,340	$	4,021	$	2,542	$	649

Variation in Quarterly Operating Results

Our quarterly results may vary significantly depending primarily on factors such as re-hospitalizations of patients, seasonality, ~~and~~the ~~usage~~timing ~~levels~~ of ~~pharmaceutical~~new ~~products~~branch office ~~and respiratory services~~openings, ~~the~~acquisitions ~~timing~~ of ~~new~~businesses, ~~branch~~public ~~office~~school ~~openings~~calendars and pricing pressures due to legislative and regulatory initiatives to contain ~~health~~healthcare ~~care~~ costs. Because of these factors, our operating results for any particular quarter may not be indicative of the results for the full fiscal year.

2730

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We face a number of market risk exposures including risks related to cash and cash equivalents, accounts receivable and interest rates. Cash and cash equivalents are held ~~primarily~~ in ~~one~~a limited number of financial ~~institution~~institutions and with institutional investors. We perform periodic evaluations of the relative financial positions and credit ~~standing~~standings of ~~this~~these financial ~~institution~~intermediaries. As part of our corporate cash management program, we are investing the retained proceeds from the sale of the Pharmacy and RTES businesses in accordance with established investment policies. We have invested in a portfolio of highly liquid investment grade securities which are managed for us by institutional investors. The concentration of credit risk with respect to accounts receivable, which are primarily ~~health~~ ~~care~~healthcare industry related, represent a risk to us given the current environment in the ~~health~~healthcare ~~care~~ industry. The risk is somewhat limited due to the large number of payors including ~~Medicare~~Medicaid and ~~Medicaid~~ Medicare, insurance companies, individuals and the diversity of geographic locations in which we operate. However, we have substantial geographic density in the eastern United States, which we believe exposes us to payor initiated reimbursement ~~changes, substantial accounts receivable for a small~~ ~~number of hemophilia factor patients and disruptions to cash collections due to the inability of some payors to process claims~~changes.

Our Notes, issued in 1998, have a fixed coupon rate of 10%. The fair value of our Notes is subject to change as a result of changes in market prices or interest rates. We estimate potential changes in the fair value of interest rate sensitive financial instruments based on the hypothetical increase (or decrease) in interest rates. Our use of this methodology to quantify the market risk of such instruments should not be construed as an endorsement of its accuracy or the accuracy of the related assumptions. The quantitative information about market risk is necessarily limited because it does not take into account other factors such as our financial performance and credit ratings.

Based on a hypothetical immediate 150 basis point increase in interest rates at June 30, 2005 and 2004, the market value of our Notes would be reduced by approximately $0.7 million and $0.9 million, respectively. Conversely, a 150 basis point decrease in interest rates would result in a net increase in the market value of our Notes outstanding at June 30, 2005 and 2004 of approximately $0.7 million and $1.0 million, respectively.

ITEM 4.

CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures. We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Our ~~chief~~management, ~~executive~~with ~~officer~~participation of our Chief Executive Officer and ~~chief~~Chief ~~financial~~Financial ~~officer~~Officer, ~~after~~has ~~evaluating~~conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Quarterly Report on Form 10-Q, have concluded that our disclosure controls and procedures are adequate and effective in timely alerting them to material information relating to our company (including our consolidated subsidiaries) required to be included in our periodic SEC filings.

~~(b)~~As previously ~~Changes~~disclosed in ~~internal~~our ~~controls.~~Annual ~~There~~Report on Form 10-K/A for the fiscal year ended September 30, 2006, we determined that, as of the end of the fiscal year 2006, there were nomaterial ~~changes~~weaknesses inaffecting our internal ~~controls~~control over financial reporting ~~that~~and, ~~occurred~~as ~~during~~a result of those material weaknesses, our ~~most~~disclosure ~~recent~~controls ~~fiscal~~and ~~quarter~~procedures ~~that~~were not effective. As described below, we have ~~materially~~remediated ~~affected~~those material weaknesses. Consequently, orbased ~~are~~on ~~reasonably~~the ~~likely~~evaluation todescribed ~~materially~~above, ~~affect~~our management, including our ~~internal~~Chief Executive Officer and Chief Financial Officer, have concluded that, as of the end of the quarter ended March 31, 2007, our disclosure controls ~~over~~and ~~financial~~procedures ~~reporting~~were effective.

28Changes to Remediate Material Weakness

~~Table~~We have improved our internal controls over our accounting for income taxes by expanding the level of ~~Contents~~review and discussion of significant tax matters and supporting documentation with senior finance management. We terminated BDO Seidman, LLP as our tax advisor and have hired a local Georgia CPA firm to assist in performing these services.

(b) Changes in internal controls over financial reporting. There were no changes in our internal controls over financial reporting that occurred during our most recent fiscal quarter except as discussed above that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

PART II – OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

From time to time, we are involved in various pending or threatened legal actions, some of which seek relief or damages in amounts that are substantial. These actions and proceedings arise in the ordinary course of our business and allege damages relating to personal injury torts, product liability, and other legal issues. Because of the complex nature of some of these actions and proceedings, it may be a number of years before such matters ultimately are resolved. We currently maintain professional and commercial liability insurance intended to cover such actions and proceedings as discussed in Part I, Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources. In addition, some of these lawsuits may allege damages that may not be covered under our existing insurance polices. Based upon information available to date, management believes it has provided adequate reserves if needed for any unfavorable resolution; however, there can be no assurance that the ultimate resolution of such current pending legal proceedings would not have a material adverse effect on our consolidated financial or liquidity position.

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Our 2007 Annual Meeting of Shareholders was held on February 6, 2007. Proxies with regard to the matters to be voted upon at the Annual Meeting were solicited under Regulation 14A of the Securities Exchange Act of 1934, as amended. Set forth below is a brief description of the sole matter voted upon at the Annual Meeting and the results of the voting on such matter:

Election of two Class I directors, Robert Pinkas and Joel Kimbrough, as directors for a term of three years expiring at the 2010 Annual Meeting of Shareholders:


	Votes
Nominees	For	Withheld
Robert Pinkas	6,216,648 (82%)	1,159,165 (15%)
Joel Kimbrough	6,260,719 (83%)	1,115,094 (15%)

The terms of Messrs. Daniel Kohl, Michael Axelrod, David Crane and Michael Finn and Ms. Phyllis Yale continued after the Annual Meeting.

ITEM 6.

EXHIBITS.

The following exhibits are filed with this report:


Exhibit No.		Description
31.1		Rule 13a-14(a)/15d-14(a) Certification (CEO)

31.2		Rule 13a-14(a)/15d-14(a) Certification (CFO)

32.1		Section 1350 Certification (CEO)

32.2		Section 1350 Certification (CFO)

		10.9(x)		Amended and Restated Employment Agreement by and between the Company and James M. McNeill (incorporated by reference to Exhibit 10.9(x) of the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2002).
		10.9(ff)		Employment Agreement by and between the Company and Daniel J. Kohl (incorporated by reference to Exhibit 10.9(ff) of the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2004).
		10.9(gg)		First Amendment to Employment Agreement by and between the Company and Daniel J. Kohl, effective July 29, 2005.
		10.9(hh)		Second Amendment to Employment Agreement by and between the Company and James M. McNeill, effective July 29, 2005.
		31.1		Rule 13a-14(a)/15d-14(a) Certification (CEO).
		31.2		Rule 13a-14(a)/15d-14(a) Certification (CFO).
		32.1		Section 1350 Certification (CEO).
		32.2		Section 1350 Certification (CFO).

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	PEDIATRIC SERVICES OF AMERICA, INC. (Registrant)
Date: August 9, 2005	By: /s/ JAMES M. MCNEILL
Date: May 9, 2007	By:	/S/ JAMES M. MCNEILL
	~~James M. McNeill Senior Vice President, Chief Financial Officer, Treasurer and Secretary (Duly authorized officer and Principal Financial Officer)~~	James M. McNeill Senior Vice President, Chief Financial Officer, Treasurer and Secretary (Duly authorized officer and Principal Financial Officer)

3033

INDEX OF EXHIBITS


Exhibit No.		Description
31.1		Rule 13a-14(a)/15d-14(a) Certification (CEO)

31.2		Rule 13a-14(a)/15d-14(a) Certification (CFO)

32.1		Section 1350 Certification (CEO)

32.2		Section 1350 Certification (CFO)

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Filing Compare · PEDIATRIC SERVICES OF AMERICA INC