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 March 31, 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. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨

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


		Page Number
PART I FINANCIAL INFORMATION

ITEM 1:	Financial Statements

	Condensed Consolidated Balance Sheets as of March 31, 2007 and September 30, 2006	3

	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 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	21

ITEM 3:	Quantitative and Qualitative Disclosures about Market Risk	31

ITEM 4:	Controls and Procedures	31

PART II OTHER INFORMATION

ITEM 1:	Legal Proceedings	31

ITEM 4:	Submission of Matters to a Vote of Security Holders	32

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 )


	March 31,			September 30,
	2007			2006
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	60,748		$	48,848
Accounts receivable, less allowances for doubtful accounts of $650 and $541, respectively		22,432			17,705
Prepaid expenses		2,146			944
Income taxes receivable		1,618			875
Deferred income taxes		2,323			3,197
Workers’ compensation loss fund		4,667			4,529
Insurance recoveries, less allowances for insurance recoveries of $1,246 and $1,327, respectively		964			618
Transition services		116			—
Other current assets		218			170
Assets held for sale		—			24,385

Total current assets		95,232			101,271

Property and equipment:
Home care equipment		68			73
Furniture and fixtures		10,147			9,912
Leasehold improvements		2,345			2,494

		12,560			12,479
Accumulated depreciation and amortization		(9,756	)		(9,605	)

		2,804			2,874

Other assets:
Goodwill, less accumulated amortization of approximately $3,721		25,378			20,019
Noncompete agreements, less accumulated amortization of approximately $894 and $868, respectively		516			127
Deferred income taxes		3,689			3,232
Workers’ compensation bond collateral		955			1,262
Insurance cash surrender value and recoveries, less allowances for insurance recoveries of $800 and $1,104, respectively		4,737			4,454
Other		221			258

		35,496			29,352

Total assets	$	133,532		$	133,497

See Accompanying Notes.

PEDIATRIC SERVICES OF AMERICA, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS – (Continued)

(In thousands, except par value )


	March 31,		September 30,
	2007		2006
	(Unaudited)
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	1,174	$	3,039
Accrued compensation		6,145		5,262
Accrued insurance		7,625		6,897
Refunds payable		2,334		2,116
Accrued interest		42		42
Professional service liabilities		988		866
Additional rent payable		1,211		1,484
Transition services		268		358
Other accrued liabilities		262		406
Deferred revenue		—		902

Total current liabilities		20,049		21,372
Long-term accrued insurance		12,110		12,375
Long-term income taxes payable		88		88
Deferred compensation		1,252		1,051

Total liabilities		33,499		34,886
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 7,556 and 7,533 shares issued and outstanding at March 31, 2007 and September 30, 2006, respectively		75		75
Additional paid-in capital		56,663		55,805
Retained earnings		43,295		42,731

Total stockholders’ equity		100,033		98,611

Total liabilities and stockholders’ equity	$	133,532	$	133,497

See Accompanying Notes.

PEDIATRIC SERVICES OF AMERICA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)


	Three Months Ended						Six Months Ended
	March 31,						March 31,
	2007			2006			2007			2006
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Net revenue	$	33,644		$	29,203		$	65,702		$	57,136
Costs and expenses:
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		5,416			4,910			10,640			9,711
Business insurance		1,495			1,408			2,790			2,604
Overhead		1,903			1,841			3,715			3,699

Other operating costs and expenses		8,814			8,159			17,145			16,014
Corporate, general and administrative
Salaries, wages and benefits		2,469			3,329			5,540			7,079
Business insurance		63			59			132			123
Professional services		1,196			1,044			2,128			1,938
Overhead		608			675			1,227			1,394

Corporate, general and administrative		4,336			5,107			9,027			10,534
Provision for doubtful accounts		215			60			326			65
Provision for insurance recoveries		(134	)		—			(384	)		—
Depreciation and amortization		279			246			553			488

Total costs and expenses		34,470			31,066			67,073			61,523

Operating loss		(826	)		(1,863	)		(1,371	)		(4,387	)
Other income		—			5			58			8
Loss on early extinguishment of debt		—			—			—			(837	)
Interest income		832			626			1,642			1,011
Interest expense		—			(4	)		—			(564	)

Income (loss) from continuing operations, before income tax expense (benefit)		6			(1,236	)		329			(4,769	)
Income tax expense (benefit)		2			(446	)		190			(1,561	)

Income (loss) from continuing operations		4			(790	)		139			(3,208	)
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		7,549			7,372			7,543			7,321

Diluted		7,734			7,372			7,723			7,321

See Accompanying Notes.

PEDIATRIC SERVICES OF AMERICA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)


	Six Months Ended
	March 31,
	2007			2006
	(Unaudited)			(Unaudited)
Operating activities:
Net income	$	564		$	21,959
Less income from discontinued operations, net of income tax expense		(1,192	)		(3,329	)
Less loss (gain) on disposal from discontinued operations, net of income tax expense		767			(21,838	)

Income (loss) from continuing operations, net of income tax expense (benefit)		139			(3,208	)
Adjustments to reconcile income (loss) from continuing operations to net cash used in operating activities:
Depreciation and amortization		553			488
Provision for doubtful accounts		326			65
Provision for insurance recoveries		(384	)		—
Amortization of deferred financing fees		—			37
Loss on early extinguishment of debt		—			837
Incentive stock option expense		176			200
Nonqualified stock option expense		493			493
Deferred income taxes		417			2,482
Changes in operating assets and liabilities
Accounts receivable		(5,054	)		(1,095	)
Prepaid expenses		(1,202	)		(1,025	)
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		(436	)		(490	)
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 and extinguishment of long-term debt		—			(20,689	)
Disqualifying disposition of stock options		31			534
Proceeds from exercise of stock options		158			1,341

Net cash provided by (used in) financing activities of continuing operations		189			(18,814	)
Net cash used in financing activities of discontinued operations		—			(6	)

Net cash provided by (used in) financing activities		189			(18,820	)

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	$	1		$	1,505

Cash paid for taxes	$	2,720		$	8,219

See 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 six months ended March 31, 2007 are not necessarily indicative of the results to be expected for the entire fiscal year ending September 30, 2007. These condensed consolidated financial statements should be read in conjunction with our audited consolidated financial statements for the year ended September 30, 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 2006 Annual Report.

2. Summary of Significant Accounting Policies

Description of Business

We provide a broad range of pediatric healthcare services including private duty nursing, pediatric rehabilitation services, day treatment centers for medically fragile and chronically ill children and pediatric well care. 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 healthcare providers. Our services are designed to provide a high quality, lower cost alternative to prolonged hospitalization for medically fragile children. For financial reporting purposes, our branch offices are aggregated into two reportable segments based on the patient populations and relevant services provided in accordance with the Statement of Financial Accounting Standards No. 131 “Disclosures about Segments of an Enterprise and Related Information” (See Note 6).

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. 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. 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.

PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited (Continued)

2. Summary of Significant Accounting Policies - 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 $5.3 million and $4.2 million for which services have been rendered but the amounts were unbilled as of March 31, 2007 and September 30, 2006, respectively. Such unbilled amounts are primarily a result of the time required to process bills for services rendered.

Identifiable Intangible Assets

Amortization expense on identifiable intangible assets was approximately $0.05 million and $0.04 million for the three months ended March 31, 2007 and March 31, 2006, respectively and $0.08 million and $0.07 million for the six months ended March 31, 2006 and 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 Ending September 30,
2007	$	170
2008	$	176
2009	$	176
2010	$	176
2011	$	167

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 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.

On October 1, 2006, we completed our annual renewal of our risk management program. 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 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 with Charter Oak Fire Insurance, a subsidiary of St. Paul Travelers, rated A+ by AM Best Company, with the deductible remaining at $0.35 million.

PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited (Continued)

2. Summary of Significant Accounting Policies - 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.

Net Revenue

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 products or services rendered during the period. The Company’s 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. 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.

PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited (Continued)

2. Summary of Significant Accounting Policies - Continued

Our net revenue may vary significantly depending primarily on factors such as re-hospitalizations of patients, seasonality, the timing of new branch office openings, acquisitions of businesses, public school calendars and pricing pressures due to legislative and regulatory initiatives to contain healthcare costs. Certain RTES equipment rentals are billed in advance of our rendering the related services. Such amounts are deferred in the balance sheet until the related services are performed (See Note 4).

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.

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.

We have developed a methodology to record the estimated net revenue as a result of the inherent time lag between certain RTES patient treatments and input of the related information into our billing and collection system. This methodology measures relative changes in the time and overall activity level at each branch office location and aggregates these measurements to estimate the impact to consolidated net revenue. The estimated net revenue from the inherent time lag was approximately 0.4%, 0.5% and 0.4% of net revenue for fiscal years ended 2006, 2005 and 2004, respectively. Any unforeseen volatility to either the time or activity level at specific branch offices had the potential to significantly impact the estimate (See Note 4).

In other select cases, patient treatments may cease for a number of reasons including re-hospitalizations, changes in treatment needs or death, and a time lag may exist before this information is reflected in our billing and collection system. We have developed a methodology which measures the historical experience of all patient net revenue adjustments over the trailing four quarters and applies this methodology to reduce net revenues recognized in the current period. Included in this calculation is the reversal of revenue for patients without authorizations.

Stock Option Plans

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 Stock Option Plan (the “Option Plan”) provides for the granting of stock options covering up to 2,300,000 shares of Common Stock, of which 810,950 options are outstanding to eligible participants as of March 31, 2007. Options may be issued as either incentive stock options or as nonqualified stock options. Options may be granted to those persons who are officers or employees of our company or to certain outside consultants. The terms and conditions of options granted under the Option Plan, including the number of shares, the exercise price and the time at which such options become exercisable are determined by the Compensation Committee of the Board of Directors (the “Compensation Committee”). The vesting period of the options is typically four years. Upon the occurrence of certain events, the vesting period of some options accelerate. The term of options granted under the Option Plan may not exceed 10 years. We have the right to repurchase the Common Stock issued upon the exercise of these options at the then fair 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)

2. Summary of Significant Accounting Policies - Continued

reserved for issuance pursuant to options granted under the Directors’ Plan of which 278,500 options are outstanding to eligible participants as of March 31, 2007. During fiscal 2006, the Compensation Committee agreed to eliminate the use of equity compensation in the form of Director Stock Option awards and replace these awards with an annual contribution of approximately $13,000 on behalf of each Director into the Company’s Non-qualified Deferred Compensation Plan (“NQDCP”) at the conclusion of each fiscal year. Such contributions would be eligible for a 50% match funded by the Company and would be subject to the existing requirements of the NQDCP.

The fair value of the options awarded under Statement 123(R) is estimated on the date of grant using the Black Scholes Merton option pricing formula that used the assumptions noted in the following table. Expected volatilities are based on historical volatility of our stock and other factors. We use historical option exercise and employee termination dates to estimate the expected term. The expected term represents the period of time that options granted are expected to be outstanding. We perform these calculations separately for each plan because the participants exhibit different behavior. The estimate for forfeitures was reviewed and updated in the six months ended March 31, 2007 to reflect the impact of certain changes to our long-term compensation strategies. This change resulted in an increase to compensation expense of approximately $0.2 million. The risk free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. We have elected to use the straightline method to recognize compensation expense under Statement 123(R).


	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	%

PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited (Continued)

2. Summary of Significant Accounting Policies - Continued

Option Plan

A summary of option activity under the Option 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	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)

2. Summary of Significant Accounting Policies - Continued

As of March 31, 2007 there was no unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Directors’ Plan.

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)

4. Discontinued Operations

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)

4. Discontinued Operations - Continued

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)

4. Discontinued Operations - Continued

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,” “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, 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 healthcare regulations, including changes resulting from the Health Insurance Portability and Accountability Act (“HIPAA”);

•

performance of investments in our corporate cash management 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 healthcare 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 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

The Deficit Reduction Act of 2005 (“DRA”), which was signed into law on February 8, 2006, will have a significant impact on the Medicaid services we provide, including:

•

Expanding access to home and community-based services by establishing them as an optional Medicaid benefit that would not require a waiver for individuals whose income does not exceed 150% of the federal poverty level (“FPL”).

•

Creating a new optional Medicaid eligibility group for children with disabilities under the age of 19 who meet the severity of disability required under the Supplemental Security Income (“SSI”) program without regard to any income or asset requirements that apply under SSI where family income does not exceed 300% of the FPL.

•

Establishing Family to Family Health Information Centers to provide information and assistance to help families of children with special health care needs navigate the system of care and make decisions about the needs and available support mechanisms for their children. The DRA increases funding for this initiative under Title V of the Social Security Act.

•

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.

Many of 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.

Company Events & Updates

On April 1, 2007, we renewed our contract with United Health Care (“United”) for private duty nursing services. This contract contains financial incentives contingent upon satisfaction of a broad range of criteria including: volume and accuracy of electronic claims, patient satisfaction and nurse staffing. These incentives will not be recorded as revenues until we receive confirmation from United as to their achievement. The Company hopes that this contract will be a model for future managed care contract negotiations and will serve to differentiate us from our competitors and reinforce our value proposition.

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.

On February 9, 2007, the Company received a favorable verdict defending itself against a claim of tortious interference related to a 1996 acquisition. The Company 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 recover legal fees incurred since the date of its most recent rejected settlement offer. Plaintiff has filed a motion to appeal the verdict and the recovery of fees, if any, is pending resolution of the appeal.

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.

Operations

We have two reportable segments: (i) Nursing and (ii) PPEC (see “Notes to Condensed Consolidated Financial Statements”—Note 6).

In the Nursing segment, we are focused on increasing our staffed hours and reimbursement rates to drive revenue growth. During the six months ended March 31, 2007, we continue to believe our nurse recruiting strategy with its focus upon weekly staffed hours targets, for each branch office, as well as our incentive programs to reward achievement of these targets best positions us to achieve our growth objectives. We have also instituted a variety of new programs to monetarily reward our nurses to increase the number of hours that they work for us. We continue to experience wage pressures in select markets. During the six months ended March 31, 2007, we began to see the impact of increased rates from select managed care payors on our gross margin rate. Our branch office directors’ focus is upon increasing gross margin dollars which will improve the branch office contribution margin.

In the PPEC segment, we continue to be pleased with the financial results of our Georgia centers. Our census has continued to grow, community acceptance of our business model has expanded and feedback from state officials is positive. In North Carolina our pilot project continues to demonstrate the desired outcomes and we are in discussions with the appropriate agency managers to secure a permanent source of funding. We are very pleased with our new West Palm Beach PPEC facility expansion. The center is now at full capacity.

Source & Availability of Clinical Personnel

We believe that case hours staffed is the most appropriate measurement of nursing activity. During the 13 weeks ending March 31, 2007, our case hours staffed increased to approximately 928,000 as compared to 874,000 in the 13 weeks ended December 30, 2006. A substantial portion of the increase relates to the acquisitions completed in the second quarter of fiscal 2007. We continue to aggressively compete for nurses to staff hours ordered, retain nurses with select wage and benefit improvements and implement employee satisfaction initiatives. We have made investments in nine local market nurse recruiters to help reduce unstaffed hours.

CRITICAL ACCOUNTING POLICIES

This Form 10-Q reflects disclosure updates to our critical accounting policies. These critical accounting policies should be read in conjunction with our audited consolidated financial statements for the year ended September 30, 2006 which are included in our Annual Report on Form 10-K/A for such year filed with the Securities and Exchange Commission.

Billing and Collection

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.

Management of accounts receivable, through effective billing, collection and reimbursement procedures, 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.

The following table summarizes our days sales outstanding as of the dates indicated:


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

The days sales outstanding increase is primarily due to the Melmedica acquisition whose operations are in the States of Illinois and Indiana. Delays in processing ownership applications resulted in an inability to tie physician authorizations to services provided. The majority of these claims were released in December 2006 and January 2007. Payment in full for these claims is expected. In addition, the operations acquired during the three months ended March 31, 2007 encountered routine delays in the reauthorization of patient services. These delays are temporary and payment for services rendered is expected during the third fiscal quarter of fiscal 2007.

Allowance for Doubtful Accounts

In determining the adequacy of the allowance and related provision for doubtful accounts, we have 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. This detailed review involves both 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. Co-payments are captured under the private pay category and a higher reserve percentage is applied to these balances based on historical collection patterns. 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 estimate of the allowance for doubtful accounts. During the six months ended March 31, 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. This change was implemented due to the dramatic decline in the number of unbilled claims as a result of the sale of the RTES business. Inherent in this estimate is the risk that it will need to be revised or updated, with the changes recorded in subsequent periods, as additional information becomes available to management.

The following table provides a comparison of approximate percentages of our aging of net accounts receivable by payor for the periods ended March 31, 2007 and September 30, 2006:


	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	%

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 amount of each item from the comparative prior period:


	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.

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 $0.7 million, or 8%, to $8.8 million in the three months ended March 31, 2007 from $8.2 million in the three months ended March 31, 2006. In the Nursing segment, other operating costs and expenses increased $0.7 million or 12% to $6.8 million in the three months ended March 31, 2007 as compared to $6.1 million for the three months ended March 31, 2006. In the PPEC segment, other operating costs and expenses decreased $0.1 million, or 2%, to $2.0 million in the three months ended March 31, 2007 from $2.1 million in the three months ended March 31, 2006. As a percentage of net revenue these costs increased to 78% in the three months ended March 31, 2007 from 73% in 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.

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 $1.1 million, or 7%, to $17.1 million in the six months ended March 31, 2007 from $16.0 million in the six months ended March 31, 2006. In the Nursing segment, other operating costs and expenses increased $1.1 million, or 9%, to $13.1 million in the six months ended March 31, 2007 compared to $12.0 million in the six months ended March 31, 2006. As a percentage of net revenue, the Nursing segment costs were 22% in the six months ended March 31, 2007 as compared to 23% in the six months

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

For the three months ended March 31, 2007, we made routine purchases of computer equipment and purchased, instead of continuing to lease, office copiers for our branch offices to maintain and upgrade our technology infrastructure. We anticipate future capital expenditures for maintenance, support and enhancements of existing technology and continued investments in new start up locations. We anticipate funding these capital expenditures with cash on hand and cash flow from operations.

Asset Sales

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 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 outstanding accounts receivable at closing (See Note 4).

Asset Purchases

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.

Risk Management

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.

On January 1, 2007, we renewed our self-insured employee medical benefit plans. In January 2007, we made minor design changes to our benefit plans and analyzed the impact of the removal of the employees who transitioned to Lincare, Inc. as part of the sale of the RTES business.

As a result of operating in the healthcare 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 March 31, 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.

On 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.

Capital Resources

We have invested the retained proceeds from the sale of the Pharmacy and RTES businesses in accordance with the terms of our Investment Policy which has been approved by the Board of Directors. This policy provides for the establishment of short-term, highly liquid investments within prescribed parameters. Some 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 particular securities are classified as investing activities in the condensed consolidated statements of cash flows. As of the balance sheet date, all funds were held in a money market fund and classified as a cash equivalent on the condensed consolidated balance sheet. The dividends and interest earned from some of these securities are not subject to Federal income taxes and will result in a permanent 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, 2006, we completed our annual renewal of our risk management programs and implemented several changes (see “Liquidity and Capital Resources”).

We received notification of a claim from one commercial payor primarily relating to our discontinued pharmacy operation (see Note 7).

We have entered 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 failure to comply with any material terms of the agreements. We have a Non-Qualified Deferred Compensation Plan for certain of our employees. The deferred compensation liability as of March 31, 2007 and September 30, 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.

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, the timing of new branch office openings, acquisitions of businesses, public school calendars and pricing pressures due to legislative and regulatory initiatives to contain healthcare costs. Because of these factors, our operating results for any particular quarter may not be indicative of the results for the full fiscal year.

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 in a limited number of financial institutions and with institutional investors. We perform periodic evaluations of the relative financial positions and credit standings 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 environment in the healthcare industry. The risk is somewhat limited due to the large number of payors including Medicaid and 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.

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 management, with participation of our Chief Executive Officer and Chief Financial Officer, has 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.

As previously disclosed in our Annual 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 material weaknesses affecting our internal control over financial reporting and, as a result of those material weaknesses, our disclosure controls and procedures were not effective. As described below, we have remediated those material weaknesses. Consequently, based on the evaluation described above, our management, including our Chief Executive Officer and Chief Financial Officer, have concluded that, as of the end of the quarter ended March 31, 2007, our disclosure controls and procedures were effective.

Changes to Remediate Material Weakness

We have improved our internal controls over our accounting for income taxes by expanding the level of 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.


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)

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: 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)

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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PEDIATRIC SERVICES OF AMERICA INC 10-Q