##### Table of Contents

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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

For the quarterly period ended December 31, 2006

OR



| ̈ | 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



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PEDIATRIC
SERVICES OF AMERICA, INC.

(Exact name of Registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|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)



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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 February 6, 2007, the Registrant had 7,545,713 shares of Common Stock, $0.01 par value, outstanding.



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##### Table of Contents

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 December 31, 2006 and September 30, 2006                  |  | 3          
|                             |  |         | 
|                             |  |         |  | Condensed Consolidated Statements of Operations for the three months ended December 31, 2006 and 2005 |  | 5          
|                             |  |         | 
|                             |  |         |  | Condensed Consolidated Statements of Cash Flows for the three months ended December 31, 2006 and 2005 |  | 6          
|                             |  |         | 
|                             |  |         |  | Notes to Condensed Consolidated Financial Statements                                                  |  | 7          
|                             |  |         | 
|                             |  | ITEM 2: |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                 |  | 20         
|                             |  |         | 
|                             |  | ITEM 3: |  | Quantitative and Qualitative Disclosures about Market Risk                                            |  | 29         
|                             |  |         | 
|                             |  | ITEM 4: |  | Controls and Procedures                                                                               |  | 29         
|                             | 
|PART II OTHER INFORMATION    |  |        
|                             |  |         | 
|                             |  | ITEM 1: |  | Legal Proceedings                                                                                     |  | 29         
|                             |  |         | 
|                             |  | ITEM 6: |  | Exhibits                                                                                              |  | 30         
|                             | 
|SIGNATURES                   |  | 31     



2



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##### Table of Contents

PART I  FINANCIAL INFORMAT
ION



|ITEM 1. | FINANCIAL STATEME
NTS
|------- | ---------------------

PEDIATRIC SERVICES OF AMERICA, INC.

CONDENSED CONSOLIDA
TED BALANCE SHEETS

(In thousands)



|                                                                                                                         |  |                  |         |   |                   |   |         |  
|------------------------------------------------------------------------------------------------------------------------ |  | ---------------- | ------- | - | ----------------- | - | ------- | -
|                                                                                                                         |  | December 31,2006 |         |   | September 30,2006 |  
|                                                                                                                         |  | (Unaudited)      |         |   |                   |  
|ASSETS                                                                                                                   |  |                  |         |   |                   |   |         |  
|Current assets:                                                                                                          |  |                  |         |   |                   |   |         |  
|Cash and cash equivalents                                                                                                |  | $                | 70,587  |   |                   | $ | 48,848  |  
|Accounts receivable, less allowances for doubtful accounts of $575 and $541, respectively                                |  |                  | 19,824  |   |                   |   | 17,705  |  
|Prepaid expenses                                                                                                         |  |                  | 2,621   |   |                   |   | 944     |  
|Income taxes receivable                                                                                                  |  |                  |        |   |                   |   | 875     |  
|Deferred income taxes                                                                                                    |  |                  | 2,108   |   |                   |   | 3,197   |  
|Workers compensation loss fund                                                                                          |  |                  | 4,625   |   |                   |   | 4,529   |  
|Insurance recoveries, less allowances for insurance recoveries of $1,280 and $1,327, respectively                        |  |                  | 873     |   |                   |   | 618     |  
|Transition services                                                                                                      |  |                  | 320     |   |                   |   |        |  
|Other current assets                                                                                                     |  |                  | 348     |   |                   |   | 170     |  
|Assets held for sale                                                                                                     |  |                  |        |   |                   |   | 24,385  |  
|                                                                                                                         |  |                  |         |   |                   |   |         |  
|Total current assets                                                                                                     |  |                  | 101,306 |   |                   |   | 101,271 |  
|                                                                                                                         |  |                 
|Property and equipment:                                                                                                  |  |                  |         |   |                   |   |         |  
|Home care equipment                                                                                                      |  |                  | 71      |   |                   |   | 73      |  
|Furniture, fixtures and vehicles                                                                                         |  |                  | 9,916   |   |                   |   | 9,912   |  
|Leasehold improvements                                                                                                   |  |                  | 2,353   |   |                   |   | 2,494   |  
|                                                                                                                         |  |                  |         |   |                   |   |         |  
|                                                                                                                         |  |                  | 12,340  |   |                   |   | 12,479  |  
|Accumulated depreciation and amortization                                                                                |  |                  | (9,735  | ) |                   |   | (9,605  | )
|                                                                                                                         |  |                  |         |   |                   |   |         |  
|                                                                                                                         |  |                  | 2,605   |   |                   |   | 2,874   |  
|                                                                                                                         |  |                 
|Other assets:                                                                                                            |  |                  |         |   |                   |   |         |  
|Goodwill, less accumulated amortization of approximately $3,721                                                          |  |                  | 20,019  |   |                   |   | 20,019  |  
|Noncompete agreements, less accumulated amortization of approximately $875 and $868, respectively                        |  |                  | 120     |   |                   |   | 127     |  
|Deferred income taxes                                                                                                    |  |                  | 3,733   |   |                   |   | 3,232   |  
|Workers compensation bond collateral                                                                                    |  |                  | 944     |   |                   |   | 1,262   |  
|Insurance cash surrender value and recoveries, less allowances for insurance recoveries of $901 and $1,104, respectively |  |                  | 4,565   |   |                   |   | 4,454   |  
|Other                                                                                                                    |  |                  | 223     |   |                   |   | 258     |  
|                                                                                                                         |  |                  |         |   |                   |   |         |  
|                                                                                                                         |  |                  | 29,604  |   |                   |   | 29,352  |  
|                                                                                                                         |  |                  |         |   |                   |   |         |  
|Total assets                                                                                                             |  | $                | 133,515 |   |                   | $ | 133,497 |  
|                                                                                                                         |  |                  |         |   |                   |   |         |  

See Accompanying Notes.



3



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##### Table of Contents

PEDIATRIC SERVICES OF AMERICA, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS  (Continued)

(In thousands)



|                                                                                                                                                               |  |                  |         |                   |   |        
|-------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------- | ------- | ----------------- | - | -------
|                                                                                                                                                               |  | December 31,2006 |         | September 30,2006
|                                                                                                                                                               |  | (Unaudited)      |         |                  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                           |  |                  |         |                   |   |        
|Current liabilities:                                                                                                                                           |  |                  |         |                   |   |        
|Accounts payable                                                                                                                                               |  | $                | 1,144   |                   | $ | 3,039  
|Accrued compensation                                                                                                                                           |  |                  | 6,396   |                   |   | 5,262  
|Income taxes payable                                                                                                                                           |  |                  | 381     |                   |   |       
|Accrued insurance                                                                                                                                              |  |                  | 7,622   |                   |   | 6,897  
|Refunds payable                                                                                                                                                |  |                  | 2,445   |                   |   | 2,116  
|Accrued interest                                                                                                                                               |  |                  | 42      |                   |   | 42     
|Professional service liabilities                                                                                                                               |  |                  | 594     |                   |   | 866    
|Additional rent payable                                                                                                                                        |  |                  | 1,287   |                   |   | 1,484  
|Transition services                                                                                                                                            |  |                  | 444     |                   |   | 358    
|Other accrued liabilities                                                                                                                                      |  |                  | 367     |                   |   | 406    
|Deferred revenue                                                                                                                                               |  |                  |        |                   |   | 902    
|                                                                                                                                                               |  |                  |         |                   |   |        
|Total current liabilities                                                                                                                                      |  |                  | 20,722  |                   |   | 21,372 
|                                                                                                                                                               |  |                 
|Long-term accrued insurance                                                                                                                                    |  |                  | 11,769  |                   |   | 12,375 
|Long-term income taxes payable                                                                                                                                 |  |                  | 88      |                   |   | 88     
|Deferred compensation                                                                                                                                          |  |                  | 1,190   |                   |   | 1,051  
|                                                                                                                                                               |  |                  |         |                   |   |        
|Total liabilities                                                                                                                                              |  |                  | 33,769  |                   |   | 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 7,545 and 7,533 shares issued and outstanding at December 31, 2006 and
September 30, 2006, respectively |  |                  | 75      |                   |   | 75     
|Additional paid-in capital                                                                                                                                     |  |                  | 56,374  |                   |   | 55,805 
|Retained earnings                                                                                                                                              |  |                  | 43,297  |                   |   | 42,731 
|                                                                                                                                                               |  |                  |         |                   |   |        
|Total stockholders equity                                                                                                                                     |  |                  | 99,746  |                   |   | 98,611 
|                                                                                                                                                               |  |                  |         |                   |   |        
|Total liabilities and stockholders equity                                                                                                                     |  | $                | 133,515 |                   | $ | 133,497
|                                                                                                                                                               |  |                  |         |                   |   |        

See Accompanying Notes.



4



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##### Table of Contents

PEDIATRIC SERVICES OF AMERICA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS

(In thousands, except per share data)



|                                                                               |             |                                |        |             |  |   |        |  
|------------------------------------------------------------------------------ | ----------- | ------------------------------ | ------ | ----------- |  | - | ------ | -
|                                                                               |             | Three Months EndedDecember 31, |       
|                                                                               | 2006        |                                |        | 2005        | 
|                                                                               | (Unaudited) |                                |        | (Unaudited) | 
|Net revenue                                                                    |             | $                              | 32,058 |             |  | $ | 27,933 |  
|                                                                               |             |                               
|Costs and expenses:                                                            |             |                                |        |             |  |   |        |  
|Costs of goods and services (exclusive of depreciation shown separately below) |             |                                | 19,446 |             |  |   | 16,928 |  
|Other operating costs and expenses                                             |             |                                |        |             |  |   |        |  
|Salaries, wages and benefits                                                   |             |                                | 5,224  |             |  |   | 4,801  |  
|Business insurance                                                             |             |                                | 1,295  |             |  |   | 1,196  |  
|Overhead                                                                       |             |                                | 1,812  |             |  |   | 1,858  |  
|                                                                               |             |                                |        |             |  |   |        |  
|Other operating costs and expenses                                             |             |                                | 8,331  |             |  |   | 7,855  |  
|Corporate, general and administrative                                          |             |                                |        |             |  |   |        |  
|Salaries, wages and benefits                                                   |             |                                | 3,071  |             |  |   | 3,750  |  
|Business insurance                                                             |             |                                | 69     |             |  |   | 64     |  
|Professional services                                                          |             |                                | 932    |             |  |   | 894    |  
|Overhead                                                                       |             |                                | 619    |             |  |   | 719    |  
|                                                                               |             |                                |        |             |  |   |        |  
|Corporate, general and administrative                                          |             |                                | 4,691  |             |  |   | 5,427  |  
|Provision for doubtful accounts                                                |             |                                | 111    |             |  |   | 5      |  
|Provision for insurance recoveries                                             |             |                                | (250   | )           |  |   |       |  
|Depreciation and amortization                                                  |             |                                | 275    |             |  |   | 242    |  
|                                                                               |             |                                |        |             |  |   |        |  
|Total costs and expenses                                                       |             |                                | 32,604 |             |  |   | 30,457 |  
|                                                                               |             |                                |        |             |  |   |        |  
|Operating loss                                                                 |             |                                | (546   | )           |  |   | (2,524 | )
|Other income                                                                   |             |                                | 58     |             |  |   | 3      |  
|Loss on early extinguishment of debt                                           |             |                                |       |             |  |   | (837   | )
|Interest income                                                                |             |                                | 810    |             |  |   | 385    |  
|Interest expense                                                               |             |                                |       |             |  |   | (560   | )
|                                                                               |             |                                |        |             |  |   |        |  
|                                                                               |             |                               
|Income (loss) from continuing operations, before income tax expense (benefit)  |             |                                | 322    |             |  |   | (3,533 | )
|Income tax expense (benefit)                                                   |             |                                | 188    |             |  |   | (1,115 | )
|                                                                               |             |                                |        |             |  |   |        |  
|Income (loss) from continuing operations                                       |             |                                | 134    |             |  |   | (2,418 | )
|Discontinued operations:                                                       |             |                                |        |             |  |   |        |  
|Income from discontinued operations, net of tax                                |             |                                | 1,191  |             |  |   | 2,021  |  
|(Loss) income on disposal of discontinued operations, net of tax               |             |                                | (759   | )           |  |   | 21,758 |  
|                                                                               |             |                                |        |             |  |   |        |  
|                                                                               |             |                               
|Net income                                                                     |             | $                              | 566    |             |  | $ | 21,361 |  
|                                                                               |             |                                |        |             |  |   |        |  
|                                                                               |             |                               
|Basic net income per share data:                                               |             |                                |        |             |  |   |        |  
|Income (loss) from continuing operations                                       |             | $                              | 0.02   |             |  | $ | (0.33  | )
|Income from discontinued operations, net of tax                                |             |                                | 0.16   |             |  |   | 0.28   |  
|(Loss) gain on disposal of discontinued operations, net of tax                 |             |                                | (0.10  | )           |  |   | 2.99   |  
|                                                                               |             |                                |        |             |  |   |        |  
|Net income                                                                     |             | $                              | 0.08   |             |  | $ | 2.94   |  
|                                                                               |             |                                |        |             |  |   |        |  
|                                                                               |             |                               
|Diluted net income per share data:                                             |             |                                |        |             |  |   |        |  
|Income (loss) from continuing operations                                       |             | $                              | 0.02   |             |  | $ | (0.33  | )
|Income from discontinued operations, net of tax                                |             |                                | 0.15   |             |  |   | 0.28   |  
|(Loss) gain on disposal of discontinued operations, net of tax                 |             |                                | (0.10  | )           |  |   | 2.99   |  
|                                                                               |             |                                |        |             |  |   |        |  
|Net income                                                                     |             | $                              | 0.07   |             |  | $ | 2.94   |  
|                                                                               |             |                                |        |             |  |   |        |  
|                                                                               |             |                               
|Weighted average shares outstanding:                                           |             |                                |        |             |  |   |        |  
|Basic                                                                          |             |                                | 7,538  |             |  |   | 7,269  |  
|                                                                               |             |                                |        |             |  |   |        |  
|Diluted                                                                        |             |                                | 7,712  |             |  |   | 7,269  |  
|                                                                               |             |                                |        |             |  |   |        |  

See Accompanying Notes.



5



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##### Table of Contents

PEDIATRIC SERVICES OF AMERICA, INC.

CONDENSED CONSOLIDATED STATEMENTS
OF CASH FLOWS

(In thousands)



|                                                                                                            |  |                                |         |   |             |   |         |  
|----------------------------------------------------------------------------------------------------------- |  | ------------------------------ | ------- | - | ----------- | - | ------- | -
|                                                                                                            |  | Three Months EndedDecember 31, |        
|                                                                                                            |  | 2006                           |         |   | 2005        |  
|                                                                                                            |  | (Unaudited)                    |         |   | (Unaudited) |  
|Operating activities:                                                                                       |  |                                |         |   |             |   |         |  
|Net income                                                                                                  |  | $                              | 566     |   |             | $ | 21,361  |  
|Less income from discontinued operations, net of income tax expense                                         |  |                                | (1,191  | ) |             |   | (2,021  | )
|Less loss (gain) on disposal from discontinued operations, net of income tax expense                        |  |                                | 759     |   |             |   | (21,758 | )
|                                                                                                            |  |                                |         |   |             |   |         |  
|Income (loss) from continuing operations, net of income tax expense (benefit)                               |  |                                | 134     |   |             |   | (2,418  | )
|Adjustments to reconcile income (loss) from continuing operations to net cash used in operating activities: |  |                                |         |   |             |   |         |  
|Depreciation and amortization                                                                               |  |                                | 275     |   |             |   | 242     |  
|Provision for doubtful accounts                                                                             |  |                                | 111     |   |             |   | 5       |  
|Provision for insurance recoveries                                                                          |  |                                | (250    | ) |             |   |        |  
|Amortization of deferred financing fees                                                                     |  |                                |        |   |             |   | 37      |  
|Loss on early extinguishment of debt                                                                        |  |                                |        |   |             |   | 837     |  
|Incentive stock option expense                                                                              |  |                                | 97      |   |             |   | 109     |  
|Nonqualified stock option expense                                                                           |  |                                | 393     |   |             |   | 299     |  
|Deferred income taxes                                                                                       |  |                                | 589     |   |             |   | 2,459   |  
|Changes in operating assets and liabilities                                                                 |  |                                |         |   |             |   |         |  
|Accounts receivable                                                                                         |  |                                | (2,230  | ) |             |   | (663    | )
|Prepaid expenses                                                                                            |  |                                | (1,677  | ) |             |   | (1,423  | )
|Other assets                                                                                                |  |                                | (169    | ) |             |   | (121    | )
|Workers compensation loss fund                                                                             |  |                                | (96     | ) |             |   | (647    | )
|Workers compensation bond collateral                                                                       |  |                                | 318     |   |             |   | (13     | )
|Accounts payable                                                                                            |  |                                | (1,895  | ) |             |   | (2,846  | )
|Income taxes                                                                                                |  |                                |        |   |             |   | (40     | )
|Accrued compensation, insurance, liabilities, refunds and interest                                          |  |                                | (1,059  | ) |             |   | 392     |  
|                                                                                                            |  |                                |         |   |             |   |         |  
|Net cash used in operating activities of continuing operations                                              |  |                                | (5,459  | ) |             |   | (3,791  | )
|Net cash used in operating activities of discontinued operations                                            |  |                                | (2,484  | ) |             |   | (1,348  | )
|                                                                                                            |  |                                |         |   |             |   |         |  
|Net cash used in operating activities                                                                       |  |                                | (7,943  | ) |             |   | (5,139  | )
|                                                                                                            |  |                               
|Investing activities:                                                                                       |  |                                |         |   |             |   |         |  
|Purchases of property and equipment                                                                         |  |                                | (49     | ) |             |   | (280    | )
|Purchases of available for sale securities                                                                  |  |                                | (40,675 | ) |             |   |        |  
|Sales of available for sale securities                                                                      |  |                                | 40,675  |   |             |   |        |  
|Proceeds from the sale of discontinued operations                                                           |  |                                | 30,048  |   |             |   | 71,915  |  
|                                                                                                            |  |                                |         |   |             |   |         |  
|Net cash provided by investing activities of continuing operations                                          |  |                                | 29,999  |   |             |   | 71,635  |  
|Net cash used in investing activities of discontinued operations                                            |  |                                | (396    | ) |             |   | (711    | )
|                                                                                                            |  |                                |         |   |             |   |         |  
|Net cash provided by investing activities                                                                   |  |                                | 29,603  |   |             |   | 70,924  |  
|                                                                                                            |  |                               
|Financing activities:                                                                                       |  |                                |         |   |             |   |         |  
|Principal payments and extinguishment of long-term debt                                                     |  |                                |        |   |             |   | (20,689 | )
|Disqualifying disposition of stock options                                                                  |  |                                | 12      |   |             |   | 44      |  
|Proceeds from exercise of stock options                                                                     |  |                                | 67      |   |             |   | 101     |  
|                                                                                                            |  |                                |         |   |             |   |         |  
|Net cash provided by (used in) financing activities of continuing operations                                |  |                                | 79      |   |             |   | (20,544 | )
|Net cash used in financing activities of discontinued operations                                            |  |                                |        |   |             |   | (6      | )
|                                                                                                            |  |                                |         |   |             |   |         |  
|Net cash provided by (used in) financing activities                                                         |  |                                | 79      |   |             |   | (20,550 | )
|                                                                                                            |  |                                |         |   |             |   |         |  
|Increase in cash and cash equivalents                                                                       |  |                                | 21,739  |   |             |   | 45,235  |  
|Cash and cash equivalents at beginning of year                                                              |  |                                | 48,848  |   |             |   | 19,037  |  
|                                                                                                            |  |                                |         |   |             |   |         |  
|Cash and cash equivalents at end of period                                                                  |  | $                              | 70,587  |   |             | $ | 64,272  |  
|                                                                                                            |  |                                |         |   |             |   |         |  
|Supplemental disclosure of cash flow information:                                                           |  |                                |         |   |             |   |         |  
|Cash paid for interest                                                                                      |  | $                              |        |   |             | $ | 1,482   |  
|                                                                                                            |  |                                |         |   |             |   |         |  
|Cash paid for taxes                                                                                         |  | $                              | 576     |   |             | $ | 50      |  
|                                                                                                            |  |                                |         |   |             |   |         |  

See Accompanying Notes.



6



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##### Table of Contents

PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATE
D 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 months ended December 31, 2006 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 5).

Discontinued Operations

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 due and will be recorded upon the satisfaction of certain criteria, including the successful transition of certain patients and the collection of accounts receivable outstanding at closing (See Note 3).

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. As part of the transaction, the parties executed a transition
services agreement that provides for the collection of outstanding accounts receivable for a period of 180 days and order fulfillment, billing services and related accounting services for a period of 120 days after closing. At December 31,
2006, we have satisfied our responsibilities under the transition services agreement.

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.



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##### Table of Contents

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 $4.6 million and $4.2 million for which services have been rendered but the amounts were unbilled as of December 31, 2006 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 $0.03 million for the three months ended
December 31, 2006 and $0.04 million for the three months ended December 31, 2005. 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 |  | $                                 | 124
|2008 |  | $                                 | 110
|2009 |  | $                                 | 110
|2010 |  | $                                 | 110
|2011 |  | $                                 | 101

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.



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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 three months ended December 31, 2006, we reduced our allowance by $0.3 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 December 31, 2006 and September 30, 2006 was $4.6
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 December 31, 2006, the surety bonds were collateralized by $0.9 million cash posted to a third party escrow account. We believe that our collateral
remains secure despite the insurance carriers 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.



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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 3).

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 December 31, 2006, 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 has the potential to significantly impact the estimate (See Note 3).

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 December 31, 2006, 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 826,600 options are outstanding to eligible participants as
of December 31, 2006. 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 reserved for issuance
pursuant to options granted under the Directors Plan of which 278,500 options are outstanding to



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##### Table of Contents

PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  Unaudited (Continued)

2. Summary
of Significant Accounting Policies  Continued



eligible participants as of December 31, 2006. 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 three months ended December 31, 2006 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 December 31, |  
|                         |  | 2006                           |   |  | 2005 |  
|Expected volatility      |  | 44                             | % |  | 53   | %
|Expected dividends       |  | 0                              | % |  | 0    | %
|Expected term (in years) |  | 4                              |   |  | 4    |  
|Risk-free rate           |  | 4.68                           | % |  | 4.43 | %
|                         | 
|                         |  | Directors Plan December 31,   |  
|                         |  | 2006                           |   |  | 2005 |  
|Expected volatility      |  |                               |   |  | 75   | %
|Expected dividends       |  |                               |   |  | 0    | %
|Expected term (in years) |  |                               |   |  | 8    |  
|Risk-free rate           |  |                               |   |  | 4.49 | %



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##### Table of Contents

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 December 31, 2006, and changes during the period then ended is presented below:



|                                            |  |         |   |  |                                |       |                                          |      |                          |   |          
|------------------------------------------- |  | ------- | - |  | ------------------------------ | ----- | ---------------------------------------- | ---- | ------------------------ | - | ---------
|Options                                     |  | Shares  |   |  | Weighted-AverageExercise Price |       | Weighted-AverageRemainingContractualTerm |      | AggregateIntrinsic Value
|Outstanding at October 1, 2006              |  | 767,550 |   |  | $                              | 10.67 |                                          |      |                          |   |          
|Granted                                     |  | 91,000  |   |  |                                | 12.61 |                                          |      |                          |   |          
|Exercised                                   |  | (11,950 | ) |  |                                | 5.58  |                                          |      |                          |   |          
|Forfeited or expired                        |  | (20,000 | ) |  |                                | 10.50 |                                          |      |                          |   |          
|                                            |  |         |   |  |                                |       |                                          |      |                          |   |          
|Outstanding at December 31, 2006            |  | 826,600 |   |  | $                              | 10.96 |                                          | 7.37 |                          | $ | 2,092,792
|                                            |  |         |   |  |                                |       |                                          |      |                          |   |          
|Vested and exercisable at December 31, 2006 |  | 431,375 |   |  | $                              | 10.52 |                                          | 6.42 |                          | $ | 1,400,557
|                                            |  |         |   |  |                                |       |                                          |      |                          |   |          

The weighted-average grant-date fair value of options granted during the three months ended
December 31, 2006 and 2005, respectively was $5.06 and $6.85. The total intrinsic value of options exercised during the three months ended December 31, 2006 and 2005, respectively was $0.1 million and $0.2 million.

As of December 31, 2006 there was $1.3 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 sixteen months.

Directors Plan

A summary of option activity under the Directors Plan as of December 31, 2006, and changes during the period then ended is
presented below:



|                                            |  |         |  |                                |      |                                          |      |                          |   |          
|------------------------------------------- |  | ------- |  | ------------------------------ | ---- | ---------------------------------------- | ---- | ------------------------ | - | ---------
|Options                                     |  | Shares  |  | Weighted-AverageExercise Price |      | Weighted-AverageRemainingContractualTerm |      | AggregateIntrinsic Value
|Outstanding at October 1, 2006              |  | 278,500 |  | $                              | 8.68 |                                          |      |                          |   |          
|Granted                                     |  |        |  |                                |      |                                          |      |                          |   |          
|Exercised                                   |  |        |  |                                |      |                                          |      |                          |   |          
|Forfeited or expired                        |  |        |  |                                |      |                                          |      |                          |   |          
|                                            |  |         |  |                                |      |                                          |      |                          |   |          
|Outstanding at December 31, 2006            |  | 278,500 |  | $                              | 8.68 |                                          | 5.12 |                          | $ | 1,496,330
|                                            |  |         |  |                                |      |                                          |      |                          |   |          
|Vested and exercisable at December 31, 2006 |  | 278,500 |  | $                              | 8.68 |                                          | 5.12 |                          | $ | 1,496,330
|                                            |  |         |  |                                |      |                                          |      |                          |   |          

The weighted-average grant-date fair value of options granted during the three months ended
December 31, 2005 was $11.31. There were no options granted under the Directors plan during the three months ended December 31, 2006.



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##### Table of Contents

PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  Unaudited (Continued)

2. Summary
of Significant Accounting Policies  Continued



As of December 31, 2006 there was no unrecognized compensation cost related to non-vested
share-based compensation arrangements granted under the Directors Plan.

During the three months ended December 31, 2006 and
2005, respectively, 11,950 and 21,400 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.



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PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  Unaudited (Continued)



3. 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:



|                                                |  |                                 |       |   |      |   |       
|----------------------------------------------- |  | ------------------------------- | ----- | - | ---- | - | ------
|                                                |  | Three Months Ended December 31,
|In Thousands                                    |  | 2006                            |       |   | 2005
|RTES Business                                   |  |                                 |       |   |      |   |       
|                                                |  |                                
|Net revenue                                     |  | $                               | 5,963 |   |      | $ | 14,300
|Income before income tax expense                |  |                                 | 1,708 |   |      |   | 2,051 
|Income tax expense                              |  |                                 | 517   |   |      |   | 807   
|                                                |  |                                 |       |   |      |   |       
|Net income                                      |  | $                               | 1,191 |   |      | $ | 1,244 
|                                                |  |                                 |       |   |      |   |       
|Net income per share                            |  |                                 |       |   |      |   |       
|Basic                                           |  | $                               | 0.16  |   |      | $ | 0.17  
|                                                |  |                                 |       |   |      |   |       
|Diluted                                         |  |                                 | 0.15  |   |      | $ | 0.17  
|                                                |  |                                 |       |   |      |   |       
|Loss on Disposal of RTES Business               |  |                                 |       |   |      |   |       
|                                                |  |                                
|Gain on disposal of discontinued operations (1) |  | $                               | 970   |   |      | $ |      
|Income tax expense (2)                          |  |                                 | 1,729 |   |      |   |      
|                                                |  |                                 |       |   |      |   |       
|Net loss                                        |  | $                               | (759  | ) |      | $ |      
|                                                |  |                                 |       |   |      |   |       
|Net loss per share                              |  |                                 |       |   |      |   |       
|Basic                                           |  | $                               | (0.10 | ) |      | $ |      
|                                                |  |                                 |       |   |      |   |       
|Diluted                                         |  | $                               | (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 netted 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.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  Unaudited (Continued)

3.
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:



|                                            |  |                                 |   |      |   |       
|------------------------------------------- |  | ------------------------------- | - | ---- | - | ------
|                                            |  | Three Months Ended December 31,
|In Thousands                                |  | 2006                            |   | 2005
|Pharmacy Business                           |  |                                 |   |      |   |       
|                                            |  |                                
|Net revenue                                 |  | $                               |  |      | $ | 11,318
|Income before income tax expense            |  |                                 |  |      |   | 1,281 
|Income tax expense                          |  |                                 |  |      |   | 504   
|                                            |  |                                 |   |      |   |       
|Net income                                  |  | $                               |  |      | $ | 777   
|                                            |  |                                 |   |      |   |       
|                                            |  |                                
|Net income per share                        |  |                                 |   |      |   |       
|Basic                                       |  | $                               |  |      | $ | 0.11  
|                                            |  |                                 |   |      |   |       
|                                            |  |                                
|Diluted                                     |  | $                               |  |      | $ | 0.11  
|                                            |  |                                 |   |      |   |       
|                                            |  |                                
|Gain on Disposal of Pharmacy Business       |  |                                 |   |      |   |       
|                                            |  |                                
|Gain on disposal of discontinued operations |  | $                               |  |      | $ | 40,524
|Income tax expense                          |  |                                 |  |      |   | 18,766
|                                            |  |                                 |   |      |   |       
|Net income                                  |  | $                               |  |      | $ | 21,758
|                                            |  |                                 |   |      |   |       
|                                            |  |                                
|Net income per share                        |  |                                 |   |      |   |       
|Basic                                       |  | $                               |  |      | $ | 2.99  
|                                            |  |                                 |   |      |   |       
|                                            |  |                                
|Diluted                                     |  | $                               |  |      | $ | 2.99  
|                                            |  |                                 |   |      |   |       



15



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PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  Unaudited (Continued)

3.
Discontinued Operations  Continued



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



|                                                   |  |                                |       |   |      |   |       
|-------------------------------------------------- |  | ------------------------------ | ----- | - | ---- | - | ------
|                                                   |  | Three Months EndedDecember 31,
|In Thousands                                       |  | 2006                           |       |   | 2005
|Total Discontinued Operations                      |  |                                |       |   |      |   |       
|                                                   |  |                               
|Net revenue                                        |  | $                              | 5,963 |   |      | $ | 25,618
|Income before income tax expense                   |  |                                | 1,708 |   |      |   | 3,332 
|Income tax expense                                 |  |                                | 517   |   |      |   | 1,311 
|                                                   |  |                                |       |   |      |   |       
|Net income                                         |  | $                              | 1,191 |   |      | $ | 2,021 
|                                                   |  |                                |       |   |      |   |       
|                                                   |  |                               
|Net income per share                               |  |                                |       |   |      |   |       
|Basic                                              |  | $                              | 0.16  |   |      | $ | 0.28  
|                                                   |  |                                |       |   |      |   |       
|                                                   |  |                               
|Diluted                                            |  | $                              | 0.15  |   |      | $ | 0.28  
|                                                   |  |                                |       |   |      |   |       
|                                                   |  |                               
|(Loss) Gain on Disposal of Discontinued Operations |  | $                              | 970   |   |      | $ | 40,524
|Income tax expense                                 |  |                                | 1,729 |   |      |   | 18,766
|                                                   |  |                                |       |   |      |   |       
|Net (loss) gain                                    |  | $                              | (759  | ) |      | $ | 21,758
|                                                   |  |                                |       |   |      |   |       
|                                                   |  |                               
|Net (loss) gain per share                          |  |                                |       |   |      |   |       
|Basic                                              |  | $                              | (0.10 | ) |      | $ | 2.99  
|                                                   |  |                                |       |   |      |   |       
|                                                   |  |                               
|Diluted                                            |  | $                              | (0.10 | ) |      | $ | 2.99  
|                                                   |  |                                |       |   |      |   |       

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



|                                             |  |                   |       
|-------------------------------------------- |  | ----------------- | ------
|In Thousands                                 |  | September 30,2006
|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.

4. 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).



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PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  Unaudited (Continued)

4. Basic
and Diluted Income per Share  Continued



For the three months ended December 31, 2005, 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 EndedDecember 31,
|(In thousands)                                                            |  | 2006                           |  | 2005 
|Denominator for basic income per share-weighted average shares            |  | 7,538                          |  | 7,269
|Effect of dilutive securities:                                            |  |                                |  |      
|Options                                                                   |  | 174                            |  |     
|                                                                          |  |                                |  |      
|Denominator for diluted income per shareadjusted weighted average shares |  | 7,712                          |  | 7,269
|                                                                          |  |                                |  |      
|                                                                          |  |                               
|Antidilutive securities:                                                  |  |                                |  |      
|Options                                                                   |  | 299                            |  | 168  
|                                                                          |  |                                |  |      

5. 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 3).

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



|        |                   |          |                    |  |   |       
|------- | ----------------- | -------- | ------------------ |  | - | ------
|        |                   | Goodwill
|        | December 31, 2006 |          | September 30, 2006
|        |                  
|Nursing |                   | $        | 19,284             |  | $ | 19,284
|PPEC    |                   |          | 735                |  |   | 735   
|        |                   |          |                    |  |   |       
|Total   |                   | $        | 20,019             |  | $ | 20,019
|        |                   |          |                    |  |   |       



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PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  Unaudited (Continued)



5. Segments  Continued

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



|                                                                               |  |         |        |   |      |   |       |                   |  |   |       
|------------------------------------------------------------------------------ |  | ------- | ------ | - | ---- | - | ----- | ----------------- |  | - | ------
|                                                                               |  | Nursing |        |   | PPEC |   |       | ConsolidatedTotal
|Three Months Ended December 31, 2006                                           |  |         |        |   |      |   |       |                   |  |   |       
|Net revenue                                                                    |  | $       | 29,497 |   |      | $ | 2,561 |                   |  | $ | 32,058
|                                                                               |  |         |       
|Costs of goods and services (exclusive of depreciation shown separately below) |  |         |        |   |      |   |       |                   |  |   |       
|                                                                               |  |         |       
|Nursing and therapist salaries, wages, benefits and supplies                   |  |         | 19,347 |   |      |   | 88    |                   |  |   | 19,435
|Disposables/Supplies                                                           |  |         | 8      |   |      |   | 3     |                   |  |   | 11    
|                                                                               |  |         |        |   |      |   |       |                   |  |   |       
|Total cost of goods and services                                               |  |         | 19,355 |   |      |   | 91    |                   |  |   | 19,446
|Other operating costs and expenses                                             |  |         |        |   |      |   |       |                   |  |   |       
|Administrative and marketing salaries, wages and benefits                      |  |         | 3,740  |   |      |   | 1,484 |                   |  |   | 5,224 
|Business Insurance                                                             |  |         | 1,176  |   |      |   | 119   |                   |  |   | 1,295 
|Overhead                                                                       |  |         | 1,414  |   |      |   | 398   |                   |  |   | 1,812 
|                                                                               |  |         |        |   |      |   |       |                   |  |   |       
|Total operating costs and expenses                                             |  |         | 6,330  |   |      |   | 2,001 |                   |  |   | 8,331 
|                                                                               |  |         |       
|Provision for doubtful accounts                                                |  |         | 117    |   |      |   | (6    | )                 |  |   | 111   
|Depreciation                                                                   |  |         | 53     |   |      |   | 68    |                   |  |   | 121   
|                                                                               |  |         |        |   |      |   |       |                   |  |   |       
|                                                                               |  |         |       
|Branch office contribution margin                                              |  | $       | 3,642  |   |      | $ | 407   |                   |  | $ | 4,049 
|                                                                               |  |         |        |   |      |   |       |                   |  |   |       
|                                                                               |  |         |       
|Three Months Ended December 31, 2005                                           |  |         |        |   |      |   |       |                   |  |   |       
|Net revenue                                                                    |  | $       | 25,375 |   |      | $ | 2,558 |                   |  | $ | 27,933
|                                                                               |  |         |       
|Costs of goods and services (exclusive of depreciation shown separately below) |  |         |        |   |      |   |       |                   |  |   |       
|                                                                               |  |         |       
|Nursing and therapist salaries, wages, benefits and supplies                   |  |         | 16,771 |   |      |   | 136   |                   |  |   | 16,907
|Disposables/Supplies                                                           |  |         | 13     |   |      |   | 8     |                   |  |   | 21    
|                                                                               |  |         |        |   |      |   |       |                   |  |   |       
|Total cost of goods and services                                               |  |         | 16,784 |   |      |   | 144   |                   |  |   | 16,928
|Other operating costs and expenses                                             |  |         |        |   |      |   |       |                   |  |   |       
|Administrative and marketing salaries, wages and benefits                      |  |         | 3,380  |   |      |   | 1,421 |                   |  |   | 4,801 
|Business Insurance                                                             |  |         | 1,103  |   |      |   | 93    |                   |  |   | 1,196 
|Overhead                                                                       |  |         | 1,434  |   |      |   | 424   |                   |  |   | 1,858 
|                                                                               |  |         |        |   |      |   |       |                   |  |   |       
|Total operating costs and expenses                                             |  |         | 5,917  |   |      |   | 1,938 |                   |  |   | 7,855 
|                                                                               |  |         |       
|Provision for doubtful accounts                                                |  |         | (38    | ) |      |   | 43    |                   |  |   | 5     
|Depreciation                                                                   |  |         | 40     |   |      |   | 45    |                   |  |   | 85    
|                                                                               |  |         |        |   |      |   |       |                   |  |   |       
|                                                                               |  |         |       
|Branch office contribution margin                                              |  | $       | 2,672  |   |      | $ | 388   |                   |  | $ | 3,060 
|                                                                               |  |         |        |   |      |   |       |                   |  |   |       



|                                                                              |      |                                 |        |      |  |   |        |  
|----------------------------------------------------------------------------- | ---- | ------------------------------- | ------ | ---- |  | - | ------ | -
|                                                                              |      | Three Months Ended December 31, |       
|                                                                              | 2006 |                                 |        | 2005 | 
|Total profit for reportable segments                                          |      | $                               | 4,049  |      |  | $ | 3,060  |  
|                                                                              |      |                                
|Corporate, general and administrative                                         |      |                                 | (4,691 | )    |  |   | (5,427 | )
|Corporate depreciation and amortization                                       |      |                                 | (154   | )    |  |   | (157   | )
|Provision for insurance recoveries                                            |      |                                 | 250    |      |  |   |       |  
|Loss on early extinguishment of debt                                          |      |                                 |       |      |  |   | (837   | )
|Other income                                                                  |      |                                 | 58     |      |  |   | 3      |  
|Interest income                                                               |      |                                 | 810    |      |  |   | 385    |  
|Interest expense                                                              |      |                                 |       |      |  |   | (560   | )
|                                                                              |      |                                 |        |      |  |   |        |  
|                                                                              |      |                                
|Income (loss) from continuing operations, before income tax expense (benefit) |      | $                               | 322    |      |  | $ | (3,533 | )
|                                                                              |      |                                 |        |      |  |   |        |  



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PEDIATRIC SERVICES OF AMERICA, INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  Unaudited (Continued)

5.
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 December 31,
|                              | 2006 |                                 | 2005
|Travel                        |      | $                               | 83   |  | $ | 67 
|Auto gas, mileage and repairs |      |                                 | 153  |  |   | 211
|Auto leases                   |      |                                 | 87   |  |   | 50 
|Delivery charges              |      |                                 | 19   |  |   | 17 
|                              |      |                                 |      |  |   |    
|                              |      | $                               | 342  |  | $ | 345
|                              |      |                                 |      |  |   |    

6. 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 settlements; 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 December 31, 2006, 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.

7. Subsequent Events

On January 6, 2007, we acquired select 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 Americare retaining its accounts receivable. Americares
annualized net pediatric revenue, all of which is being acquired by PSA, totals approximately $2.7 million.



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|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, 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:



| |  |  | 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.



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##### Table of Contents

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 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 due and will be recorded 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 3).

On January 6, 2007, we acquired select 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 Americare retaining its accounts receivable.
Americares annualized net pediatric revenue, all of which is being acquired by PSA, totals approximately $2.7 million.

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 on-going 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 three months ended December 31, 2006 we
reduced our allowance by approximately $0.3 million.



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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 intensify 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 $7.2 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 5).

In the Nursing segment, we are focused on increasing our staffed hours and reimbursement rates to drive revenue growth. During the three months ended December 31, 2006, 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 three months ended December 31, 2006, 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 December 30, 2006, our case hours staffed increased to approximately 874,000 as compared to 873,000 in the 13 weeks ended September 30, 2006. 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

We derive substantially all of our net revenue from patients who have a third party payor (insurance company or government) who
either has contractually agreed to pay the patients account or is obligated to pay based on the patients participation in its program (i.e. Medicare or Medicaid). Net revenues from Medicaid and Medicare are generally based on



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##### Table of Contents

reimbursement of the reasonable direct and indirect costs of providing services to program participants. Revenues are recorded based on estimated net
realizable amounts to be received for products or services rendered during the period. Our accounting system is programmed to calculate the expected reimbursement to be received on a patient-by-patient basis based on the type of payor and the
contractual terms of the payor or pre-negotiated reimbursement rates.

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

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

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:



|                                                            |  |                   |  |                   
|----------------------------------------------------------- |  | ----------------- |  | ------------------
|                                                            |  | December 31, 2006 |  | September 30, 2006
|                                                            | 
|Days sales outstanding (calculated on year to date revenue) |  | 57                |  | 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.

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 three months ended December 31, 2006, 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.



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



|                                  |            |            |   |              |                    |   |              |              |   |              |              |   |           |           |   |       |       |  
|--------------------------------- | ---------- | ---------- | - | ------------ | ------------------ | - | ------------ | ------------ | - | ------------ | ------------ | - | --------- | --------- | - | ----- | ----- | -
|                                  |            |            |   |              | December 31, 2006  |   |              |              |  
|                                  | 0-120 days |            |   | 121-180 days |                    |   | 181-240 days |              |   | 241-365 days |              |   | >365 days |           |   | Total |      
|Commercial and contract insurance |            | 31.4       | % |              | 2.7                | % |              | 1.5          | % |              | 0.6          | % |           | -1.3      | % |       | 34.9  | %
|Medicaid                          |            | 33.3       | % |              | 3.1                | % |              | 1.7          | % |              | 0.7          | % |           | 0.9       | % |       | 39.7  | %
|Medicare                          |            | 0.5        | % |              | 0.0                | % |              | 0.0          | % |              | 0.0          | % |           | 0.0       | % |       | 0.5   | %
|Private pay                       |            | 0.5        | % |              | 0.2                | % |              | 0.1          | % |              | 0.2          | % |           | 0.1       | % |       | 1.1   | %
|Unbilled                          |            | 22.3       | % |              | 1.2                | % |              | 0.3          | % |              | 0.0          | % |           | 0.0       | % |       | 23.8  | %
|                                  |            |            |   |              |                    |   |              |              |   |              |              |   |           |           |   |       |       |  
|Total net accounts receivable     |            | 88.0       | % |              | 7.2                | % |              | 3.6          | % |              | 1.5          | % |           | -0.3      | % |       | 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 | %



24



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##### Table of Contents

RESULTS OF OPERATIONS

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



|                                                                               |                                |                           |   |                                |                                                |     |      |       |   
|------------------------------------------------------------------------------ | ------------------------------ | ------------------------- | - | ------------------------------ | ---------------------------------------------- | --- | ---- | ----- | --
|                                                                               |                                | Percentage of Net Revenue |   |                                | Period-to-Period PercentageIncrease (Decrease) |    
|                                                                               | Three Months EndedDecember 31, |                           |   | Three Months EndedDecember 31, |                                               
|                                                                               | 2006                           |                           |   | 2005                           |                                                |     | 2006 |      
|Net Revenue                                                                    |                                | 100.0                     | % |                                | 100.0                                          | %   |      | 15    | % 
|Costs of goods and services (exclusive of depreciation shown separately below) |                                | 60.7                      |   |                                | 60.6                                           |     |      | 15    |   
|Other operating costs and expenses                                             |                                |                           |   |                                |                                                |     |      |       |   
|Salaries, wages and benefits                                                   |                                | 16.3                      |   |                                | 17.2                                           |     |      | 9     |   
|Business insurance                                                             |                                | 4.0                       |   |                                | 4.3                                            |     |      | 8     |   
|Overhead                                                                       |                                | 5.7                       |   |                                | 6.7                                            |     |      | (2    | ) 
|                                                                               |                                |                           |   |                                |                                                |     |      |       |   
|Other operating costs and expenses                                             |                                | 26.0                      |   |                                | 28.2                                           |     |      | 6     |   
|Corporate, general and administrative                                          |                                |                           |   |                                |                                                |     |      |       |   
|Salaries, wages and benefits                                                   |                                | 9.6                       |   |                                | 13.4                                           |     |      | (18   | ) 
|Business insurance                                                             |                                | 0.2                       |   |                                | 0.2                                            |     |      | 8     |   
|Professional services                                                          |                                | 2.9                       |   |                                | 3.2                                            |     |      | 4     |   
|Overhead                                                                       |                                | 1.9                       |   |                                | 2.6                                            |     |      | (14   | ) 
|                                                                               |                                |                           |   |                                |                                                |     |      |       |   
|Corporate, general and administrative                                          |                                | 14.6                      |   |                                | 19.4                                           |     |      | (14   | ) 
|Provision for doubtful accounts                                                |                                | 0.3                       |   |                                |                                               |     |      | 2,120 |   
|Provision for insurance recoveries                                             |                                | (0.8                      | ) |                                |                                               |     |      | 100   |   
|Depreciation and amortization                                                  |                                | 0.9                       |   |                                | 0.9                                            |     |      | 14    |   
|                                                                               |                                |                           |   |                                |                                                |     |      |       |   
|Operating loss                                                                 |                                | (1.7                      | ) |                                | (9.1                                           | )   |      | (78   | ) 
|Other income                                                                   |                                | 0.2                       |   |                                |                                               |     |      | 1,833 |   
|Loss on early extinguishment of debt                                           |                                |                          |   |                                | (3.0                                           | )   |      | (100  | ) 
|Interest income                                                                |                                | 2.5                       |   |                                | 1.4                                            |     |      | 110   |   
|Interest expense                                                               |                                |                          |   |                                | (2.0                                           | )   |      | (100  | ) 
|                                                                               |                                |                           |   |                                |                                                |     |      |       |   
|Income (loss) from continuing operations, before income tax expense (benefit)  |                                | 1.0                       |   |                                | (12.7                                          | )   |      | (109  | ) 
|Income tax expense (benefit)                                                   |                                | 0.6                       |   |                                | (4.0                                           | )   |      | (117  | ) 
|                                                                               |                                |                           |   |                                |                                                |     |      |       |   
|Income (loss) from continuing operations                                       |                                | 0.4                       | % |                                | (8.7                                           | ) % |      | (106  | )%
|                                                                               |                                |                           |   |                                |                                                |     |      |       |   

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 EndedDecember 31, |  
|                                 | 2006    |                                |   | 2005    |      
|                                 | % Total |                                |   | % Total |      
|Pediatric Home Health Care       |         |                                |   |         |       |  
|Nursing                          |         | 81.7                           | % |         | 80.1  | %
|PPEC                             |         | 8.0                            | % |         | 9.2   | %
|                                 |         |                                |   |         |       |  
|Total Pediatric Home Health Care |         | 89.7                           | % |         | 89.3  | %
|                                 |         |                               
|Adult Home Health Care           |         |                                |   |         |       |  
|Nursing                          |         | 10.3                           | % |         | 10.7  | %
|                                 |         |                                |   |         |       |  
|Total Adult Home Health Care     |         | 10.3                           | % |         | 10.7  | %
|                                 |         |                                |   |         |       |  
|Total                            |         | 100.0                          | % |         | 100.0 | %
|                                 |         |                                |   |         |       |  



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##### Table of Contents

Three Months Ended December 31, 2006 Compared to Three Months Ended December 31, 2005

Net revenue increased $4.1 million, or 15%, to $32.1 million in the three months ended December 31, 2006 from $27.9 million in the three months ended
December 31, 2005. For the Nursing segment, net revenue increased $4.1 million, or 16%, to $29.5 million in the three months ended December 31, 2006 from $25.4 million in the three months ended December 31, 2005. Of the $4.1 million
increase, $2.2 million was attributable to the Melmedica acquisition. For the PPEC segment, net revenue remained relatively constant at $2.6 million in the three months ended December 31, 2006 as compared to the three months ended
December 31, 2005. In the three months ended December 31, 2006, we derived approximately 35% of our net revenue from commercial insurers and other private payors, 65% from Medicaid and less than 1% from Medicare.

Costs of goods and services consist primarily of branch office nursing and therapist compensation and benefits, medical equipment and related supplies.
Costs of goods and services increased $2.5 million, or 15%, to $19.4 million in the three months ended December 31, 2006 from $16.9 million in the three months ended December 31, 2005. Costs of goods and services of the Nursing segment
increased $2.6 million, or 15%, to $19.4 million in the three months ended December 31, 2006 from $16.8 million in the three months ended December 31, 2005. Costs of goods and services as a percentage of the Nursing segment net revenue
remained relatively constant at 66% in the three months ended December 31, 2006 as compared to the three months ended December 31, 2005. Costs of goods and services of the PPEC segment relatively constant at $0.1 million in the three
months ended December 31, 2006 as compared to the three months ended December 31, 2005.

Other operating costs and expenses
include branch office administrative and marketing compensation and benefits, allocated business insurance costs, facility and overhead costs. Other operating costs and expenses increased $0.5 million, or 6%, to $8.3 million in the three months
ended December 31, 2006 from $7.9 million in the three months ended December 31, 2005. In the Nursing segment, other operating costs and expenses increased $0.4 million, or 7% to $6.3 million in the three months ended December 31,
2006 from $5.9 million in the three months ended December 31, 2005. The increase includes a $0.1 million increase business insurance and $0.4 million increase in labor costs. In the PPEC segment, other operating costs and expenses increased
$0.1 million, or 3%, to $2.0 million in the three months ended December 31, 2006 from $1.9 million in the three months ended December 31, 2005. As a percentage of PPEC net revenue these costs increased to 78% in the three months ended
December 31, 2006 compared to 76% in the three months ended December 31, 2005.

Corporate, general and administrative costs
decreased $0.7 million, or 14%, to $4.7 million in the three months ended December 31, 2006 from $5.4 million in the three months ended December 31, 2005. As a percentage of net revenue, corporate, general and administrative costs
decreased to 15% in the three months ended December 31, 2006 compared to 19% in the three months ended December 31, 2005. Certain corporate administrative salaries, wages and benefits were impacted by the reduction in force related to the
sale of the RTES business.

Provision for doubtful accounts increased $0.1 million, or 2120%, to $0.1 million in the three months ended
December 31, 2006 as compared to $.005 million in the three months ended December 31, 2005.

Provision for insurance recoveries
decreased $0.3 million in the three months ended December 31, 2006 as compared to zero in the three months ended December 31, 2005 (See Note 2).

Depreciation and amortization increased $0.03 million, or 14%, to $0.3 million in the three months ended December 31, 2006 as compared to $0.2 million in the three months ended December 31, 2005.

Interest income increased $0.4 million, or 110%, to $0.8 million in the three months ended December 31, 2006, as compared to $0.4 million in the
three months ended December 31, 2005 (See Liquidity and Capital Resources below for further discussion).

Interest expense
decreased $0.6 million, or 100%, to zero in the three months ended December 31, 2006 from $0.6 million in the three months ended December 31, 2005. (See Note 2).

Income tax expense for continuing operations increased $1.3 million, or 117%, to an expense of $0.2 million in the three months ended December 31,
2006 from a benefit of $1.1 million in the three months ended December 31, 2005. For the three months ended December 31, 2006, tax expense is impacted by the permanent item of $4.7 million of non-deductible goodwill specifically related to the
sale of the RTES business.

LIQUIDITY AND CAPITAL RESOURCES

Operations

For the three months
ended December 31, 2006, we purchased medical equipment to service existing patients and made routine purchases of computer equipment to maintain and upgrade our technology infrastructure. We anticipate future capital expenditures for
maintenance, support and enhancements of existing technology and continued investments in new start up locations. We anticipate funding these capital expenditures with cash on hand and cash flow from operations.



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##### Table of Contents

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 due upon the satisfaction of certain criteria, including the successful transition of certain patients and the collection of outstanding accounts receivable at closing (See Note 3).

Asset Purchases

On January 6,
2007, we acquired select 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 Americare retaining its accounts receivable. Americares annualized net pediatric revenue, all of which is being acquired by PSA, totals approximately $2.7 million.

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 December 31, 2006 and September 30, 2006 was $4.6 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.

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 December 31, 2006, the surety bonds were collateralized by $0.9 million cash posted to a third party escrow account. We believe that our collateral remains secure despite the insurance carriers financial distress discussed above.

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 December 31, 2006, 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 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.



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##### Table of Contents

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).

The Company received notification of a claim from one commercial payor
primarily relating to our discontinued pharmacy operation (see Note 6).

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 December 31, 2006 and September 30, 2006 was approximately $1.6 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 December 31, 2006:



|                         |       |   |                  |                                       |          |       |          |   |                  |  |   |       |  |   |    
|------------------------ | ----- | - | ---------------- | ------------------------------------- | -------- | ----- | -------- | - | ---------------- |  | - | ----- |  | - | ---
|                         |       |   |                  | Payments Due by Period (In thousands) |          |      
|                         | Total |   | Less Than 1 Year |                                       | 1-3Years |       | 3-5Years |   | More than5 Years
|Contractual Obligations: |       |   |                  |                                       |          |       |          |   |                  |  |   |       |  |   |    
|Operating leases         |       | $ | 9,312            |                                       | $        | 2,205 |          | $ | 3,756            |  | $ | 2,490 |  | $ | 861
|                         |       |   |                  |                                       |          |       |          |   |                  |  |   |       |  |   |    
|                         |       | $ | 9,312            |                                       | $        | 2,205 |          | $ | 3,756            |  | $ | 2,490 |  | $ | 861
|                         |       |   |                  |                                       |          |       |          |   |                  |  |   |       |  |   |    

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.



28



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##### Table of Contents

|ITEM 3. | QUANTITATIVE A
ND 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 PROCED
URES
|------- | ------------------------

(a) Evaluation of disclosure controls and procedures. The Company maintains
disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Companys 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 the Companys Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required
disclosure. The Companys management, with participation of the Companys Chief Executive Officer and Chief Financial Officer, has conducted an evaluation of the effectiveness of the Companys 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 the Companys Annual Report on Form 10-K/A for the fiscal year ended September 30, 2006, the Company determined that, as of the end of the fiscal year 2006, there were material
weaknesses affecting its internal control over financial reporting and, as a result of those material weaknesses, the Companys disclosure controls and procedures were not effective. As described below, the Company is in the process of
remediating those material weaknesses. Consequently, based on the evaluation described above, the Companys management, including its Chief Executive Officer and Chief Financial Officer, have concluded that, as of the end of the quarter ended
December 31, 2006, the Companys disclosure controls and procedures were not 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. The Company will also reassess the technical proficiency and quality controls of its existing tax advisor and make whatever changes are deemed appropriate.

(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 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

PAR
T II  OTHER INFORMATION



|ITEM 1. | LEG
AL 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.



29



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##### Table of Contents

|ITEM 6. | EXHI
BITS.
|------- | ----------



|            |  |                                             
|----------- |  | --------------------------------------------
|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)            



30



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##### Table of Contents

SIGN
ATURES

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: February 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)



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##### Table of Contents

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)            



32