PEDIATRIC SERVICES OF AMERICA INC - 10-Q Quarterly Report

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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2003

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

For the transition period from ______ to ______

Commission file number 0-23946

PEDIATRIC SERVICES OF AMERICA, INC.

(Exact name of Registrant as specified in its charter)

Delaware
(State or other jurisdiction of
incorporation or organization)

58-1873345
(I.R.S. Employer
Identification No.)

310 Technology Parkway, Norcross GA 30092-2929
(Address of principal executive offices, including zip code)

(770) 441-1580
(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

Yes o No x

As of May 8, 2003, the Registrant had 6,862,237 shares of Common Stock, $0.01 Par Value, outstanding.

Page 1 of 29

FORM 10-Q
PEDIATRIC SERVICES OF AMERICA, INC.

INDEX

		Page Number
PART I	FINANCIAL INFORMATION

ITEM 1:	Financial Statements

	Condensed Consolidated Balance Sheets as of March 31, 2003 and September 30, 2002	3

	Condensed Consolidated Statements of Operations for the three and six months ended March 31, 2003 and 2002	5

	Condensed Consolidated Statements of Cash Flows for the six months ended March 31, 2003 and 2002	6

	Notes to Condensed Consolidated Financial Statements	7

ITEM 2:	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13

ITEM 3:	Quantitative and Qualitative Disclosures about Market Risk	24

ITEM 4:	Controls and Procedures	24



PART II	OTHER INFORMATION

ITEM 1:	Legal Proceedings	24

ITEM 4:	Submission of Matters to a Vote of Security Holders	25

ITEM 6:	Exhibits and Reports on Form 8-K	26

SIGNATURES	27

CERTIFICATIONS	28

PART I - FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS

PEDIATRIC SERVICES OF AMERICA, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)

	March 31, 2003			September 30, 2002

	(Unaudited)

Assets
Current Assets:
Cash and cash equivalents	$	5,692		$	10,990
Accounts receivable, less allowance for doubtful accounts of $4,763 and $5,364, respectively		36,667			32,412
Prepaid expenses		1,529			943
Workers’ compensation loss fund		1,242			—
Income taxes receivable		—			441
Deferred income taxes		4,626			4,626
Inventory		3,972			3,312
Other current assets		530			266

Total current assets		54,258			52,990
Property and equipment:
Home care equipment held for rental		31,517			31,065
Furniture and fixtures		11,289			11,278
Vehicles		700			725
Leasehold improvements		1,914			1,888

		45,420			44,956
Accumlated depreciation and amortization		(36,838	)		(35,779	)

		8,582			9,177
Other assets:
Goodwill, less accumulated amortization of $9,613		36,539			32,893
Certificates of need, less accumulated amortization of $592 and $581, respectively		81			92
Deferred financing fees, less accumulated amortization of $725 and $699, respectively		429			492
Non-compete agreements, less accumulated amortization of $1,149 and $1,136, respectively		131			34
Deferred income taxes		4,214			4,214
Workers’ compensation bond collateral		2,766			1,851
Other		264			325

		44,424			39,901

Total assets	$	107,264		$	102,068

See accompanying notes.

PEDIATRIC SERVICES OF AMERICA, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS—(Continued)
(In thousands)

	March 31, 2003		September 30, 2002

	(Unaudited)

Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	6,639	$	5,224
Accrued compensation		5,071		4,907
Income taxes payable		845		—
Accrued insurance		7,513		6,358
Refunds payable		1,168		1,148
Accrued interest		1,094		1,135
Other accrued liabilities		2,558		1,953
Deferred revenue		724		734
Current maturities of long-term obligations to related parties		—		25
Current maturities of long-term obligations		153		169

Total current liabilities		25,765		21,653
Long-term obligations, net of current maturities		23,545		24,642
Stockholders’ equity:
Preferred stock, $.01 par value, 2,000 shares authorized, no shares issued and outstanding		—		—
Common stock, $.01 par value, 80,000 shares authorized 6,862 and 6,838 shares issued and outstanding at March 31, 2003 and September 30, 2002, respectively		69		68
Additional paid-in capital		49,166		49,084
Retained earnings		8,719		6,621

Total stockholders’ equity		57,954		55,773

Total liabilities and stockholders’ equity	$	107,264	$	102,068

See accompanying notes.

PEDIATRIC SERVICES OF AMERICA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)

	Three Months Ended March 31,						Six Months Ended March 31,

	2003			2002			2003			2002

	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Net Revenue	$	53,637		$	48,065		$	106,199		$	97,205
Costs and expenses:
Operating salaries, wages and employee benefits		23,545			22,475			46,663			45,112
Other operating costs		21,890			17,982			43,089			35,239
Corporate, general and administrative		4,687			4,424			9,375			9,140
Provision for doubtful accounts		132			360			411			665
Depreciation and amortization		1,013			994			2,073			2,088

Total costs and expenses		51,267			46,235			101,611			92,244

Operating income		2,370			1,830			4,588			4,961
Other income		43			—			43			—
Early extinguishment of debt		31			—			31			387
Interest income		35			23			66			81
Interest expense		(620	)		(714	)		(1,270	)		(1,433	)

Income before income tax expense		1,859			1,139			3,458			3,996
Income tax expense		731			—			1,360			—

Net income	$	1,128		$	1,139		$	2,098		$	3,996

Net income per share data:
Basic	$	0.16		$	0.17		$	0.31		$	0.59

Diluted	$	0.16		$	0.16		$	0.30		$	0.56

Weighted average shares outstanding:
Basic		6,858			6,778			6,852			6,746

Diluted		7,063			7,249			7,071			7,191

See accompanying notes.

PEDIATRIC SERVICES OF AMERICA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

	Six Months Ended March 31,

	2003			2002

	(Unaudited)			(Unaudited)
Operating activities:
Net income	$	2,098		$	3,996
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		2,073			2,088
Provision for doubtful accounts		411			665
Amortization of deferred financing fees		44			63
Early extinguishment of debt		(31	)		(387	)
Deferred income taxes		—			127
Changes in operating assets and liabilities, net of effects from acquisition:
Accounts receivable		(4,717	)		(2,154	)
Prepaid expenses		(586	)		(210	)
Inventory		(660	)		646
Other assets		(272	)		(116	)
Workers’ compensation loss fund		(1,242	)		—
Workers’ compensation bond collateral		(915	)		(1,825	)
Accounts payable		1,415			(1,550	)
Income taxes		1,286			(260	)
Accrued liabilities		1,882			876

Net cash provided by operating activities		786			1,959
Investing activities:
Purchases of property and equipment		(1,329	)		(2,133	)
Acquisition of business		(3,781	)		—

Net cash used in investing activities		(5,110	)		(2,133	)
Financing activities:
Principal payments and extinguishment of long-term debt		(1,057	)		(4,525	)
Proceeds from exercise of stock options		83			362

Net cash used in financing activities		(974	)		(4,163	)

Decrease in cash and cash equivalents		(5,298	)		(4,337	)
Cash and cash equivalents at beginning of period		10,990			15,259

Cash and cash equivalents at end of period	$	5,692		$	10,922

Supplemental disclosure of cash flow information:
Cash paid for interest	$	1,351		$	1,682

Cash paid for taxes	$	173		$	196

See accompanying notes.

PEDIATRIC SERVICES OF AMERICA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of Pediatric Services of America, Inc. (the “Company”) and its majority-owned subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all information and notes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. Results of operations for the three and six months ended March 31, 2003 are not necessarily indicative of the results to be expected for the entire fiscal year ending September 30, 2003. These condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the year ended September 30, 2002 included in the Company’s Annual Report on Form 10-K for such year filed with the Securities and Exchange Commission. Principal accounting policies are set forth in the Company’s 2002 Annual Report.

Summary of Significant Accounting Policies

Description of Business

The Company provides a broad range of pediatric health care services and equipment including nursing, respiratory therapy, rental and sale of durable medical equipment, pharmaceutical services and infusion therapy services. In addition, the Company provides pediatric rehabilitation services, day treatment centers for medically fragile children, pediatric well care services and special needs educational services for pediatric patients. The Company also provides case management services in order to assist the family and patient by coordinating the provision of services between the insurer or other payor, the physician, the hospital and other health care providers. The Company’s services are designed to provide a high quality, lower cost alternative to prolonged hospitalization for medically fragile children. As a complement to its pediatric respiratory and infusion therapy services, the Company also provides respiratory and infusion therapy and related services for adults.

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 date of the financial statements and the reported amount of net revenue and expenses during the reporting period. 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 the Company operates, certain estimates are required in recording net revenue and determining the provision for doubtful accounts. Inherent in these estimates is the risk that they will have to be revised or updated as additional information becomes available to management.

Accounts Receivable

Accounts receivable include approximately $7.9 million and $7.2 million for which services have been rendered but the amounts were unbilled as of March 31, 2003 and September 30, 2002, respectively. Such unbilled amounts are primarily a result of the time required to process bills for services rendered.

PEDIATRIC SERVICES OF AMERICA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited - (Continued)

Summary of Significant Accounting Policies - continued

Identifiable Intangible Assets

Amortization expense on identifiable intangible assets was approximately $0.047 million and $0.042 million for the three months ended March 31, 2003 and 2002, respectively and approximately $0.094 million and $0.085 million for the six months ended March 31, 2003 and 2002, respectively. Estimated amortization expense of identifiable intangible assets for each of the fiscal years ending September 30, is presented below:

	For The Year Ending September 30,

2003	$	200,000
2004	$	140,000
2005	$	140,000
2006	$	122,000
2007	$	80,000

Concentration of Credit Risk

The Company’s principal financial instruments subject to potential concentration of credit risk are cash and cash equivalents and accounts receivable. Cash and cash equivalents are held primarily in one financial institution. The Company performs periodic evaluations of the relative credit standing of this financial institution.

The concentration of credit risk with respect to accounts receivable, which are primarily health care industry related, represent a risk to the Company given the current health care environment. The risk is somewhat limited due to the large number of payors including governmental payors, insurance companies, and individuals and the diversity of geographic locations in which the Company operates. However, the Company has substantial geographic density in the eastern United States, which it believes exposes the Company to payor initiated reimbursement changes.

Reclassifications

Certain amounts for prior periods have been reclassified to conform to the current year presentation.

Workers’ Compensation Loss Fund

The Company’s new insurance carrier requires the twelve month estimated loss reserve to be funded entirely with cash over the first ten months of fiscal 2003. This cash requirement is estimated to be $2.1 million, which is reduced by the monthly loss fund payments. The new insurance carrier has the right to increase this cash requirement at the end of the first twelve months if the claim experience is greater than anticipated.

Workers’ Compensation Bond Collateral

The Company has secured surety bonds of $4.0 million to satisfy its prior workers’ compensation carrier’s policy requirements. On November 4, 2002, the Company posted $0.9 million cash to its workers’ compensation third party escrow account to satisfy the expiring $1.0 million letter of credit. As a result, the surety bonds are collateralized by $2.8 million cash posted to a third party escrow account.

PEDIATRIC SERVICES OF AMERICA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited - (Continued)

Summary of Significant Accounting Policies - continued

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.

In the three and six months ended March 31, 2003, the Company had a current income tax expense of $0.7 million and $1.4 million, respectively. In the three and six months ended March 31, 2002, the Company had a current income tax benefit of $0.1 million and a current income tax expense of $0.5 million, respectively, which was offset by the reduction of the valuation allowance related to the net deferred tax asset resulting in zero income tax expense.

Stock Option Plans

The Company has elected to follow Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and related interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under SFAS 123, “Accounting for Stock-Based Compensation,” requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.

Pro forma information regarding net income and earnings per share is required by SFAS 123, determined as if the Company had accounted for its employee stock options granted subsequent to December 31, 1994 under the fair value method. The fair value of these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for the periods ending March 31, 2003 and 2002, respectively: risk-free interest rates of 2.35% and 1.95%, a dividend yield of 0.0%; volatility factors of the expected market price of the Company’s Common Stock of 126% and 138% and a weighted-average expected life of the option of four years.

For purposes of the pro forma disclosures, the estimated fair value of the options is amortized over the options’ vesting period. The Company’s pro forma information follows (in thousands, except for net income per share information):

	Three Months Ended March 31,				Six Months Ended March 31,

	2003		2002		2003		2002

Net income
As reported	$1,128		$ 1,139		$2,098		$3,996
Fair value based method compensation expense, net of related tax effect	(163	)	(156	)	(321	)	(320	)

Proforma net income	$965		$983		$1,777		$3,676

Basic income per share
As reported	$0.16		$0.17		$0.31		$0.59

Proforma	$0.14		$0.15		$0.26		$0.54

Diluted income per share
As reported	$0.16		$0.16		$0.30		$0.56

Proforma	$0.14		$0.14		$0.25		$0.51

PEDIATRIC SERVICES OF AMERICA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited - (Continued)

Summary of Significant Accounting Policies – continued

Impact of Recently Issued Accounting Standards

In December 2002, the FASB issued SFAS 148, “Accounting for Stock-Based Compensation - Transition Disclosure, An Amendment of FASB Statement No. 123” (“SFAS 148”). This statement provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of Statement No. 123 to require more prominent and more frequent disclosures in financial statements about the effects of stock-based compensation. The provisions of SFAS 148 are effective for fiscal years ending after December 15, 2002 and the interim disclosure provisions are effective for financial reports containing financial statements for interim periods beginning after December 15, 2002. The Company will continue to apply Accounting Principles Board Opinion No. 25 as the method used to account for stock-based employee compensation arrangements, where applicable, but has adopted the disclosure requirements of SFAS 148 beginning with this quarter ending March 31, 2003.

In July 2002, the FASB issued SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and supercedes Emerging Issues Task Force Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of this new Statement did not have a significant effect on the consolidated financial position, results of operations, or cash flows of the Company.

Long-Term Borrowing Arrangements

During the three months ended March 31, 2003, the Company repurchased $1.0 million of its 10% Senior Subordinated Notes due 2008 (the “Notes”). The Notes were purchased in a private transaction for $0.95 million cash, plus accrued interest. The gain (net of the write-off of the related deferred financing fees) of approximately $0.03 million is reflected in the condensed consolidated statements of operations for the three and six months ended March 31, 2003. The aggregate principal amount of the Notes outstanding as of the date of this filing is $23.4 million.

During the six months ended March 31, 2002, the Company completed a transaction to repurchase a total of $5.0 million of the Notes for $4.5 million cash plus accrued interest. The gain (net of the write-off of the related deferred financing fees) of approximately $0.4 million is reflected in the condensed consolidated statements of operations for the six months ended March 31, 2002.

PEDIATRIC SERVICES OF AMERICA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited - (Continued)

Basic and Diluted Net Income Per Share

Basic net income per share is computed using the weighted average number of shares of common stock outstanding during the period. Diluted net income per share is computed using the weighted average number of shares of common stock outstanding and the dilutive effect of common equivalent shares (calculated using the treasury stock method). The dilutive effect of the weighted average options included in the diluted earnings per share is 204,867 and 470,987 for the three months ended March 31, 2003 and 2002, respectively and 219,696 and 445,006 for the six months ended March 31, 2003 and 2002, respectively.

Commitments and Contingencies

As a result of operating in the health care industry, the Company’s business entails an inherent risk of lawsuits alleging malpractice, product liability or related legal theories, which can involve large claims and significant defense costs. The Company is, from time to time, subject to such suits arising in the ordinary course of business. The Company currently maintains professional and commercial liability insurance intended to cover such claims. As of March 31, 2003, this insurance coverage is provided under a “claims-made” policy which, subject to the terms and conditions of the policy, provides coverage for certain types of claims made against the Company 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.

As a result of a field audit by a Medicare carrier, the Company was notified of an asserted claim for recoupment of approximately $1.7 million of accounts receivable. The carrier claimed that incomplete clinical documentation was contained in the patient’s medical record to substantiate the payments for the services provided. The Company has investigated the assertion and has determined that the alleged insufficiency relates to information that is required to be maintained in the patient’s medical record.

The Company believes that a repayment of some amount is probable. At this point in time the Company’s estimate of the liability is based upon the status of its review to date, and the settlement of similar claims made against other home health care providers. Based upon this estimate, the Company accrued a $0.36 million liability in the condensed consolidated financial statements for the six months ended March 31, 2003.

During January 2003, the Medicare carrier notified the Company that it had begun recoupment of the $1.7 million under audit against weekly disbursements made to the Company. As of April 28, 2003, the Company was notified by a representative of the Medicare carrier that upon further review a significant number of the patients contained in the original audit sample were deemed to have sufficient medical documentation and would be excluded from their reported findings and a revised amount of recoupment would be forthcoming. To date a formal notification of the revised amount has not yet been received. Among the issues under examination was the Company’s compliance with a local medical review policy (“LMRP”) requiring that a specific type of documentation be included in the patient’s medical record. As of April 1, 2003, the Medicare carrier rescinded the LMRP. While this action does not directly affect the audit sample, which pre-dates the rescission of the LMRP, the Company believes that arguments it intends to cite on appeal regarding the validity of the LMRP may be bolstered by this rescission, however, the ultimate resolution of this issue cannot be predicted at this time. The Company continues to believe that its documentation for substantially all the remaining patients in the audit sample is sufficient and will ultimately be determined as such, upon appeal. Consequently, the Company believes that its accrued liability of $0.36 million recorded in the six months ended March 31, 2003 will be adequate to resolve this claim. The ultimate resolution of this asserted claim may be different from the current estimate and could have a material adverse effect on the Company’s consolidated financial or liquidity position.

PEDIATRIC SERVICES OF AMERICA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited - (Continued)

Commitments and Contingencies – continued

The Company is subject to claims and suits arising in the ordinary course of business. In the opinion of management, the ultimate resolution of such current pending legal proceedings at this time should not have a material adverse effect on the Company’s consolidated financial or liquidity position.

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

Acquisition of a Business

On January 10, 2003 the Company acquired the Pennsylvania assets of Health Med One, Inc., a Pennsylvania corporation doing business as Advanced Health Care, for a purchase price of $3.75 million in cash. The acquisition included Advanced Health Care’s pediatric private duty nursing facilities in York, Harrisburg, Allentown and Philadelphia, Pennsylvania. Pro-forma revenues from these locations are estimated to be in excess of $7.0 million annually.

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 Pediatric Services of America, Inc. (the “Company”). When used in this Form 10-Q, the words “may,” “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 the Company’s control. The Company cautions that various factors, including the factors described hereunder and those discussed in the Company’s other filings with the Securities and Exchange Commission, as well as general economic conditions, industry trends, the Company’s ability to collect for equipment sold or rented, assimilate and manage previously acquired field operations, collect accounts receivable, including receivables related to acquired businesses and receivables under appeal, hire and retain qualified personnel and comply with and respond to billing requirements issues, including those related to the Company’s billing and collection system, nurse shortages, competitive bidding, HIPAA regulations, Average Wholesale Price (“AWP”) reductions, adverse litigation, workers’ compensation losses, availability and cost of medical malpractice insurance and reduced state funding levels and nursing hours authorized by Medicaid programs, could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements of the Company made by or on behalf of the Company. Any forward-looking statement speaks only as of the date on which such statement is made, and the Company undertakes no obligation to update any forward-looking statement or statements to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of an unanticipated event. New factors emerge from time to time, and it is not possible for management to predict all of such factors. Further, management cannot assess the impact of each such factor on the business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

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

Recent Developments

Home Healthcare Industry Events & Updates

During the second quarter of fiscal 2003 a number of state legislatures were in session dealing with record budget deficits and contemplating cuts to Medicaid funding, some of which, if enacted, would reduce reimbursement levels for services provided by the Company. As is typically the case, many of the original proposals highlighted in the media were substantially modified either in committee or in the general sessions of the various legislatures. As of the date of this filing, the Company is not aware of any enacted state changes that would have a material adverse effect on the Company’s consolidated financial or liquidity position; however, many states are still considering rate or volume reductions which, if enacted could have a significant impact on the Company’s consolidated financial or liquidity position. In an effort to impact these legislative issues, the Company engaged consultants in selective markets to directly present the Company’s cost saving strategies and related rate requests to the Medicaid programs. In addition, the Company’s local market staff routinely advocates to the appropriate community and regulatory authorities on behalf of the Company and its patients.

In addition, a few states are experiencing internal problems with the administration of their Medicaid programs, which are temporarily disrupting payments of claims for services rendered by the Company.

Company Events & Updates

The Company has investigated the assertion and has determined that the alleged insufficiency relates to information that is required to be maintained in the patient’s medical record.

During January 2003, a Medicare carrier notified the Company that it had begun recoupment of the $1.7 million under audit against weekly disbursements made to the Company. As of April 28, 2003, the Company was notified by a representative of the Medicare carrier that upon further review a significant number of the patients contained in the original audit sample were deemed to have sufficient medical documentation and would be excluded from their reported findings and a revised amount of recoupment would be forthcoming. To date a formal notification of the revised amount has not yet been received. Among the issues under examination was the Company’s compliance with a local medical review policy (“LMRP”) requiring that a specific type of documentation be included in the patient’s medical record. As of April 1, 2003, the Medicare carrier rescinded the LMRP. While this action does not directly affect the audit sample, which pre-dates the rescission of the LMRP, the Company believes that arguments it intends to cite on appeal regarding the validity of the LMRP may be bolstered by this rescission, however, the ultimate resolution of this issue cannot be predicted at this time. The Company continues to believe that its documentation for substantially all the remaining patients in the audit sample is sufficient and will ultimately be determined as such, upon appeal. Consequently, the Company believes that its accrued liability of $0.36 million recorded in the six months ended March 31, 2003 will be adequate to resolve this claim. The ultimate resolution of this asserted claim may be different from the current estimate and could have a material adverse effect on the Company’s consolidated financial or liquidity position.

On January 10, 2003, the Company acquired the Pennsylvania assets of Health Med One, Inc., a Pennsylvania corporation doing business as Advanced Health Care, for a purchase price of $3.75 million in cash. The acquisition includes Advanced Health Care’s pediatric private duty nursing facilities in York, Harrisburg, Allentown and Philadelphia, Pennsylvania. Pro-forma revenues from these locations are estimated to be in excess of $7.0 million annually.

During the three months ended March 31, 2003, the Company repurchased $1.0 million of its Notes. The Notes were purchased in a private transaction for $0.95 million cash, plus accrued interest. The gain (net of the write-off of the related deferred financing fees) of approximately $0.03 million is reflected in the condensed consolidated statements of operations for the three and six months ended March 31, 2003. The aggregate principal amount of the Notes outstanding as of the date of this filing is $23.4 million.

The Company anticipates opening a new pilot Prescribed Pediatric Extended Care center, (“PPEC”) in North Carolina during the third quarter of this fiscal year. This PPEC will be an important step in establishing the PPEC concept in the state of North Carolina where the Company owns and operates seven private duty nursing locations as well as pharmacy and respiratory businesses. The Company believes that the potential exists to create a statewide network of centers in North Carolina and may use this relationship model in other states.

The Company’s management will continue to assess its various growth opportunities, ranging from evaluation of acquisition alternatives in key markets, geographical expansion through the use of start-up branch offices, marketing initiatives’ impact on existing branch office growth and technology improvements in order to ration capital available from operations.

Risk Management

On October 1, 2002, the Company completed its annual renewal of its risk management program and implemented several changes. Due to the exiting of St. Paul Fire and Marine Insurance Company from the medical malpractice insurance marketplace, the Company has entered into a new insurance program for medical malpractice, commercial and general liability coverage with Arch Specialty Insurance Company, rated A- by AM Best Company. Material changes included an increase in per claim deductible limits from $250,000 to $1,000,000. The annual aggregate also changed from $750,000 to no annual aggregate. The policy amount remains at $10,000,000 with a

slight increase in annual premiums. However, the Company chose to decline renewal of a $10,000,000 umbrella policy due to significant price increases.

The Company’s third party actuary has completed an analysis of the Company’s medical malpractice loss history and has quantified liability recognition for fiscal 2003 under the new policy terms. Under the new medical malpractice policy, if the Company’s loss experience worsens it could have a material adverse effect on the Company’s financial results and liquidity position. In recognition of the increased exposure, the Company has further re-engineered its risk management processes. The Company’s Risk Committee continues to monitor incident reporting and claim adjustment activity, and also reviews existing patient census and discharges high-risk cases where legally permissible. The Company continues to educate location staff on risk management procedures including appropriate nurse staffing decisions.

Operations

The Company continues to experience downward pressure on its operating margins. The most notable factors include: (1) nurse shortages, (2) increased insurance costs, (3) selected reductions in pharmacy reimbursements and increased product acquisition costs, (4) negative risk loss experience, (5) select state Medicaid program funding reductions and a decrease in Medicaid nursing hours authorized and (6) increased revenue from existing start-up locations offset by increased costs from locations which opened during fiscal 2003. The Company has implemented a number of programs to try to improve operating margins which include: staffing reductions at selected locations including the corporate office, primarily through position eliminations, reductions in workforce and attrition; certain supplier relationships have been adjusted to yield cost savings while still satisfying business requirements; and full implementation of the nurse scheduling system. In addition, the Company has engaged consultants and commenced negotiations with a number of state Medicaid programs to identify additional opportunities for the Company’s private duty nursing and PPEC services which could provide the states with lower cost alternatives to existing care plans.

The Company continues to pursue a managed care marketing strategy which focuses on select key markets with unfulfilled market share potential. The Company’s regional managed care sales personnel work directly with branch office directors to increase local market share. Initiatives include: (1) identification of the dominant local market managed care companies and their provider networks, (2) coordinated marketing and contracting efforts, (3) relationship development and expansion with key referral sources, (4) appropriate patient intakes, (5) development of clinical outcome reporting to satisfy contractual obligations and demonstrate cost savings to the payor, and (6) effective coordination with local market Medicaid programs. The Company recently made senior management changes in its managed care marketing organization in an effort to accelerate progress on these initiatives.

The Company is aware of ongoing changes in the infusion drug delivery alternatives available to various payors. If some of these alternatives are selected by various payors, there could be significant reductions to the Company’s future pharmacy revenues. In addition, the Company remains exposed to significant revenue fluctuations as a result of change in service or usage levels by a limited number of hemophilia factor patients. The Company is expanding its capability to distribute injectable medication nationally and continues to assess opportunities for these injectables in selected payor patient populations. The Company’s marketing strategy is to capitalize on core product opportunities within these patient populations, as well as to expand product offerings. Start-up operations are underway for pharmacy, diabetic and respiratory therapy supply distribution programs.

Source & Availability of Clinical Personnel

During the 13 weeks ending March 27, 2003, the Company experienced a decrease in total hours ordered and case hours staffed. The un-staffed hours increased to approximately 12% of total hours ordered as compared to the prior rolling 13 week period ending December 26, 2002 which was 10%. The Company experienced a reduction in the number of hours staffed in the Northeast due to inclement weather affecting our location operations. The Company continues to aggressively compete for nurses to staff hours ordered, retain nurses with select wage and benefit improvements and implement employee satisfaction initiatives. To date, management has seen inconsistent results in a number of markets and will continue to assess and respond accordingly. Management anticipates that with the full implementation of the nurse

scheduling system, improvements in both un-staffed hours and gross margin levels should occur over time; however, there can be no assurance that this will occur.

The following table represents the approximate total hours for the time periods indicated:

	Total hours ordered	Total hours declined	Total case hours staffed	Total case hours un-staffed

Rolling 13 weeks ended December 26, 2002	905,480	88,497	723,529	93,454
Rolling 13 weeks ended March 27, 2003	895,630	87,554	699,806	108,270

Critical Accounting Policies

Net Revenue

Due to the nature of the health care industry and the reimbursement environment in which the Company operates, certain estimates are required to record net revenues and accounts receivable at their 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 management. Specifically, the complexity of many third-party billing arrangements and the uncertainty of reimbursement amounts for certain 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 account review. As of March 31, 2003, the Company had no material claims, disputes or unsettled matters with third-party payors, nor were there any material pending settlements with third-party payors except as disclosed under the “Recent Developments” section above.

Net revenue represents the estimated net realizable amounts from patients, third-party payors and others for patient services rendered and products provided. Such revenue is recognized as the treatment plan is administered to the patient and recorded at amounts estimated to be received under reimbursement arrangements with payors. Net revenues to be reimbursed by contracts with third-party payors are recorded at an amount to be realized under these contractual arrangements. Revenues from Medicaid and Medicare are generally based on reimbursement of the reasonable direct and indirect costs of providing services to program participants. In certain situations, the services and products are recorded separately. In other situations, the services and products are billed and reimbursed on a per diem or contract basis whereby the insurance carrier pays the Company one combined amount for treatment. Because the reimbursement arrangements in these situations are based on a per diem or contract amount, the Company does not maintain records that provide a breakdown between the service and product components.

The Company has developed a methodology to record the estimated revenue as a result of the inherent time lag between certain patient treatments and input of the related information into its 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. As of September 30, 2002 the estimated revenue was approximately 0.5% of revenue for fiscal year ended 2002. Any unforeseen volatility to either the time or activity level at specific branch offices has the potential to significantly impact the estimate.

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 the Company’s billing and collection system. The Company has developed a methodology that measures the relative magnitude of these events over recent time periods and applies this methodology to reduce net revenues recognized in the current period.

Allowance for Doubtful Accounts

In determining the adequacy of the allowance and related provision for doubtful accounts, the Company has developed a process that combines statistical analysis of historical collection 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. These assessments are aggregated and compared to the results of the statistical analysis to provide additional support to management in making the estimate of the allowance for doubtful accounts. 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.

Goodwill and Other Acquired Intangible Assets

The Statement of Financial Accounting Standards (“SFAS”) No. 142 eliminates goodwill amortization from the consolidated statements of operations and requires an evaluation of goodwill for impairment on an annual basis, and more frequently if circumstances indicate a possible impairment. The Company performs its annual impairment test in the fourth quarter of each fiscal year. For these evaluations, the Company is using an implied fair value approach, which uses a discounted cash flow analysis and other valuation methodologies. These evaluations use many assumptions and estimates in determining an impairment loss, including certain assumptions and estimates related to future earnings. The Company completed the impairment test and, at September 30, 2002, there was no resulting impairment. Subsequent impairments, if any, would be classified as operating expense.

Intangible assets that meet certain criteria will qualify for recording on the consolidated balance sheet and will continue to be amortized in the consolidated statements of operations. Such intangible assets will be subject to a periodic impairment test based on estimated fair value.

Accrued Insurance

The Company’s insurance broker retained the services of an independent actuary to prepare an actuarial analysis of the Company’s development of reported and incurred but not reported claims. These estimates are updated quarterly and are used in the valuation of the accrued insurance liability. 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.

Results of Operations

The following table is derived from the Company’s 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 Percentage Increase (Decrease)

	Three Months ended March 31,				Six Months ended March 31,				Three Months ended March 31,			Six Months ended March 31,

	2003		2002		2003		2002		2003			2003

Net revenue	100.0	%	100.0	%	100.0	%	100.0	%		12	%		9	%
Operating salaries, wages and employee benefits	43.9		46.8		43.9		46.4			5			3
Other operating costs	40.8		37.4		40.6		36.3			22			22
Corporate, general and administrative	8.7		9.2		8.8		9.4			6			3
Provision for doubtful accounts	0.2		0.7		0.4		0.7			(63	)		(38	)
Depreciation and amortization	1.9		2.1		2.0		2.2			2			(1	)

Operating income	4.5		3.8		4.3		5.0			29			(8	)
Other income	0.1		—		—		—			—			—
Early extinguishment of debt	0.1		—		—		0.4			—			(92	)
Interest income	0.1		0.0		0.1		0.1			52			(19	)
Interest expense	(1.2	)	(1.5	)	(1.2	)	(1.5	)		(13	)		(11	)

Income before income tax expense	3.6	%	2.3	%	3.2	%	4.0	%		63	%		(13	)%

The Company provides a broad range of health care services and products principally for children and, to a lesser extent, young adults and geriatric patients. The following table summarizes both services and products based upon estimated percentages of net revenue to total net revenue of each major category from continuing operations offered by the Company for the periods indicated. The prior period includes reclassifications.

	Three Months Ended March 31,				Six Months Ended March 31,

(In thousands)	2003		2002		2003		2002

Pediatric Home Health Care
Nursing	$	21,918	$	20,522	$	42,981	$	41,539
Respiratory Therapy Equipment and Home Medical Equipment		4,623		4,162		9,347		8,597
PPEC		1,656		1,544		3,197		2,996
Pharmacy and Other		13,635		11,498		26,788		22,775

Total Pediatric Home Health Care		41,832		37,726		82,313		75,907

Adult Home Health Care:
Nursing		2,697		2,883		5,431		5,808
Respiratory Therapy Equipment and Home Medical Equipment		5,202		4,440		10,761		9,321
PPEC		—		—		—		—
Pharmacy and Other		3,906		3,016		7,694		6,169

Total Adult Home Health Care		11,805		10,339		23,886		21,298

Total Net Revenue	$	53,637	$	48,065	$	106,199	$	97,205

Three Months Ended March 31, 2003 Compared to Three Months Ended March 31, 2002

Net revenue increased $5.6 million, or 12%, to $53.6 million in the three months ended March 31, 2003 from $48.1 million in the three months ended March 31, 2002. Pediatric home health care net revenue increased by $4.1 million for the three months ended March 31, 2003, due to a number of factors, including, the acquisition of pediatric private duty nursing facilities in Pennsylvania, increased pharmacy deliveries to new and existing hemophilia factor patients, seasonal Synagis and other core products and increased provision of core respiratory products and services as compared to the three months ended March 31, 2002. Adult health care net revenue increased $1.5 million for the three months ended March 31, 2003, primarily as a result of an increase in the provision of core products and services to respiratory therapy patients and increased pharmacy deliveries. In the three months ended March 31, 2003, the Company derived approximately 51% of its net revenue from commercial insurers and other private payors, 42% from Medicaid and 7% from Medicare.

Operating salaries, wages and employee benefits consist primarily of branch office employee costs. Operating salaries, wages and employee benefits increased $1.1 million, or 5%, to $23.5 million in the three months ended March 31, 2003 from $22.5 million in the three months ended March 31, 2002. The Company experienced increases in its labor costs for nursing and branch office staff for both existing and new start-up locations in the three months ended March 31, 2003 as compared to the three months ended March 31, 2002. As a percentage of net revenue, operating salaries, wages and employee benefits for the three months ended March 31, 2003 decreased to 44% from 47% for the three months ended March 31, 2002.

Other operating costs include medical supplies, branch office rent, utilities, vehicle expenses, allocated insurance costs and cost of sales. Cost of sales consists primarily of the costs of pharmaceuticals and related services. Other operating costs increased $3.9 million, or 22%, to $21.9 million in the three months ended March 31, 2003 from $18.0 million in the three months ended March 31, 2002. The increase in other operating costs relates primarily to increased pharmacy deliveries, business insurance costs, facility costs for new startup locations and medical supply usage. As a percentage of net revenue, other operating costs for the three months ended March 31, 2003 increased to 41% from 37% for the three months ended March 31, 2002.

Corporate, general and administrative costs increased $0.3 million, or 6% to $4.7 million in the three months ended March 31, 2003 from $4.4 million in the three months ended March 31, 2002. The increase relates primarily to increased managed care marketing personnel and increased professional service costs. As a percentage of net revenue, corporate, general and administrative costs remained relatively constant at 9%.

Provision for doubtful accounts decreased $0.2 million, or 63% to $0.1 million in the three months ended March 31, 2003 from $0.4 million in the three months ended March 31, 2002. Cash collections as a percentage of net revenue were 96% and 98% for the three months ended March 31, 2003 and 2002, respectively. In connection with the acquisition of Advanced Health Care’s Pennsylvania facilities, the Company has encountered delays in obtaining new provider numbers from the State, which has resulted in services performed remaining as unbilled accounts receivable of approximately $0.6 million until such provider numbers are obtained.

Depreciation and amortization remained relatively unchanged at $1.0 million in the three months ended March 31, 2003 as compared to the three months ended March 31, 2002. As a percentage of net revenue, depreciation and amortization remained relatively constant at 2%.

Interest expense decreased $0.1 million, or 13%, to $0.6 million in the three months ended March 31, 2003 from $0.7 million in the three months ended March 31, 2002. The Company’s average debt outstanding decreased $3.8 million as the Company completed several transactions to repurchase a portion of the Notes.

Interest income increased $0.01 million to $0.03 million in the three months ended March 31, 2003 from $0.02 million in the three months ended March 31, 2002. The Company invested its excess cash balances in highly liquid guaranteed principal investments.

Six Months Ended March 31, 2003 Compared to Six Months Ended March 31, 2002

Net revenue increased $9.0 million, or 9%, to $106.2 million in the six months ended March 31, 2003 from $97.2 million in the six months ended March 31, 2002. Pediatric home health care net revenue increased by $6.4 million for the six months ended March 31, 2003, due to a number of factors, including, the acquisition of pediatric private duty nursing facilities in Pennsylvania, increased pharmacy deliveries to new and existing hemophilia factor patients, seasonal Synagis and other core products and increased provision of core respiratory products and services as compared to the six months ended March 31,2002. Adult health care net revenue increased $2.6 million for the six months ended March 31, 2003, primarily as a result of an increase in the provision of core products and services to respiratory therapy patients and increased pharmacy deliveries. In the six months ended March 31, 2003, the Company derived approximately 51% of its net revenue from commercial insurers and other private payors, 42% from Medicaid and 7% from Medicare.

Operating salaries, wages and employee benefits consist primarily of branch office employee costs. Operating salaries, wages and employee benefits increased $1.6 million, or 3%, to $46.7 million in the six months ended March 31, 2003 from $45.1 million in the six months ended March 31, 2002. The Company experienced increases in its labor costs for nursing and branch office staff for both existing and new start-up locations in the six months ended March 31, 2003 as compared to the six months ended March 31, 2002. As a percentage of net revenue, operating salaries, wages and employee benefits for the six months ended March 31, 2003 decreased to 44% from 46% for the six months ended March 31, 2002.

Other operating costs include medical supplies, branch office rent, utilities, vehicle expenses, allocated insurance costs and cost of sales. Cost of sales consists primarily of the costs of pharmaceuticals and related services. Other operating costs increased $7.9 million, or 22%, to $43.1 million in the six months ended March 31, 2003 from $35.2 million in the six months ended March 31, 2002. The increase in other operating costs relates primarily to increased pharmacy deliveries, business insurance costs, facility costs for new startup locations and medical supply usage. As a percentage of net revenue, other operating costs for the six months ended March 31, 2003 increased to 41% from 36% for the six months ended March 31, 2002.

Corporate, general and administrative costs increased $0.2 million, or 3% to $9.4 million in the six months ended March 31, 2003 from $9.1 million in the six months ended March 31, 2002. The increase relates primarily to increased managed care marketing personnel and increased professional service costs. As a percentage of net revenue, corporate, general and administrative costs remained relatively constant at 9%.

Provision for doubtful accounts decreased $0.3 million, or 38%, to $0.4 million in the six months ended March 31, 2003 from $0.7 million in the six months ended March 31, 2002. Cash collections as a percentage of net revenue were 97% and 99% for the six months ended March 31, 2003 and 2002, respectively. In connection with the acquisition of Advanced Health Care’s Pennsylvania facilities, the Company has encountered delays in obtaining new provider numbers from the State, which has resulted in services performed remaining as unbilled accounts receivable of approximately $0.6 million until such provider numbers are obtained.

Depreciation and amortization remained relatively unchanged at $2.1 million in the six months ended March 31, 2003 as compared to the six months ended March 31, 2002. As a percentage of net revenue, depreciation and amortization remained relatively constant at 2%.

Interest expense decreased $0.2 million, or 11%, to $1.3 million in the six months ended March 31, 2003 from $1.4 million in the six months ended March 31, 2002. The Company’s average debt outstanding decreased $3.7 million as the Company completed several transactions to repurchase a portion of the Notes.

Interest income decreased $0.02 million to $0.07 million in the six months ended March 31, 2003 from $0.08 million in the six months ended March 31, 2002. The Company invested its excess cash balances in highly liquid guaranteed principal investments.

Liquidity and Capital Resources

Company Events & Updates

On January 14, 2003, the Company completed a transaction to repurchase a total of $1.0 million of the Notes for $0.95 million cash, plus accrued interest. The gain (net of the write-off of the related deferred financing fees) of approximately $0.03 million is reflected in the condensed consolidated statement of operations for the three and six months ended March 31, 2003.

The Indenture under which the Notes were issued allows the Company to repurchase the Notes at its discretion. All bids to repurchase have been based upon a number of factors including cash availability, interest rates on invested cash, other capital investment alternatives, and relative ask prices quoted by the market maker. Each decision by the Company to repurchase has been arrived at independently using the above criteria and the Company does not have a formal plan in place to repurchase the Notes.

On January 10, 2003, the Company acquired the Pennsylvania assets of Health Med One, Inc., a Pennsylvania corporation doing business as Advanced Health Care for a purchase price of $3.75 million in cash. The acquisition includes Advanced Health Care’s pediatric private duty nursing facilities in York, Harrisburg, Allentown and Philadelphia, Pennsylvania. Pro-forma revenues from these locations are estimated to be in excess of $7.0 million annually.

Operations

Cash collections as a percentage of net revenue for the three months ended March 31, 2003 and 2002 were 96% and 98%, respectively. In connection with the acquisition of Advanced Health Care’s Pennsylvania facilities, the Company has encountered delays in obtaining new provider numbers from the State, which has resulted in services performed remaining as unbilled accounts receivable of approximately $0.6 million until such provider numbers are obtained. While management anticipates the Company will continue to achieve its cash collection targets, there can be no assurance that disruptions to cash flow will not occur.

Among a number of states, one has encountered three missed deadlines by its contractor for implementation of a new computer system designed to standardize its technology platform and facilitate faster claims payment. As a result, the percentage of Medicaid claims being paid in a timely manner has declined by half. While the Company has encountered only modest disruption of our payment cycles to date, the Company continues to monitor the situation on a weekly basis and will aggressively pursue collection of monies due.

For the six months ended March 31, 2003, the Company purchased medical equipment with technology upgrades to service existing patients, and made routine purchases of computer equipment to maintain and upgrade its technology infrastructure. The Company anticipates future capital expenditures for maintenance, support and enhancements of existing technology, continued investments in new start up locations and continued durable medical equipment purchases. The Company anticipates funding these capital expenditures with cash flow from operations.

For the three and six months ended March 31, 2003, the Company had a current income tax expense of $0.7 million and $1.4 million.

Risk Management

As a result of operating in the health care industry, the Company’s business entails an inherent risk of lawsuits alleging malpractice, product liability or related legal theories, which can involve large claims and significant defense costs. The Company is, from time to time, subject to such suits arising in the ordinary course of business. The Company currently maintains professional and commercial liability insurance intended to cover such claims. As of March 31, 2003, 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 the Company 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 the Company’s insurance policy will be adequate.

In addition, the Company is subject to accident claims arising out of the normal operation of its fleet of vans and small trucks, and maintains insurance intended to cover such claims. A successful claim against the Company in excess of the Company’s insurance coverage could have an adverse effect upon the Company’s business. Claims against the Company, regardless of their merits or eventual outcome also may have an adverse effect upon the Company’s reputation and business.

Capital Resources

Management currently believes that its liquidity position will be adequate to satisfy the Company’s working capital requirements, professional and commercial liability insurance loss funding, funding of start-up locations, selected acquisitions, workers’ compensation collateral requirements, and income tax payments. The Company’s current source of liquidity is cash on hand and cash flow from operations and as a result, the Company is exposed to fluctuations in cash collection results. The Company has engaged a financial advisor to review capital structure alternatives necessary to support the Company’s growth plans. These alternatives include recapitalization of its debt obligations to take advantage of potential interest rate arbitrage opportunities and financing of potential acquisitions. However, there can be no assurance that external financing to satisfy a preferred alternative will be obtained.

Variation in Quarterly Operating Results

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

Contingent Liabilities and Commitments

The Company’s former workers’ compensation carrier requires the estimated loss reserve to be secured by surety bonds. As of March 31, 2003, the Company had posted $2.8 million cash as collateral for $4.0 million surety bonds. The carrier has the right to require the Company to post cash up to the loss reserve liability. In addition, all loss fund payments are made monthly from cash flow from operations.

The Company’s new workers’ compensation insurance carrier requires the twelve month estimated loss reserve to be funded entirely with cash over the first ten months of fiscal 2003. This cash requirement is estimated to be $2.1 million, which is reduced by the monthly loss fund payments. The new insurance carrier has the right to increase this cash requirement at the end of the first twelve months if the claim experience is greater than anticipated.

During January 2003, a Medicare carrier notified the Company that it had begun recoupment of the $1.7 million under audit against weekly disbursements made to the Company. As of April 28, 2003, the Company was notified by a representative of the Medicare carrier that upon further review a significant number of the patients contained in the original audit sample were deemed to in fact have sufficient medical documentation and would be excluded from their reported findings and a revised amount of recoupment would be forthcoming. To date a formal notification of the revised amount has not yet been received. Among the issues under examination was the Company’s compliance with a local medical review policy (“LMRP”) requiring that a specific type of documentation be included in the patient’s medical record. As of April 1, 2003, the Medicare carrier rescinded the LMRP. While this action does not directly affect the audit sample, which pre-dates the rescission of the LMRP, the Company believes that arguments it intends to cite on appeal regarding the validity of the LMRP may be bolstered by this rescission, however, the ultimate resolution of this issue cannot be predicted at this time. The Company continues to believe that its documentation for substantially all the remaining patients in the audit sample is sufficient and will ultimately be determined as such, upon appeal. Consequently, the Company believes that its accrued liability of $0.36 million recorded in the six months ended March 31, 2003 will be adequate to resolve this claim. The ultimate resolution of this asserted claim may be different than the current estimate and could have a material adverse effect on the Company’s consolidated financial or liquidity position.

The following table represents a schedule of the Company’s contractual obligations and commitments as of March 31, 2003:

	Payments Due by Period (In thousands)

	Total		Less Than 1 Year		1-3 Years		4-5 Years		After 5 Years

Contractual Obligations:
Long-term debt
Subordinated Notes	$	23,350	$	—	$	—	$	—	$	23,350
Other notes payable		348		153		195		—		—
Operating leases		14,759		4,246		6,315		2,838		1,360

	$	38,457	$	4,399	$	6,510	$	2,838	$	24,710

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company faces a number of market risk exposures including risks related to cash and cash equivalents, accounts receivable and interest rates. Cash and cash equivalents are held primarily in one financial institution. The Company performs periodic evaluations of the relative credit standing of this financial institution. The concentration of credit risk with respect to accounts receivable, which are primarily health care industry related, represent a risk to the Company given the current environment in the health care industry. The risk is somewhat limited due to the large number of payors including governmental payors, insurance companies, individuals and the diversity of geographic locations in which the Company operates. However, the Company has substantial geographic density in the eastern United States which it believes exposes the Company to payor initiated reimbursement changes.

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

Based on a hypothetical immediate 150 basis point increase in interest rates at March 31, 2003 and 2002, the market value of the Company’s Notes would be reduced by approximately $1.2 million and $1.8 million, respectively. Conversely, a 150 basis point decrease in interest rates would result in a net increase in the market value of the Company’s Notes outstanding at March 31, 2003 and 2002 of approximately $1.2 million and $2.0 million, respectively.

ITEM 4.

CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures. The Company’s chief executive officer and chief financial officer are responsible for establishing and maintaining “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-14(c) and 15d-14(c)) for the Company. The Company’s disclosure controls and procedures include the Company’s “internal controls,” as that term is used in Section 302 of the Sarbanes-Oxley Act of 2002 and described in the Securities and Exchange Commission’s Release No. 34-46427 (August 29, 2002). The Company’s chief executive officer and chief financial officer, after evaluating the effectiveness of the Company’s disclosure controls and procedures as of a date within 90 days before the filing date of this Quarterly Report on Form 10-Q, have concluded that the Company’s disclosure controls and procedures are adequate and effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic SEC filings.

(b) Changes in internal controls. There were no significant changes in the Company’s internal controls or in other factors that could significantly affect those controls subsequent to the date of the evaluation. As a result, there were no corrective actions to be taken.

PART II - OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

On March 11, 1999, a putative class action complaint was filed against the Company in the United States District Court for the Northern District of Georgia. The Company and certain of its then current officers and directors were among the named defendants. To the Company’s knowledge, no other putative class action complaints were filed within the 60-day time period provided for in the Private Securities Litigation Reform Act. The plaintiffs and their counsel were appointed lead plaintiffs and lead counsel, and an amended complaint was filed on or about July 22, 1999. The amended complaint did not specify an amount or range of damages that the plaintiffs were seeking. In general, the plaintiffs alleged that prior to the decline in the price of the Company’s Common Stock on July 28, 1998, there were violations of the Federal Securities Laws arising from misstatements of material information in and/or omissions of material information from certain of the Company’s securities filings and other public disclosures principally related to its reporting of accounts receivable and the allowance for doubtful accounts. The

amended complaint purported to expand the class to include all persons who purchased the Company’s Common Stock during the period from July 29, 1997 through and including July 29, 1998. On October 8, 1999, the Company and the individuals named as defendants moved to dismiss the amended complaint on both substantive and procedural grounds. On March 30, 2000, the Court denied the motions to dismiss. On May 15, 2000, the Company and the individuals named as defendants filed their answer, denying liability.

On February 27, 2001, Plaintiffs’ Motion for Class Certification was granted by the Court. Fact discovery in the case closed on July 31, 2001. On September 5, 2001, Plaintiffs moved for leave to file a Second Amended Complaint and to expand the class period. The proposed Second Amended Complaint purported to expand the class to include all persons who purchased the Company’s stock between November 11, 1996 and July 28, 1998. The Court denied Plaintiffs Motion on October 12, 2001.

In January, 2002, the parties entered into a Stipulation of Settlement settling all claims asserted in the lawsuit against all parties for a total of $3.2 million, subject to court approval. On March 14, 2002, following a hearing on the fairness, reasonableness and adequacy of the proposed settlement, the Court entered an Order approving the settlement. The time for appeal of the Settlement Order has expired and no appeal has been taken. Under the terms of the settlement, the $3.0 million contribution of the Company to the settlement was fully funded by its insurance carrier under its Directors and Officers insurance policy.

On July 28, 1999, a civil action was filed against the Company and certain of its current and former officers and directors in the United States District Court for the Middle District of Tennessee. The action was filed by Phyllis T. Craighead and Healthmark Partners, LLC, as well as a liquidating trust apparently established to wind up the business affairs of their corporation, Kids & Nurses, Inc. In the original complaint, in general, the plaintiffs alleged that the defendants violated Federal and Tennessee Securities Laws and committed common law fraud in connection with the Company’s purchase of Kids & Nurses, Inc. in November, 1997. The plaintiffs sought actual damages in an amount between $2.5 million and $3.5 million, plus punitive damages and the costs of litigation, including reasonable attorneys’ fees. On September 24, 1999, the defendants filed a motion to dismiss the complaint on both substantive and procedural grounds. On December 20, 1999, the plaintiffs filed an amended complaint in which they withdrew their claims under the Federal Securities Laws, and added claims under Georgia’s securities laws. The plaintiffs also filed a brief in response to the Company’s motion to dismiss. On February 1, 2000, the defendants filed an amended motion to dismiss addressing the allegations of the amended complaint. On March 29, 2001, the motion to dismiss was denied without prejudice pending a ruling by the Tennessee Supreme Court on an unrelated case. On May 2, 2001, the Company and the individuals named as defendants, filed their answer, denying liability. On May 8, 2002, the case was dismissed with prejudice, subject only to the Plaintiffs’ reservation of their rights to participate in the Class Settlement.

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The 2003 Annual Meeting of Shareholders of the Company was held on February 12, 2003. Proxies with regard to the matters to be voted upon at the Annual Meeting were solicited under Regulation 14A of the Securities Exchange Act of 1934, as amended. Set forth below is a brief description of each matter voted upon at the Annual Meeting and the results of the voting on each matter:

Election of Joseph D. Sansone as director for a term of three years expiring at the 2006 Annual Meeting of Shareholders.

	Votes				Broker

Nominee	For		Withheld		Abstentions	Non-Votes


Joseph D. Sansone	3,661,868 (54.7%	)	3,032,985 (45.3%	)	—	—

The terms of Messrs. Pinkas, Wissing, Finn and Axelrod continued after the Annual Meeting.

ITEM 6.

EXHIBITS AND REPORTS ON FORM 8-K.

(a)

Exhibits

No exhibits are filed as part of this report.

(b)

Reports on Form 8-K

On January 7, 2003, the Company filed a Current Report on Form 8-K responding to an Amended Schedule 13D filed with the Securities and Exchange Commission on December 30, 2003 by beneficial shareholder, David Nierenberg.

SIGNATURES

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

	PEDIATRIC SERVICES OF AMERICA, INC. (Registrant)
Date: May 12, 2003	By:	/s/ JAMES M. MCNEILL

		James M. McNeill Senior Vice President, Chief Financial Officer, Treasurer and Secretary (Duly authorized officer and Principal Financial Officer)

CERTIFICATION PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Joseph D. Sansone, certify that:

I have reviewed the quarterly report on Form 10-Q of Pediatric Services of America, Inc.;

Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under with such statements are made, not misleading with respect to the period covered by this quarterly report;

Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report.

The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing of this quarterly report (the “Evaluation Date”); and

presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or person performing the equivalent functions):

all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

The registrant’s other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.


				/s/ JOSEPH D. SANSONE

				Joseph D. Sansone President and Chief Executive Officer May 12, 2003

CERTIFICATION PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, James M. McNeill, certify that:

I have reviewed the quarterly report on Form 10-Q of Pediatric Services of America, Inc.;

evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing of this quarterly report (the “Evaluation Date”); and

presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and


				/s/ JAMES M. MCNEILL

				James M. McNeill Senior Vice President and Chief Financial Officer May 12, 2003