10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

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

For the fiscal year ended December 31, 2005

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 No. 000-50364

The Providence Service Corporation

(Exact name of registrant as specified in its charter)

Delaware	86-0845127
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
5524 East Fourth Street, Tucson, Arizona	85711
(Address of principal executive offices)	(Zip code)

Registrant’s telephone number, including area code

(520) 747-6600

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $0.001 par value per share

(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.     ¨  Yes    x  No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.     ¨  Yes    x  No

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.    x  Yes    ¨  No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “Accelerated file and Large accelerated filer” in Rule 12b-2 of the Act. (Check one):

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

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates based on the closing price for such common equity as reported on the Nasdaq National Market on the last business day of the registrant’s most recently completed second fiscal quarter (June 30, 2005) was $231,885,706.

As of March 15, 2006, there were outstanding 9,681,850 shares (excluding treasury shares of 146,905) of the registrant’s Common Stock, $.001 par value per share, which is the only outstanding capital stock of the registrant.

DOCUMENTS INCORPORATED BY REFERENCE

None.

TABLE OF CONTENTS

		Page No.
	PART I
Item 1.	Business	1
Item 1A.	Risk Factors	14
Item 1B.	Unresolved Staff Comments	24
Item 2.	Properties	24
Item 3.	Legal Proceedings	24
Item 4.	Submission of Matters to a Vote of Security Holders	24
	PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	25
Item 6.	Selected Financial Data	26
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operation	28
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	55
Item 8.	Financial Statements and Supplementary Data	56
Item 9.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure	95
Item 9A.	Controls and Procedures	95
Item 9B.	Other Information	96
	PART III
Item 10.	Directors and Executive Officers of the Registrant	97
Item 11.	Executive Compensation	101
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	106
Item 13.	Certain Relationships and Related Transactions	109
Item 14.	Principal Accounting Fees and Services	109
	PART IV
Item 15.	Exhibits, Financial Statement Schedules	110
SIGNATURES		114
EXHIBIT INDEX

PART I

Item 1.    Business

We deliver privatized social services

We provide and manage government sponsored social services. Our counselors, social workers and mental health professionals work with clients who are eligible for government assistance due to income level, emotional/educational disabilities or court order. The state and local government agencies that fund the services we provide are required by law to provide counseling, case management, foster care and other support services to eligible individuals and families. We do not own or operate any hospitals, residential treatment centers or group homes. Instead, we provide care primarily in the client’s home or community, reducing the cost to the government of such services while affording the client a better quality of life. Since our inception, we have grown from 1,333 clients served in a single state to approximately 35,600 clients served, either directly or through our managed entities, from 204 locations in 25 states and the District of Columbia as of December 31, 2005.

Our revenue is derived from our provider contracts with state and local government agencies and government intermediaries and our management contracts with not-for-profit social services organizations. The government entities that pay for our services include welfare, child welfare and justice departments, public schools and state Medicaid programs. Under a majority of the contracts where we provide services directly, we are paid an hourly fee. Under other contracts we receive a set monthly amount or we are paid amounts equal to the costs we incur to provide agreed upon services. Where we contract to manage the operations of a not-for-profit social services provider, we receive a management fee that is either based upon a percentage of the revenues of the managed entity or a predetermined fee.

When we formed our business as a Delaware corporation in 1996, most government social services were delivered directly by governments in institutional settings such as psychiatric hospitals, residential treatment centers or group homes. We recognized that social services could be delivered more economically and effectively in a home or community based setting. Additionally, we anticipated that payers would increasingly seek to privatize the provision of these social services in order to reduce costs and provide quality social services to an increasing number of recipients. Based on this outlook, we developed a system for delivering these services that is less costly and, we believe, more effective than the traditional institutional care system.

Social services environment

Many different agencies and programs, including welfare, child welfare and justice departments, public schools and state Medicaid programs, fund government social services. Historically, governments have provided social services directly to eligible individuals and have often provided these services in institutional settings. We believe there are growing trends in the United States toward privatization of government social services and the delivery of these social services in non-institutional settings. The following factors contribute to these trends:

• Large population of eligible beneficiaries.    Government funded social services are available to persons who are eligible for assistance due to income level, emotional/educational disabilities or court order. The following statistics demonstrate the significant number of eligible beneficiaries:

• 37.0 million people were living in poverty in 2004, up from 35.9 million in 2003 and 34.6 million in 2002;

• 49.7 million people were enrolled in Medicaid benefits in 2004, up from 42.7 million in 2003 and 40.1 million in 2002;

• 10% of all students failed to attain high school diplomas in 2004;

• There were 2.2 million juvenile arrests in 2003;

• For federal fiscal year ended September 30, 2003, an estimated 2.9 million referrals concerning the welfare of approximately 5.5 million children were accepted by State and local child protective services agencies for investigation or assessment; and

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• 4.9 million adults were released to the community under probation or parole programs at December 31, 2004.

Persons from each of these groups are potentially eligible for government sponsored social services. The size of the population of eligible recipients of government sponsored social services places additional pressure on the ability of government agencies to provide these services.

• Increasing pressure on governments to control costs.    With the number of persons eligible for government funded social services increasing and states facing budget deficits, states are struggling to fund mandated social services. Consequently, state and local governments are increasingly seeking less costly alternatives to their current service delivery systems.

• Increasing acceptance of privatized social services.    Several independent studies have concluded that privatized social services are more effective and cost efficient than direct government provided social services.

The following further describes significant government social services programs that are the subject of increasing privatization.

Medicaid funded programs

Medicaid is a state-administered program, jointly funded by the states and the federal government. Medicaid provides certain medical care services to qualified low-income persons. State controlled mental health spending is budgeted at $190 billion for 2006 compared to an estimated $188 billion spent for 2005. However, according to the Chairman’s Mark for 2007, Medicaid spending is expected to grow to $270 billion by 2011, an annual average growth rate of 7.3% and total growth of 42%.

The Medicaid program has been criticized for its traditional institutional based approach to health treatment. Because the institutional based approach is costly, states are seeking less expensive methods to deliver care to patients and as a result there is a trend toward community based care as an alternative to institutional or “out of home” care. Such alternatives include home and community based programs tailored to specific populations of beneficiaries. In addition to privatizing discrete components of Medicaid funded social services, some states have, and we believe other states will, completely privatize the delivery of services under their Medicaid systems.

Welfare programs

State governments and the federal government provide entitlement payments or benefits under the Temporary Assistance for Needy Families Program. The U.S. Census Bureau reports that approximately 37.0 million people lived below the poverty line in 2004, up 1.1 million from 2003. This reflects an official poverty rate in 2004 of 12.7 percent. Reforms to the welfare system have created incentives for states to achieve federally established goals regarding work participation, marriage, and pregnancy reduction. Reform legislation mandates that the changes be implemented rapidly. Moreover, welfare reforms have permitted private entities to determine eligibility for benefits. We believe that because of the rapid deployment of these welfare initiatives and the elimination of restrictions on privatization, government agencies will increasingly contract with private companies to provide services to welfare eligible individuals.

Child welfare programs

The child welfare system consists of state and federally funded agencies required by law to protect children from abuse or neglect. These agencies may remove children from abusive homes and place them in other homes under the jurisdiction of a juvenile judge. If a child becomes a ward of the state, the state could be responsible for all aspects of the child’s care and custody until the child turns 18 years old. Often, children who are wards of the

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state are placed in foster care programs operating within the child welfare system. In 2003, reports were filed with Child Protective Services regarding the welfare of 5.5 million children suspected of abuse or neglect in the United States. Also in 2003, there were 523,000 children in foster care in the United States, up from 260,000 in the 1980s. Child welfare agencies are increasingly engaging private entities to provide child welfare services, and in late 2005 a bill was passed that enables for-profit foster care agencies to receive Medicaid funds and federal foster care grants.

Juvenile justice programs

Juvenile justice programs include court, probation, parole, prevention and intervention programs addressing delinquent youth behavior. In 2003, there were 2.2 million juvenile arrests, of which 71% were male and 29% were female. Government entities have increasingly been the target of lawsuits filed by constitutional advocacy groups claiming that a reduction in the number of incarcerated youth is necessary. Due to the large number of juvenile arrests and detention and legal pressures, government entities are increasingly seeking assistance from private providers to develop and implement alternative juvenile correction services in order to reduce costs and provide more effective solutions to juvenile justice issues.

Education programs

Approximately 10% of all students in the United States failed to attain high school diplomas in 2004, which reflects a 28% increase since 2000. Further, it is estimated that approximately 12% of African American youth and 24% of Hispanic youth were not enrolled in high school in 2004. Some of the common attributes of at-risk students are low socio-economic status and the existence of family and/or home problems. School reforms have been unable to address this growing problem of at-risk students. To manage this large population of at-risk students, schools are turning to outside service providers to provide additional support.

Adult corrections programs

At the end of 2004, there were approximately 4.9 million persons on probation and parole in the United States. The adult correctional system creates a large and costly demand for social services subsequent to an inmate’s release from incarceration and during the periods of probation or parole. These services include transitional services, parole supervision and tracking and monitoring services. We believe government entities are increasingly seeking private companies to fulfill the growing need for adult correctional services on a more economical basis.

Our services

We provide home and community based services, foster care and provider management services, directly and through entities we manage. The following describes such services:

Home and community based counseling

• Home based and intensive home based counseling.    Our home based counselors are trained professionals or para-professionals providing counseling services in the client’s own home. These services average 5 hours per client per week and can include individual, group or family sessions. Topics are prescriptive to each client and can include family dynamics, peer relationships, anger management, substance abuse prevention, conflict resolution and parent effectiveness training.

We also provide intensive home based counseling, which consists of up to 20 or more hours per client per week. Our intensive home based counselors are masters or Ph.D. level professional therapists or counselors. Intensive home based counseling is designed for clients struggling to cope with everyday situations. Our counselors are qualified to assist with marital and family issues, depression, drug or alcohol abuse, domestic violence, hyperactivity, criminal or anti-social behavior, sexual misbehavior,

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school expulsion or chronic truancy and other disruptive behaviors. In the absence of this type of counseling, many of these clients would be considered for 24-hour institutional care or incarceration.

• Substance abuse treatment services.    Our substance abuse treatment counselors provide services in the office, home and counseling centers designed specially for clients with drug or alcohol abuse problems. Our counselors use peer contracts, treatment group process and a commitment to sobriety as treatment methods. Our professional counseling, peer counseling and group and family sessions are designed to introduce clients dependent upon drugs or alcohol to a sober lifestyle.

• School support services.    Our professional counselors are assigned to and stationed in public schools to assist in dealing with problematic and at-risk students. Our counselors provide support services such as teacher training, individual and group counseling, logical consequence training, anger management training, gang awareness and drug and alcohol abuse prevention techniques. These services are incorporated into a traditional school curriculum and are provided to any student or group of students referred by a teacher or school counselor.

Foster care

• Foster care.    We recruit and train foster parents and license family foster homes to provide 24-hour care to children who have been removed from their homes due to physical or emotional abuse, abandonment, or the lack of appropriate living situations. We place children individually in a licensed home. Each child is provided 24-hour care and supervision by trained foster parents. Our professional staff and counselors match and supervise the child and foster family. We also provide tutoring and other services to the child and foster family.

• Therapeutic foster care.    We provide therapeutic foster care services. This is a 24-hour care service designed for children exhibiting serious emotional problems who could otherwise require institutional treatment. We recruit, license and train professional foster parents to care for foster children for up to a year of therapeutic intervention. Social, psychological and psychiatric services are provided on a prescriptive basis to each child and therapeutic foster care family by a team of licensed, professional staff.

Not-for-profit managed services

• Administrative support, information technology and accounting and payroll services.    We typically provide the chief executive officer for the managed organization and manage the back office and administrative functions such as accounting, cash management, billing and collections, human resources and quality management. We assist in the development of policies and procedures and supervise the day to day operations. In many of our contracts we also provide the information technology support for hardware, networking and software support. We also provide the payroll management services for our managed entities along with managing the recruiting and retention of staff. In all cases, we report directly to the not-for-profit organization’s board of directors.

• Intake, assessment and referral services.    We contract on behalf of our managed entities with governments to receive and handle telephone inquiries regarding need and eligibility for government sponsored social services, to arrange for face-to-face interviews and to conduct benefit eligibility reviews. If indicated from the telephone inquiry and/or interviews with the client, we perform an evaluation of need, which may include a psychiatric assessment, psycho-social assessment, a social history and other diagnostic tools. Once eligibility is determined, the client is referred to an appropriate social services provider.

• Monitoring services.    Monitoring services include face-to-face and telephone interactions in which we provide guidance and assistance to clients. This typically includes a strength assessment, a referral to appropriate resources, a home visit and a limited amount of consultation. This service is designed for clients that are not seriously impaired but need assistance in accessing government benefits and services and learning the applicable benefit system.

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• Case management.    In providing case management services, we supervise all aspects of an eligible client’s case and assure that the client receives the appropriate care, treatment and resources. As a case manager we are a client’s advocate, arranging for services and following up to ensure that the client receives the necessary and appropriate care and services, and further, that the client complies with the prescribed intervention plan. We maintain the client’s records required by the government unit sponsoring the care. In providing case management, our client contact may be in the office, at home, on the telephone or any combination thereof.

In addition to the social services that we provide, we have entered into several short-term consulting agreements with other social services providers pursuant to which we are providing them with our evaluation of, and recommendations with respect to, their operations. While we do not expect to engage in numerous consulting contracts, we have been able to develop new relations and prospects by providing consulting expertise.

Our competitive strengths

We believe the following competitive strengths uniquely position us to take advantage of the increase in privatization of government social services and the trend away from institutional care:

• Lower cost, non-institutional focus.    We provide a lower cost alternative to the institutional delivery of social services. Because we do not own or operate any hospital or treatment beds, our operating costs are generally low and variable. We are not burdened by the costs of building, maintaining and financing institutional facilities. Also, by focusing on delivering social services outside of institutional settings, our ability to serve clients is not constrained by a fixed number of beds or the size of a facility.

• Flexible, decentralized operations model.    We provide our services under a decentralized, local model. We operate as a network of local and regional providers who are part of the communities they serve. Our local professionals have developed extensive relationships with payers and a reputation for providing cost effective, quality service to our clients. We believe this model increases our opportunities to obtain contracts. We give local managers responsibility and incentives for local revenue generation. At the same time, we hold our local managers to stringent budgets, allowing us to control costs. Our operations model is easily scalable and allows our employees to focus on, and react quickly to, additional opportunities to provide our services.

• Diverse payer and revenue base.    We generate revenue directly and on behalf of the entities whose operations we manage pursuant to 527 contracts with payers as of December 31, 2005. Virtually all of these payers are local and state government agencies and government intermediaries, each of which determines its own rates for services. While the federal government ultimately provides a significant portion of our payers’ funding, we do not currently contract directly with the federal government, and our contract rates are not federally determined.

• Experienced management team.    The members of our management team have significant experience as government executives, state agency officials and public company leaders. These professionals bring many years of experience in government sponsored social services and the healthcare, corrections and social services industries.

• Wide range of services.    Within our core range of services, we provide intake, assessment and referral, client monitoring and mentoring, case management, home based counseling, substance abuse treatment, school support, in-home tutoring and foster care services. Our proven track record has made us an attractive partner to, or manager of, not-for-profit organizations that contract to provide government sponsored social services. Our broad range of home and community based social services allows us to be a single-source provider of alternatives to institutional care.

• Proven track record of successful growth.    Since our formation we have grown both internally and through the consummation and integration of accretive acquisitions, including eleven since our initial public offering in August 2003. See “—Our acquisition history.”

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Our growth strategy

We intend to continue to grow as a provider of home and community based social services to individuals and families in home and community based settings. The key elements of our growth strategy are as follows:

• Broaden service offerings.    We intend to expand our menu of non-institutional services in order to respond to the evolving needs of our clients and capitalize on additional cross-selling opportunities with existing payers. Historically, cross-selling our services has been an effective method of expanding our business. For example, in 2004, we added therapeutic foster care services to our Virginia as well as Texas operations as alternatives to institutional care. In 2004, our Florida subsidiary, Family Preservation Services of Florida, Inc., was awarded contracts by the Florida Department of Children and Families for the privatization of child welfare case management in Gainesville, District 3 and Ft. Pierce, District 15. In 2005, we added substance abuse treatment to our home and community based services in Indiana. We believe these examples demonstrate our ability to generate additional business in markets where we have existing relationships.

• Expand organically into new markets.    We intend to offer our services in new geographic markets that are contiguous to existing markets or where we believe we can establish a significant presence. We started providing services through two locations in one state in 1997 and now provide services through 204 locations in 25 states and the District of Columbia either directly or through entities we manage. During 2005, excluding our expansion through acquisitions, we opened locations in Arizona, Indiana, Maine, North Carolina, Oklahoma, Pennsylvania and Virginia.

• Pursue strategic acquisitions.    We intend to continue to seek acquisition opportunities that we believe will allow us to move into new geographic markets, broaden our services or expertise, expand our client base and/or develop local relationships.

Our acquisition history

Our business grows internally, through organic expansion into new markets and increases in the number of clients we service, and externally through acquisitions of companies and/or their service contracts in areas where we see opportunities, either for expansion of our service platform in existing markets or expansion of our geographic footprint into new markets.

During our first year of operations, we acquired Parents and Children Together, Inc. and Family Preservation Services, Inc., which provided the foundation upon which our business was built. In 2002 and 2003, prior to our initial public offering in August 2003, we acquired Camelot Care Corporation and Cypress Management Services, Inc., which broadened our home based and foster care platform and expanded our reach into several new states. Since our initial public offering, we have completed and integrated the following additional strategic acquisitions, for an aggregate purchase price of approximately $50 million:

• Effective January 1, 2004, we acquired all of the outstanding stock of Dockside Services, Inc., an Indiana-based provider of youth services, for cash in the amount of $3.4 million and two subordinated promissory notes each in the principal amount of $500,000, for aggregate consideration of $4.4 million. This acquisition expanded our home and community based counseling operations in the states of Indiana and Michigan.

• Also effective January 1, 2004, we acquired the remaining 50% interest in, and became the sole owner of, Rio Grande Management Company, LLC, referred to as Rio Grande Management, for cash in the amount of $820,000. Rio Grande Management was originally formed as a joint venture limited liability company in September 2001, with us owning 50% of its interests and the independent agencies whose members comprised the board of Rio Grande Behavioral Health Services, Inc., referred to as Rio Grande, a not-for-profit social services provider, owning the balance. At the time of the acquisition, Rio Grande provided community based social and mental health network services in New Mexico, and Rio Grande Management provided administrative support for those operations in return for a management fee. By acquiring the interests of our co-venturers, we acquired 100% of Rio Grande

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Management’s rights under its management agreement with Rio Grande (the operations of which are now conducted directly, as opposed to indirectly, by the independent agencies which once owned Rio Grande, but are still subject to management agreements with us).

• On May 3, 2004, we acquired all of the outstanding stock of Pottsville Behavioral Counseling Group, Inc., referred to as Pottsville, a Pennsylvania based provider of screening and assessment services to Medicaid eligible children and youth, for a cash purchase price of approximately $1.8 million. In conjunction with this acquisition, we also entered into a management agreement with The ReDCo Group, referred to as ReDCo, a Pennsylvania not-for-profit social services organization. The acquisition of Pottsville and the new management agreement with ReDCo provided us with a long-term entry into the Pennsylvania social services market.

• Effective June 24, 2004, we acquired all of the rights under existing management agreements with Care Development of Maine and FCP, Inc., two not-for-profit organizations providing foster care and community based services in the state of Maine and commonwealth of Massachusetts, respectively, for cash in the amount of $1.5 million, plus an additional $1.8 million paid in May 2005 and $327,000 paid in October 2005. This acquisition expanded our geographic reach into Massachusetts and expanded our foster care and community based services in Maine.

• Effective July 1, 2004, we acquired all of the equity interests in the three entities comprising of the community services division of Aspen Education Group, Inc., or AEG, including Choices Group, Inc., one of the first drug court treatment programs in Las Vegas, Nevada, and Aspen MSO, LLC (now known as Providence Community Services, LLC) and College Community Services, which provide home and community based services in the Kern, Los Angeles, Orange and San Diego counties of Southern California for at-risk youth and adults, all of which were divested as part of AEG’s strategic focus on private sector educational services. The total purchase price was $10 million and we received $2 million in working capital. This acquisition established operations for us in California and Nevada and added drug court treatment to our array of social services.

• On June 13, 2005, we acquired all of the equity interest in Children’s Behavioral Health, Inc., a Pennsylvania based provider of home and school based social services for children, for a total purchase price of approximately $13.6 million, consisting of $10 million in cash, 117,371 shares of our unregistered common stock valued at $3.0 million and an unsecured, subordinated promissory note in the principal amount of approximately $619,000, after the deduction of working capital adjustment credits. This acquisition expanded our presence to a number of new counties within Pennsylvania and significantly increased the children’s services component of our business.

• Effective as of August 1, 2005, we acquired all of the outstanding equity of Maple Star Nevada, a provider of therapeutic foster care services in several locations in Nevada, and Maple Services LLC, a management company that provided management services to Oregon and Colorado not-for-profit providers of foster care services for an aggregate purchase price of $8.4 million, subject to certain adjustments, plus a potential earn out payment of up to $2 million. These acquisitions expanded our presence into Colorado and Oregon through the two not-for-profit entities formerly managed by Maple Services LLC, and added foster care services to our existing roster of services in Nevada.

• On September 20, 2005, we acquired all of the outstanding equity of two Georgia companies, AlphaCare Resources, Inc. and Transitional Family Services, Inc., collectively referred to as AlphaCare, for an aggregate purchase price of approximately $5.1 million, plus a potential earn out payment based upon certain performance factors. AlphaCare has one of the largest family preservation programs in the state of Georgia and is considered a premier provider of in-home and professional therapy services. These acquisitions not only expanded our geographic footprint but also helped position us to take advantage of the growing trend within the state of Georgia for in-home delivery of mental health services.

• Effective October 1, 2005, we acquired all of the equity interest in two Kentucky based companies, Drawbridges Counseling Services, LLC, a provider of home based and case management services, and

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Oasis Comprehensive Foster Care LLC, a licensed foster care child placement agency, together referred to as Drawbridges, for an aggregate purchase price of $450,000, comprised of $400,000 in cash and a one-year $50,000 subordinated promissory note. These acquisitions provided us an entree into the state of Kentucky.

• On February 1, 2006, we acquired all of the equity interest in A to Z In-Home Tutoring, LLC, or A to Z, a Tennessee based provider of home based educational tutoring. The purchase price included $500,000 in cash and approximately $800,000 in debt excluding a $250,000 bridge loan owing to us by A to Z at the date of acquisition. In accordance with certain provisions in the purchase agreement, we may make earn out payments based on the future financial performance of A to Z. The total purchase price including earn out payments will not exceed $8.0 million. This acquisition expands our home and community based social services to include educational tutoring.

• On February 27, 2006, we acquired all of the equity interest in Family Based Strategies, Inc., or FBS, a North Carolina based provider of home based and case management services. The purchase price included $300,000 in cash less any negative working capital and a $75,000 loan owing to us by FBS at the date of acquisition. The purchase price will be paid upon the final determination of FBS’s working capital. In accordance with certain provisions in the purchase agreement, we may make an earn out payment in the second quarter of 2008 based on the financial performance of FBS over the period from March 1, 2006 to December 31, 2007. This acquisition expands our presence in North Carolina and provides us an entry into the state of New Jersey.

Revenue and payers

We derive substantially all of our revenue from contracts with state or local government agencies, government intermediaries or the not-for-profit social services organizations we manage. A majority of our contracts are negotiated fee-for-service arrangements with payers. Home and community based services are generally payable by the hour depending on the type and intensity of the service. Foster care services are generally payable for a fixed monthly fee. Approximately 61.8% of our revenue for the fiscal year ended December 31, 2005 was pursuant to fee-for-service arrangements. A majority of our agreements to provide home and community based services and foster care services contain fee-for-service payment arrangements. In addition, a significant number of our fee-for-service contracts allow the payer to terminate the contract immediately for cause (such as for our failure to meet our contract obligations) and permit the payer to terminate the contract at any time prior to its stated expiration date without cause, at will and without penalty to the payer, either upon the expiration of a short notice period, typically 30 days, and/or immediately, in the event federal or state appropriations supporting the programs serviced by the contract are reduced or eliminated.

Revenues from our cost based service contracts are generally recorded at one-twelfth of the annual contract amount less allowances for certain contingencies such as projected costs not incurred, excess cost per service over the allowable contract rate and/or insufficient encounters. This policy results in recognizing revenue from these contracts based on allowable costs incurred. The annual contract amount is based on projected costs to provide services under the contracts with adjustments for changes in the total contract amount. Annually, we submit projected costs for the coming year which assist the contracting payers in establishing the annual contract amount to be paid for services provided under the contracts. After June 30, which is the contracting payers’ year end, we submit cost reports which are used by the contracting payers to determine the amount, if any, by which funds paid to us for services provided under the contracts were greater than the allowable costs to provide these services. Completion of this review process may take several years from the date we submit the cost report. In cases where funds paid to us exceed the allowable costs to provide services under contract, we may be required to pay back the excess funds.

Our cost reports are generally audited by our contracted payers on an annual basis. We periodically review our provisional billing rates and allocation of costs and provide for estimated adjustments from the contracting payers. We believe that adequate provisions have been made in our consolidated financial statements for any adjustments that might result from the outcome of any cost report audits. Differences between the amounts

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provided and the settlement amounts are recorded in our consolidated statement of operations in the year of settlement. Cost based service contracts represented approximately 16.2% of our revenue for the year ended December 31, 2005.

We provide services under one annual block purchase contract in Arizona with The Community Partnership of Southern Arizona. Effective July 1, 2005, we are required to provide or arrange for the behavioral health services to eligible populations of beneficiaries as defined in the contract. We must provide a complete range of behavioral health clinical, case management, therapeutic and administrative services. There is no contractual limit to the number of eligible beneficiaries that may be assigned to us, or a limit to the level of services that must be provided to these beneficiaries. Therefore, we are at-risk if the costs of providing necessary services exceed the associated reimbursement. The terms of the contract typically are reviewed prospectively and amended as necessary to ensure adequate funding of our service offerings under the contract; however, no assurances can be made that such funding will adequately cover the costs of services previously provided. Our revenues under the annual block contract represented 12.1% of our total revenues for the year ended December 31, 2005.

Due to the nature of our business and the requirement or desire by certain payers to contract with not-for-profit social services organizations, we sometimes enter into management contracts with not-for-profit organizations for the purpose of developing strategic relationships, administrative, program and management services. These organizations contract directly or indirectly with state government agencies to supply a variety of community based mental health and foster care services to children and adults. Each of these organizations is separately incorporated and organized with its own board of directors. Our management fees under these contracts are either based upon a percentage of the managed entities’ revenues or a predetermined fee. Management fees earned pursuant to our management contracts with these organizations represented approximately 8.3% of our revenue for the year ended December 31, 2005.

In addition, in May 2005, we adopted a program of self-insurance with regard to a substantial portion of our general and professional liability and workers’ compensation costs and the general and professional liability and workers’ compensation costs of certain designated entities managed by us under reinsurance programs through our wholly-owned captive insurance subsidiary. Further, we offer health insurance coverage to employees of certain entities we manage under our self-funded health insurance program. In exchange for this liability coverage we receive a reimbursement equal to the pro-rata share of certain of our managed entities’ costs to participate in our reinsurance and self-funded health insurance programs. We consider these arrangements to be among the array of management services we provide to certain of our managed entities. As a result, we record amounts received from these managed entities as management fees revenue. Revenues related to these arrangements totaled approximately $1.1 million for the year ended December 31, 2005, and represented less than 1.0% of our revenue for the same period.

We have also entered into short-term consulting agreements with several other social services providers, pursuant to which we are retained to, among other things, evaluate and make recommendations with respect to their management, administrative and operational services. In exchange for these services, we receive a fixed fee that is either payable upon completion of the services or on a monthly basis. Fees earned pursuant to our consulting agreements are accounted for as management fees revenue and represented less than 1.0% of our revenue for the year ended December 31, 2005.

Employees

Job type	At December 31, 2005	% of total
Clinical	3,659	74.2	%
Administrative	1,271	25.8	%
Total	4,930	100.0	%

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As of December 31, 2005, our operations and the entities we manage conducted operations with 2,006 and 1,913 full-time and 525 and 486 part-time direct care and administrative personnel, respectively. Of this employee census, 2,058 and 1,601, are social service providers and 473 and 798, are administrative personnel, respectively, (including approximately 70 personnel employed by one of our managed entities in New Mexico under youth employment services programs where the managed entity receives funding from contracting payers to employ eligible youths in various local community enhancement and maintenance positions). Of these employees, excluding those employees employed under the youth employment services program in New Mexico, a substantial portion have attained bachelors degrees or higher, a number of those with bachelors degrees have attained masters degrees or higher and some hold Ph.D. or M.D. degrees. We have various levels of social service providers and administrators that range from behavioral health technicians to medical directors. The minimum qualifications, education and experience of direct care providers vary by level and range from a bachelors degree with up to two years of experience at the para-professional clinician level to a masters or Ph.D. degree with a state certification or license to provide direct care at the professional clinician level.

In order to preserve the high levels of service that we offer to our clients, we require and encourage our employees to pursue continuing professional education. We have developed a comprehensive employee education and training program. Orientation includes a training component under the direction of qualified staff that clinical employees receive before delivery of any direct services. Depending on educational requirements, we may also provide our staff continuing education and/or tuition reimbursement.

We believe that our future success depends in part on our ability to attract and retain qualified employees at all levels. As of December 31, 2005, the annual rate of turnover of our employees was approximately 23%. None of our employees are covered by a collective bargaining agreement. We believe that our employee relations are good because we offer competitive compensation, including stock option awards, training, education assistance and career advancement opportunities. By offering competitive compensation and benefit packages to our employees, we believe we are able to deliver consistently high quality service, recruit qualified candidates and increase employee confidence, satisfaction and retention.

Sales and marketing

Substantially all of our marketing is performed at the local and regional level. Through our local and regional managers, we have successfully developed and maintained extensive relationships with various payers. These relationships allow us to develop leads on new business, cross-sell our other services to existing payers and negotiate payer contracts. A significant portion of our business is procured in this manner. We also seek to market our services to payers in geographical areas contiguous to existing markets and in which we believe our reputation as a low cost quality service provider will enhance our ability to compete for and win business. We are regularly requested to respond to requests for proposals, or RFPs. Additionally, we subscribe to a service that keeps us informed of and tracks on a national basis RFPs for privatization of social services. We selectively choose the RFPs to which we respond based upon whether our reputation enhances our ability to compete or if the RFP presents a unique opportunity to develop a new service offering. In addition, our senior executives develop leads through meetings and discussions with a wide array of decision makers.

Competition

The social services industry is a highly fragmented industry. We compete for clients with a variety of organizations that offer similar services. Most of our competition consists of local social services organizations that compete with us for local contracts, such as United Way supported agencies and faith-based agencies such as Catholic Social Services, Jewish Family and Children’s Services and the Salvation Army. Other competitors include local, not-for-profit organizations and community based organizations. Historically, these types of organizations have been favored in our industry as incumbent providers of services to government entities. On a national level, there are very few organizations that compete for local, county and state contracts to provide the types of services we offer. We also compete with larger companies, such as Maximus, Inc., whose government operations group administers and manages welfare program services, childcare support enforcement, Medicaid

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enrollment and other consulting services for state and local governments. National Mentor, Inc. is the country’s largest provider of foster care services and competes with us in certain markets for foster care services. Many institutional providers offer some type of community based care including such organizations as Cornell Companies, Inc., Res-Care, Inc., Psychiatric Solutions, Inc. and The Devereaux Foundation. While we believe that we compete on the basis of price and quality, many of our competitors have greater financial, technical, political and marketing resources, name recognition, and a larger number of clients and payers than we do. In addition, some of these organizations offer more services than we do. We have experienced, and expect to continue to experience, competition from new entrants into our markets. Increased competition may result in pricing pressures, loss of or failure to gain market share or loss of clients or payers, any of which could harm our business.

Regulatory environment

As a provider of social services, we are subject to numerous federal, state and local laws and regulations. These laws and regulations significantly affect the way in which we operate various aspects of our business. We must also comply with state and local licensing requirements and requirements for participation in Medicaid, federal block grant requirements, requirements of various state Children’s Health Insurance Programs, or CHIP, and contractual requirements imposed upon us by the state and local agencies with which we contract for such health care and social services. CHIP is a federal program providing benefits administered by states that submit plans for health benefits for children whose parents meet certain financial needs tests. Failure to follow the rules and requirements of these programs can significantly affect our ability to be paid for the services we provide.

In addition, our revenue is largely derived from contracts that are directly or indirectly paid or funded by government agencies, including Medicaid. A significant decline in expenditures, shift of expenditures or funding could cause payers to reduce their expenditures under those contracts or not renew such contracts, either of which could have a negative impact on our future operating results.

Surveys and audits

Our programs are subject to periodic surveys by government authorities and/or their contractors to ensure compliance with various requirements. Regulators conducting periodic surveys often provide reports containing statements of deficiencies for alleged failures to comply with various regulatory requirements. In most cases, if a deficiency finding is made by a reviewing agency, we will work with the reviewing agency to agree upon the steps to be taken to bring our program into compliance with applicable regulatory requirements. In some cases, however, an agency may take a number of adverse actions against a program, including:

• the imposition of fines;

• temporary suspension of admission of new clients to our program’s service;

• in extreme circumstances, decertification from participation in Medicaid or other programs; or

• revocation of our license.

From time to time, we receive and respond to survey reports containing statements of deficiencies. While we believe that our programs are in material compliance with Medicaid and other program certification requirements and state licensure requirements, failure to comply with these requirements could have a material adverse impact on our business and our ability to enter into contracts with other agencies to provide services.

Billing/claims reviews and audits

Agencies and other payers periodically conduct pre-payment or post-payment medical reviews or other audits of our claims. In order to conduct these reviews, payers request documentation from us and then review that documentation to determine compliance with applicable rules and regulations, including the eligibility of patients to receive benefits, the appropriateness of the care provided to those patients, and the documentation of that care.

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For-profit ownership

Certain of the agencies for which we provide services restrict our ability to contract directly as a for-profit organization. Instead, these agencies contract directly with a not-for-profit organization and in certain cases we negotiate to provide administrative and management services to the not-for-profit providers. The extent to which other agencies impose such requirements may affect our ability to continue to provide the full range of services that we provide or limit the organizations with which we can contract directly to provide services.

Professional licensure and other requirements

Many of our employees are subject to federal and state laws and regulations governing the ethics and practice of their professions. In addition, professionals who are eligible to participate in Medicaid as individual providers must not have been excluded from participation in government programs at any time. Our ability to provide services depends upon the ability of our personnel to meet individual licensure and other requirements.

Federal and state anti-kickback laws and safe harbor provisions

The federal anti-kickback law applicable to Medicaid and other federal health care programs makes it a felony to knowingly and willfully offer, pay, solicit or receive any form of remuneration in exchange for referring, recommending, arranging, purchasing, leasing or ordering items or services covered by such programs. The prohibitions apply regardless of whether the remuneration is provided directly or indirectly, whether or not in cash, and applies to both the person giving and the person receiving such remuneration.

Interpretations of the anti-kickback law have been very broad and under current law, courts and federal regulatory authorities have stated that this law is violated if even one purpose (as opposed to the sole or primary purpose) of the arrangement is to induce referrals. This act is subject to numerous statutory and regulatory “safe harbors.” The safe harbor regulations, however, do not cover all lawful relationships between healthcare providers and referral sources. Failure of an arrangement to satisfy all of the requirements of a particular safe harbor does not mean that the arrangement is unlawful. However, it may mean that such an arrangement will be subject to scrutiny by the regulatory authorities.

Violations of the anti-kickback law may be punishable by civil or criminal fines, imprisonment, and exclusion from government health care programs.

Many states, including some where we do business, have adopted similar anti-kickback laws that have a potentially broad application as well.

The Stark Law and state physician self-referral laws

Section 1877 of the Social Security Act, or the Stark Law, prohibits physicians from ordering “designated health services” for Medicaid patients from entities or facilities in which such physicians hold a financial interest. This law is subject to a number of statutory or regulatory exceptions. Unlike a failure to meet a “safe harbor,” a relationship that falls within the scope of the Stark Law and fails to meet an exception would violate the law.

Certain services that we provide may be identified as “designated health services” for purposes of the self-referral laws. We cannot assure you that future regulatory changes will not result in other services we provide becoming subject to the Stark Law’s ownership, investment or compensation prohibitions in the future.

Many states, including some states where we do business, have adopted similar prohibitions against payments that are intended to induce referrals of clients. Moreover, many states where we operate have laws similar to the Stark Law prohibiting physician self-referrals.

We contract with a significant number of social services providers and practitioners, including therapists, physicians and psychiatrists, and arrange for these individuals or entities to provide services to our clients. While we believe that these contracts are in compliance with the anti-kickback and Stark Law, no assurance can be

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made that such contracts will not be considered in violation of the anti-kickback law or fall within an exception to the Stark Law. We cannot assure you that these laws will ultimately be interpreted in a manner consistent with our practices.

False claims acts

Federal criminal and civil false claims provisions, which provide that knowingly submitting claims for items or services that were not provided as represented may result in the imposition of multiple damages, administrative civil and monetary penalties, criminal fines and imprisonment. Many states, including some where we do business, have adopted laws and regulations similar to the federal law.

Health information practices

Portions of the Health Insurance Portability and Accountability Act of 1996, or HIPAA, were intended to reduce administrative expenses and burdens associated with the transmission and use of electronic health records and claims for payment. While it is likely that these provisions may reduce costs in the long-term, we believe that they will bring about significant and, in some cases, costly changes in the short-term. Under HIPAA, the United States Department of Health and Human Services, or DHHS, issued rules to define and implement standards for the electronic transactions and code sets for the submission of transactions such as claims, and privacy and security of individual health information in whatever manner it is maintained.

In February 2006, DHHS published its Final Rule on Enforcement of the HIPAA Administrative Simplification provisions, including the transaction standards, the security standards and the privacy rule. This enforcement rule addresses, among other issues, DHHS’s policies for determining violations and calculating civil money penalties, how DHHS will address the statutory limitations on the imposition of civil money penalties, and various procedural issues. The rule extends enforcement provisions currently applicable to the health care privacy regulations to other HIPAA standards, including security, transactions and code sets.

We have taken steps to ensure compliance with HIPAA and will be monitoring compliance on an ongoing basis.

Additional information

Our website is www.provcorp.com. We make available, free of charge, at this website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the United States Securities and Exchange Commission. The information on the website listed above, is not and should not be considered part of this annual report on Form 10-K and is not incorporated by reference in this document. In addition, we will provide, at no cost, paper or electronic copies of our Forms 10-K, 10-Q and 8-K and amendments to those reports made with the Securities and Exchange Commission. Requests for such filings should be directed to Kate Blute, Director of Investor and Public Relations, telephone number: (520) 747-6600.

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Item 1A.    Risk Factors

The following risks should be read in conjunction with other information contained, or incorporated by reference, in this report, including the “Management’s Discussion and Analysis of Financial Condition and Results of Operation” section and our historical consolidated financial statements and related notes and pro forma financial information. If any of the following risks actually occurs, our business, financial condition and operating results could be adversely affected.

Changes in budgetary priorities of the government entities that fund the services we provide could result in our loss of contracts or a decrease in amounts payable to us under our contracts.

Our revenue is largely derived from contracts that are directly or indirectly paid or funded by government agencies. All of these contracts are subject to legislative appropriations and state budget approval. Consequently, a significant decline in government expenditures, shift of expenditures or funding away from programs that call for the types of services that we provide or change in government contracting or funding policies could cause payers to terminate their contracts with us or reduce their expenditures under those contracts, either of which could have a negative impact on our future operating results.

The availability for funding under our contracts with state governments is dependent in part upon federal funding to states. Recent changes in Medicaid methodology may further reduce the availability of federal funds to states in which we provide services. Among the alternative Medicaid funding approaches that states have explored are provider assessments as tools for leveraging increased Medicaid federal matching funds. Provider assessment plans generate additional federal matching funds to the states for Medicaid reimbursement purposes, and implementation of a provider assessment plan requires approval by the Centers for Medicare and Medicaid Services in order to qualify for federal matching funds. These plans usually take the form of a bed tax or a quality assessment fee, which were required to be imposed uniformly across classes of providers within the state, except that such taxes only applied to Medicaid health plans.

However, the Deficit Reduction Act of 2005, which was signed into law on February 8, 2006, or Deficit Reduction Act, requires states that desire to impose provider taxes, subject to certain transitional periods, to impose taxes on all managed care organizations, not just Medicaid managed care organizations. This uniformity requirement as it relates to taxing all managed care organizations may make states more reluctant to use provider assessments as a vehicle for raising matching funds and, thus, reduce the amount of funding that the states receive and have available. Moreover, under the Deficit Reduction Act, states may be allowed to reduce the benefits provided to certain Medicaid enrollees, which could affect the services that states contract for with us. We cannot make any assurances that these Medicaid changes will not negatively affect the funding under our contracts.

Currently, all of the states in which we operate are facing budgetary shortfalls. While to date we have not experienced any rate or contract reductions as a result of these budgetary shortfalls, we are not immune to such consequences. In addition, in some states eligibility requirements for social services clients have been tightened to stabilize the number of eligible clients, which reduces the size of our potential market in those states. While many of these states are dealing with budgetary concerns by shifting costs from institutional care to home and community based care such as we provide, there is no assurance that this trend will continue.

Our contracts are not only short-term in nature but can also be terminated prior to expiration, without cause and without penalty to the payers, and there can be no assurance that they will survive until the end of their stated terms or that upon their expiration these contracts will be renewed or extended.

Most of our contracts contain base periods of only one year. While some of them also contain options for renewal, usually successive six month or one year terms, payers are not required to extend their contracts into these option periods. In addition, a significant number of our contracts not only allow the payer to terminate the contract immediately for cause (such as for our failure to meet our contract obligations) but also permit the payer

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to terminate the contract at any time prior to its stated expiration date without cause, at will and without penalty to the payer, either upon the expiration of a short notice period, typically 30 days, and/or immediately, in the event federal or state appropriations supporting the programs serviced by the contract are reduced or eliminated. The failure of payers to renew or extend significant contracts or their early termination of significant contracts could adversely affect our financial performance. We cannot anticipate if, when or to what extent a payer might terminate its contract with us prior to its expiration or fail to renew or extend its contract with us.

Each of our contracts is subject to audit and modification by the payers with whom we contract, in their sole discretion.

Our business depends on our ability to successfully perform under various government funded contracts. The payers under these contracts can review our performance under these contracts, as well as our records, accounting and general business practices at any time and may, in their discretion:

• suspend or prevent us from receiving new contracts or extending existing contracts because of violations or suspected violations of procurement laws or regulations;

• terminate or modify our existing contracts;

• reduce the amount we are paid under our existing contracts; and/or

• audit and object to our contract related fees.

As a government contractor, we are subject to an increased risk of litigation and other legal actions and liabilities.

As a government contractor, we are subject to an increased risk of investigation, criminal prosecution, civil fraud, whistleblower lawsuits and other legal actions and liabilities not often faced by companies that do not provide government sponsored services. The occurrence of any of these actions, regardless of the outcome, could disrupt our operations and cause us added expense and could limit our ability to obtain additional contracts in other jurisdictions.

A loss of our status as a licensed provider in any jurisdiction could result in the termination of a number of our contracts, which could negatively impact our revenues.

If we lost our status as a licensed provider in any jurisdiction, the contracts under which we provide services in that jurisdiction would be subject to termination. Moreover, such an event could constitute a violation of provisions of our contracts in other jurisdictions, resulting in further contract terminations.

If we fail to satisfy our contractual obligations, we could be liable for damages and financial penalties and harm our ability to keep our existing contracts or obtain new contracts.

Our failure to comply with our contract obligations could, in addition to providing grounds for immediate termination of the contract for cause, negatively impact our financial performance and damage our reputation, which, in turn, could have a material adverse effect on our ability to obtain new contracts. Our failure to meet contractual obligations could also result in substantial actual and consequential damages. The termination of a contract for cause could, for instance, subject us to liability for excess costs incurred by a payer in obtaining similar services from another source. In addition, our contracts require us to indemnify payers for our failure to meet standards of care, and some of them contain liquidated damages provisions and financial penalties that we must pay if we breach these contracts.

We derive a significant amount of our revenues from a few providers, which puts us at risk.

We provide, or manage the provision of, government sponsored social services pursuant to 527 contracts. One of these contracts, our contract with The Community Partnership of Southern Arizona, referred to as CPSA,

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an Arizona not-for-profit organization, which is our oldest contract and our only annual block purchase contract, generated approximately 11.6% and 12.1% of our revenues for the years ended December 31, 2004 and 2005. Our next five largest revenue producing contracts represented, in the aggregate, approximately 23.2% and 19.6% of our revenues for such periods. The loss of, reduction in amounts generated by, or changes in methods or regulations governing payments for our services under these contracts could materially reduce our revenue.

Effective July 1, 2005, our contract with CPSA requires us to provide a sufficient level of encounters to support the year-to-date payments received under the contract and provide necessary services that may exceed the associated reimbursement.

Our agreement with CPSA specifies that we are to provide or arrange for behavioral health services to certain eligible populations of beneficiaries as defined in the contract. We must provide a full range of behavioral health clinical, case management, therapeutic and administrative services. There is no contractual limit to the number of eligible beneficiaries that may be assigned to us, or a specified limit to the level of services that may be provided to these beneficiaries. Therefore, we are at-risk if the costs of providing necessary services exceed the associated reimbursement.

Under our CPSA contract, we are required to regularly submit service encounter data to CPSA electronically, and CPSA is obligated to monitor the service encounter value. If our service encounter value exceeds the year-to-date payments made to us, CPSA at its discretion (subject to available state funding) may compensate us for service encounter value in excess of the contractual amounts. Conversely, if at any time the service encounter value is not sufficient to support year-to-date payments made to us or if we fail to provide data sufficient to permit accurate monitoring of our service encounter value, CPSA has the right to suspend payments to us or recoup funds already paid to us.

We recognize revenue from our CPSA contract equal to the service encounter value, which represents the value of the actual services rendered, as more fully described in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation” under the caption “Critical accounting policies and estimates” in this report. CPSA monitors our service encounter value based upon data submitted by us electronically. If our service encounter value exceeds amounts paid to us under this contract (equal to one-twelfth of the annual contract amount on a monthly basis), we recognize revenue equal to the amount that yields a ratio of the service encounter value to revenue of 90%. For the first six months of this contract (July 1, 2005 to December 31, 2005), the amount of revenue we recognized in excess of amounts paid to us year-to-date amounted to approximately $2.0 million. While we believe the additional revenue over the contractual amount is collectible based on CPSA’s history of making additional payments to us, collection is subject to CPSA’s discretion and dependent upon sufficient funds allocated by the State of Arizona. If CPSA does not pay us for our service encounter value in excess of the contractual amount, the impact of not receiving such payment could have a material adverse affect on our financial position, results of operation and cash flows.

If our encounter value is not sufficient to support year-to-date payments made to us or if we fail to provide data sufficient to permit accurate monitoring of our service encounter value, CPSA can suspend payments to us. CPSA has not suspended payments to us nor have we returned any amounts to the payer. While we do not anticipate that we will be required to return any amounts to CPSA, and while we believe that our service encounter value is sufficient to support all amounts paid to us under the contract, there can be no assurances that this will be the case.

If we fail to estimate accurately the cost of performing certain contracts, we may incur losses on these contracts.

Under our fee-for-service contracts, we receive fees based on our interactions with government sponsored clients. To earn a profit on these contracts, we must accurately estimate costs incurred in providing services. Our risk on these contracts is that our client population is not large enough to cover our fixed costs, such as rent and

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other overhead. Our fee-for-service contracts are not reimbursed on a cost basis and therefore, if we fail to estimate our costs accurately, we may incur losses on these contracts.

Approximately 16.2% of our revenues for the year ended December 31, 2005 were derived from cost based service contracts for which we record revenue at one-twelfth of the annual contract amount less allowances for certain contingencies, which puts us at risk that we may be required to subsequently refund a portion of our recorded revenues for such contracts.

With our acquisition of Choices Group, Inc., Aspen MSO, LLC and College Community Services in July 2004, we acquired certain cost based service contracts that require us to allow for contingencies such as budgeted costs not incurred, excess cost per service over the allowable contract rate and/or an insufficient number of encounters. For the year ended December 31, 2005, revenues from these contracts represented approximately 16.2% of our total revenues for the period. In cases where funds paid to us exceed the allowable costs to provide services under the contracts, we may be required to pay back the excess funds.

Our results of operations will fluctuate due to seasonality.

Our quarterly operating results and operating cash flows normally fluctuate as a result of seasonal variations in our business, principally due to lower client demand for our home and community based services during the holiday and summer seasons. Historically, these seasonal variations have had a nominal affect on our operating results and operating cash flows. As we have grown our home and community based services business our exposure to seasonal variations has grown and will continue to grow, particularly with respect to our school based services, educational services and tutoring services with the acquisition of Children’s Behavioral Health, Inc. and A to Z In-Home Tutoring, LLC. We experience lower home and community based services revenue when school is not in session. Our expenses, however, do not vary significantly with these changes and, as a result, such expenses do not fluctuate significantly on a quarterly basis. We expect quarterly fluctuations in operating results and operating cash flows to continue as a result of the uneven seasonal demand for our home and community based services. In addition, as we enter new markets, we could be subject to additional seasonal variations along with any competitive response to our entry by other social services providers. As a result of these factors, quarter-to-quarter comparisons of our operating results may not be a good indicator of our future performance. Further, it is possible that in any future quarter our operating results could be below the expectations of investors and any published reports or analyses regarding our company. In that event, the price of our common stock could decline substantially.

While we obtain some of our business through responses to government requests for proposals, we may not be awarded contracts through this process in the future, and contracts we are awarded may not be profitable.

We obtain, and will continue to seek to obtain, a significant portion of our business from state or local government entities. To obtain business from government entities, we are often required to respond to requests for proposals, or RFPs. To propose effectively, we must accurately estimate our cost structure for servicing a proposed contract, the time required to establish operations and the terms of the proposals submitted by competitors. We must also assemble and submit a large volume of information within rigid and often short timetables. Our ability to respond successfully to RFPs will greatly impact our business. We may not be awarded contracts through the RFP process, and our proposals may not result in profitable contracts.

If we fail to establish and maintain important relationships with officials of government entities and agencies, we may not be able to successfully procure or retain government-sponsored contracts, which could negatively impact our revenues.

To facilitate our ability to procure or retain government-sponsored contracts, we rely in part on establishing and maintaining relationships with officials of various government entities and agencies. These relationships enable us to provide informal input and advice to the government entities and agencies prior to the development

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of an RFP or program for privatization of social services and enhance our chances of procuring contracts with these payers. The effectiveness of our relationships may be reduced or eliminated with changes in the personnel holding various government offices or staff positions. We also may lose key personnel who have these relationships. We may be unable to successfully manage our relationships with government entities and agencies and with elected officials and appointees. Any failure to establish, maintain or manage relationships with government and agency personnel may hinder our ability to procure or retain government-sponsored contracts.

The federal government may refuse to grant consents and/or waivers necessary to permit for-profit entities to perform certain elements of government programs.

Under current law, in order to privatize certain functions of government programs the federal government must grant a consent and/or waiver to the petitioning state or local agency. If the federal government does not grant a necessary consent or waiver or withdraw approval of any granted waiver, the state or local agency will be unable to contract with a for-profit entity, such as us, to provide the service. Failure by state or local agencies to obtain consents and/or waivers could adversely affect our continued business and future growth.

Our business could be adversely affected by future legislative changes that hinder or reverse the privatization of social services.

The market for our services depends largely on federal, state and local legislative programs. These programs can be modified or amended at any time. Moreover, part of our growth strategy includes aggressively pursuing opportunities created by the federal, state and local initiatives to privatize the delivery of social services. However, there are opponents to the privatization of social services and, as a result, future privatization of social services is uncertain. If additional privatization initiatives are not proposed or enacted, or if previously enacted privatization initiatives are challenged, repealed or invalidated, our growth could be adversely impacted.

Our strategic relationships with certain not-for-profit and tax exempt entities are subject to tax and other risks.

Since some government agencies prefer or require contracts for privatized social services to be administered through not-for-profit organizations, we rely heavily on our relationships with not-for-profit organizations to provide services to these government agencies. We currently maintain strategic relationships with 17 not-for-profit social services organizations with which we have management contracts, 14 of which are tax exempt organizations.

Federal tax laws require that the boards of directors of not-for-profit tax exempt organizations be independent. Although currently the boards of directors of the tax exempt not-for-profit organizations for which we provide management services are independent, prior to July 2003, our employees constituted a majority of the boards of three of these organizations. If, as a result of such past practices, we and/or these managed entities were ever found to be in violation of these federal tax laws, we and they could be subject to penalties and, as described below, the tax exempt status of these managed entities could be jeopardized.

Federal tax laws also require that the management fees we charge the not-for-profit entities we manage be at fair market rates. Prior to July 2003, however, these management contracts contained a provision that permitted us to earn bonuses to our management fee dependent upon the managed entity’s operating results. In connection with our renegotiation of our fee arrangement with these entities, we amended these agreements as of July 1, 2003, at which time we removed the bonus provision. If the Internal Revenue Service, referred to as the IRS, determined that any tax exempt organization was paying more than market rates for services performed by us, and further determined that we were, at the time those rates were set, in a position to exercise substantial influence over the affairs of the tax exempt organization (through our past majority positions on the board of directors or otherwise), the IRS could sanction us and the tax exempt organization, including levying a penalty against us of 25% of the amount paid in excess of the market rates for the services provided and the return of all excess benefit amounts, plus interest, to the tax exempt organization. If the excess benefit amount were not returned, an additional penalty equal to 200% of the excess benefit could be imposed on us.

Generally, under state law, not-for-profit entities may pay no more than reasonable compensation for services rendered. If the compensation paid to us by these not-for-profit entities is deemed unreasonable, then the state could take action against the not-for-profit entity which could adversely effect us.

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In addition, until September 2003, three of these not-for-profit organizations were co-borrowers on our credit facility and their receivables were pledged as additional collateral under the facility. As the manager of these entities, we drew down on the line of credit under our credit facility on their behalf and advanced the borrowings to them for their operating expenses. In September 2003, these entities were removed as co-borrowers under our credit facility, and their assets were removed as collateral from our line of credit.

As a result of our relationships with these tax exempt organizations, including our employees’ past majority positions on the boards of directors of some of them, the terms of our management contracts with these organizations and/or the shared borrowing relationship we previously had with some of them, the IRS could propose to revoke the tax exempt status of some or all of these tax exempt organizations. If the IRS were successful in revoking the tax exempt status of any of these tax exempt organizations, such organization would likely be treated as a taxable entity from the time of the event or events that caused the exempt status to be revoked. In addition, state authorities could investigate and take action against the not-for-profit status of these organizations for similar reasons. A state attorney general could also take action to dissolve a state not-for-profit organization that could result in our loss of the organization’s contract(s) for services. The loss of federal tax exempt and/or not-for-profit status would adversely affect the ability of these organizations to be exempt from certain federal taxes and could have the same impact on state taxes. The imposition of federal and/or state taxes on such organizations could reduce the funds available to pay our management fees. Further, these organizations’ existing payers may terminate or fail to renew or extend their contracts with the tax exempt organizations if IRS or state controversies of this type were threatened or were to occur. The loss of such contracts could have a negative effect on our earnings.

Government unions may oppose privatizing government programs to outside vendors such as us, which could limit our market opportunities.

Our success depends in part on our ability to win contracts to administer and manage programs traditionally administered by government employees. Many government employees, however, belong to labor unions with considerable financial resources and lobbying networks. These unions could apply political pressure on legislators and other officials seeking to privatize government programs. Union opposition could result in our losing government contracts or being precluded from providing services under government contracts.

Inaccurate, misleading or negative media coverage could damage our reputation and harm our ability to procure government sponsored contracts.

The media sometimes provides news coverage about our contracts and the services we provide to clients. This media coverage, if negative, could influence government officials to slow the pace of privatizing government services. Moreover, inaccurate, misleading or negative media coverage about us could harm our reputation and, accordingly, our ability to obtain government sponsored contracts.

We may incur costs before receiving related revenues, which could result in cash shortfalls.

When we are awarded a contract to provide services, we may incur expenses before we receive any contract payments. These expenses include leasing office space, purchasing office equipment and hiring personnel. As a result, in certain large contracts where the government does not fund program start-up costs, we may be required to invest significant sums of money before receiving related contract payments. In addition, payments due to us from payers may be delayed due to billing cycles or as a result of failures to approve government budgets in a timely manner. Moreover, any resulting cash shortfall could be exacerbated if we fail to either invoice the payer or to collect our fee in a timely manner.

Our business is subject to risks of litigation.

We are in the human services business and therefore are subject to claims alleging we did not properly treat an individual or failed to properly diagnose and/or care for a client. We carry professional liability and general liability insurance and have an umbrella liability insurance policy, which provide us with aggregate coverage

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limits of $2.0 million per occurrence and an annual combined policy aggregate limit of $4.0 million. A substantial award could have a material adverse impact on our operations and cash flow and could adversely impact our ability to continue to purchase appropriate liability insurance. We can be subject to claims for negligence or intentional misconduct (in addition to professional liability type claims) by an employee, including but not limited to, claims arising out of accidents involving employees driving to or from interactions with clients or assault and battery. We can be subject to employee related claims such as wrongful discharge or discrimination or a violation of equal employment law. While we are insured for these types of claims, damages exceeding our insurance limits or outside our insurance coverage, such as a claim for fraud, could adversely affect our cash flow and financial condition. Furthermore, we can be subject to miscellaneous errors and omissions liability relative to the various management agreements we have with the not-for-profit entities we manage. In the event of a claim and depending on, among other things, the circumstances, allegations, and size of the management contract, we could be subject to damages that could have a material adverse impact on our financial condition and results of operations.

Our use of a self-insurance program to cover certain claims for losses suffered and costs or expenses incurred could negatively impact our business upon the occurrence of an uninsured event.

In May 2005, we adopted a program of self-insurance with regard to a substantial portion of our general and professional liability and workers’ compensation costs and the general and professional liability and workers’ compensation costs of certain designated entities managed by us under reinsurance programs through our wholly-owned captive insurance subsidiary. In the event that our actual reinsured losses and the reinsured losses of the certain designated entities managed by us increase unexpectedly or exceed our estimated reinsured losses under the program, the aggregate of such losses could materially increase our liability and adversely affect our financial condition, liquidity, cash flows and results of operations. In addition, as the availability to us of certain traditional insurance coverage diminishes or increases in costs, we will continue to evaluate the levels of claims we include in our self-insurance program. Any increases to this program increase our risk exposure and therefore increase the risk of a possible material adverse effect on our financial condition, liquidity, cash flows and results of operations.

We could be subject to significant state regulation and potential sanctions if our health care benefits program is deemed to be a multiple employer welfare arrangement.

For the purpose of managing and providing employee healthcare benefits we deem ourselves to be a single employer under Section 3(5) of ERISA with regard to our own employees as well as the employees of certain of our managed entities covered by our healthcare benefit program. The Department of Labor, or DOL, or individual states could disagree with our interpretation and consider our program to be a multiple employer welfare arrangement, or MEWA, and, as such, subject to regulation by state insurance commissions. If involuntarily deemed a MEWA, our cost to manage the state-by-state regulatory environment for the self-funded portion of our health insurance program would be prohibitive and we could, as a result, elect to maintain our self-funded health insurance plan only for our owned entities, forcing the three managed entities currently included in our self-funded plan to negotiate and purchase their own health benefits. In addition, if our health care benefits program is determined to be a MEWA, civil and/or criminal sanctions are possible.

We face substantial competition in attracting and retaining experienced social service professionals, and we may be unable to grow our business if we cannot attract and retain qualified employees.

Our success depends to a significant degree on our ability to attract and retain highly qualified and experienced social service professionals who possess the skills and experience necessary to deliver high quality services to our clients. Our objective of providing the highest quality of service to our clients is strongly considered when we evaluate education, experience and qualifications of potential candidates for employment as direct care and administrative staff. To that end, we attempt to hire professionals who have attained a bachelors degree, masters degree or higher level of education and certification or licensure as direct care social service providers and administrators. These employees are in great demand and are likely to remain a limited resource

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for the foreseeable future. We must quickly hire project leaders and case management personnel after a contract is awarded to us. Contract provisions and client needs determine the number, education and experience levels of social service professionals we hire. We continually evaluate client census, case loads and client eligibility to determine our staffing needs under each contract. Our ability to attract and retain employees with the requisite experience and skills depends on several factors including, but not limited to, our ability to offer competitive wages, benefits and professional growth opportunities. Some of the companies with which we compete for experienced personnel have greater financial resources and name recognition than we do. The inability to attract and retain experienced personnel could have a material adverse effect on our business.

Our success depends on our ability to manage growing and changing operations.

Since 1996, our business has grown significantly in size and complexity. This growth has placed, and is expected to continue to place, significant demands on our management, systems, internal controls and financial and physical resources. In addition, we expect that we will need to further develop our financial and managerial controls and reporting systems to accommodate future growth. This could require us to incur expenses for hiring additional qualified personnel, retaining professionals to assist in developing the appropriate control systems and expanding our information technology infrastructure. The nature of our business is such that qualified management personnel can be difficult to find. Our inability to manage growth effectively could have a material adverse effect on our financial results.

Any acquisition that we undertake could be difficult to integrate, disrupt our business, dilute stockholder value and harm our operating results.

We anticipate that we will continue making strategic acquisitions as part of our growth strategy. We have made a number of acquisitions since our inception, including eleven since our initial public offering in August 2003. The success of these and other acquisitions depends in part on our ability to integrate acquired companies into our business operations. There can be no assurance that the companies acquired will continue to generate income at the same historical levels on which we based our acquisition decisions, that we will be able to maintain or renew the acquired companies’ contracts, that we will be able to realize operating and economic efficiencies upon integration of acquired companies or that the acquisitions will not adversely affect our results of operations or financial condition.

We continually review opportunities to acquire other businesses that would complement our current services, expand our markets or otherwise offer growth opportunities. In connection with some acquisitions, we could issue stock that would dilute existing stockholders’ percentage ownership and/or we could incur or assume substantial debt or assume contingent liabilities. Acquisitions involve numerous risks, including, but not limited to, the following:

• problems assimilating the purchased operations;

• unanticipated costs and legal or financial liabilities associated with an acquisition;

• diversion of management’s attention from our core businesses;

• adverse effects on existing business relationships with customers;

• entering markets in which we have limited or no experience;

• potential loss of key employees of purchased organizations;

• the incurrence of excessive leverage in financing an acquisition;

• failure to maintain and renew contracts;

• unanticipated operating, accounting or management difficulties in connection with an acquisition; and

• dilution to our earnings per share.

We cannot assure you that we will be successful in overcoming problems encountered in connection with any acquisition, and our inability to do so could disrupt our operations and adversely affect our business.

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Our future debt obligations could impair our liquidity and financial condition.

We may incur debt in the future in connection with our acquisition strategy and for other corporate opportunities. If we do so, these debt obligations could pose risk by:

• making it more difficult for us to satisfy our obligations;

• requiring us to dedicate a substantial portion of our cash flow to payments on our debt obligations, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other corporate requirements;

• impeding us from obtaining additional financing in the future for working capital, capital expenditures, acquisitions and general corporate purposes; and

• making us more vulnerable if a downturn in our business occurs and limiting our flexibility to plan for, or react to, changes in our business.

If we were to fail to make any required payment under the agreements governing our indebtedness or fail to comply with the financial and operating covenants contained in these agreements, we would be in default. A default could have a significant adverse effect on the market value and marketability of our common stock. Our lenders would have the ability to require that we immediately pay all outstanding indebtedness. If the lenders were to require immediate payment, we might not have sufficient assets to satisfy our obligations under our credit facility, our subordinated notes or our other indebtedness. In such event, we could be forced to seek protection under bankruptcy laws, which could have a material adverse effect on our existing contracts and our ability to procure new contracts as well as our ability to recruit and/or retain employees.

Our success depends on our ability to compete effectively in the marketplace.

We compete for clients and for contracts with a variety of organizations that offer similar services. Most of our competition consists of local social service organizations that compete with us for local contracts, such as United Way supported agencies and faith-based agencies such as Catholic Social Services, Jewish Family and Children’s Services and the Salvation Army. Other competitors include local, not-for-profit organizations and community based organizations. Historically, these types of organizations have been favored in our industry as incumbent providers of services to government entities. We also compete with larger companies, such as Maximus, Inc., whose government operations group administers and manages welfare program services, childcare support enforcement, Medicaid enrollment and other consulting services for state and local governments. National Mentor, Inc. is the country’s largest provider of foster care services and competes with us in existing markets for foster care services. In addition, many institutional providers offer some type of community based care including such organizations as Cornell Companies, Inc., Res-Care, Inc., Psychiatric Solutions, Inc. and The Devereaux Foundation. Some of these companies have greater financial, technical, political, marketing, name recognition and other resources and a larger number of clients and/or payers than we do. In addition, some of these companies offer more services than we do. We have experienced, and expect to continue to experience, competition from new entrants into our markets. Increased competition may result in pricing pressures, loss of or failure to gain market share or loss of clients or payers, any of which could harm our business.

Our business is subject to state licensing regulations and other regulatory provisions, including regulatory provisions governing surveys, audits, anti-kickbacks, self-referrals, false claims and The Health Insurance Portability and Accountability Act of 1996, and changes to or violations of these regulations could negatively impact our revenues.

In many of the locations where we operate, we are required by state law to obtain and maintain licenses. The applicable state and local licensing requirements govern the services we provide, the credentials of staff, record keeping, treatment planning, client monitoring and supervision of staff. The failure to maintain these licenses or the loss of a license could have a material adverse impact on our business and could prevent us from providing

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services to clients in a given jurisdiction. Most of our contracts are subject to surveys or audit by our payers. We are also subject to regulations that restrict our ability to contract directly with a government agency in certain situations. Such restrictions could affect our ability to contract with certain payers. In addition, we are or may be subject to anti-kickback, self-referral and false claim laws. Violations of these laws may result in significant penalties, including repayment of any amounts alleged to be overpayments or in violation of such laws, criminal fines, civil money penalties, damages, imprisonment, a ban from participation in federally funded healthcare programs and/or bans from obtaining government contracts. Such fines and other penalties could negatively impact our business by decreasing profits due to repayment of overpayments or from the imposition of fines and damages, damaging our reputation and diverting our management resources.

Due to our access, use or disclosure of health information relating to individuals, we are subject to the privacy mandates of the Health Insurance Portability and Accountability Act of 1996, or HIPAA.

HIPAA mandates, among other things, the adoption of standards to enhance the efficiency and simplify the administration of the nation’s healthcare system. HIPAA requires the DHHS to adopt standards for electronic transactions and code sets for basic healthcare transactions such as payment, eligibility and remittance advices, or “transaction standards,” privacy of individually identifiable health information, or “privacy standards,” security of individually identifiable health information, or “security standards,” electronic signatures, as well as unique identifiers for providers, employers, health plans and individuals and enforcement. Final regulations have been issued by DHHS for the privacy standards, certain of the transaction standards and security standards. As a healthcare provider, we are required to comply in our operations with these standards and are subject to significant civil and criminal penalties for failure to do so. In addition, in connection with providing services to customers that also are healthcare providers, we are required to provide satisfactory written assurances to those customers that we will provide those services in accordance with the privacy standards and security standards. HIPAA has and will require significant and costly changes for our company and others in the healthcare industry. Compliance with the privacy standards became mandatory in April 2003, compliance with the transaction standards became mandatory in October 2003 (although full implementation was delayed with respect to the Medicare program until October 2005), and compliance with the security standards became mandatory in April 2005.

In February 2006, DHHS published its Final Rule on Enforcement of the HIPAA Administrative Simplification provisions, including the transaction standards, the security standards and the privacy rule. This enforcement rule addresses, among other issues, DHHS’s policies for determining violations and calculating civil money penalties, how DHHS will address the statutory limitations on the imposition of civil money penalties, and various procedural issues.

We have appointed an internal committee to maintain our privacy and security policies regarding client information in compliance with HIPAA. This committee is responsible for training our employees, including our regional and local managers and staff, to comply with HIPAA and monitoring compliance with the policy.

However, like other businesses subject to HIPAA regulations, we cannot fully predict the total financial or other impact of these regulations on us. The costs associated with our ongoing compliance could be substantial, which could negatively impact our profitability.

Provisions in our corporate documents and our certificate of incorporation and bylaws, as well as Delaware General Corporation Law, may hinder a change of control.

Provisions of our certificate of incorporation and bylaws, as well as provisions of the Delaware General Corporation Law, could discourage unsolicited proposals to acquire us, even though such proposals may be beneficial to you. These provisions include:

• a classified board of directors that cannot be replaced without cause by a majority vote of our stockholders;

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• our board of director’s authorization to issue shares of preferred stock, on terms as the board of directors may determine, without stockholder approval; and

• provisions of Delaware General Corporation Law that restrict many business combinations.

We are subject to the provisions of Section 203 of the Delaware General Corporation Law, which could prevent us from engaging in a business combination with a 15% or greater stockholder for a period of three years from the date it acquired such status unless appropriate board or stockholder approvals are obtained.

Item 1B.    Unresolved Staff Comments

None.

Item 2.    Properties

We lease our approximately 4,000 square foot corporate office building in Tucson, Arizona under a seven year lease which became effective October 1, 2005. The monthly base rental payment under this lease in the amount of approximately $5,521 is subject to an annual 3% increase over the initial term of the lease. In addition, we lease 203 offices for our management and administrative functions in connection with the performance of our contracts. The lease terms vary and are generally at market rates. Additionally, we acquired a 5,760 square foot office building in Pottsville, Pennsylvania in connection with the acquisition of Pottsville Behavioral Counseling Group, Inc., which is free of any mortgage. We believe that our properties are adequate for our current business needs. Further, we believe that we can obtain adequate space to meet our foreseeable business needs.

Item 3.    Legal Proceedings

Although we believe we are not currently a party to any material litigation, we may from time to time become involved in litigation relating to claims arising from our ordinary course of business. These claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources.

Item 4.    Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.

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PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market for our common stock

Our common stock, $0.001 par value per share, our only class of common equity, has been quoted on the Nasdaq National Market under the symbol “PRSC” since August 19, 2003. Prior to that time there was no public market for our common stock. As of March 9, 2006, there were approximately 14 holders of record of our common stock. The following table sets forth the high and low sales prices per share of our common stock for the period indicated, as reported on the Nasdaq National Market:

	High		Low
2005
Fourth Quarter	$	33.40	$	25.97
Third Quarter	$	31.42	$	23.33
Second Quarter	$	26.65	$	22.13
First Quarter	$	23.70	$	18.61
2004
Fourth Quarter	$	22.07	$	17.34
Third Quarter	$	19.70	$	15.42
Second Quarter	$	20.00	$	16.61
First Quarter	$	18.76	$	14.98

Dividends

We have not paid any cash dividends on our common stock and do not plan to pay dividends on our common stock in the foreseeable future. In addition, our ability to pay dividends is prohibited by the terms of our loan and security agreement with CIT Healthcare LLC (formerly known as Healthcare Business Credit Corporation) if there is a default under such agreement or if the payment of a dividend would result in a default. The payment of future cash dividends, if any, will be reviewed periodically by the board of directors and will depend upon, among other things, our financial condition, funds from operations, the level of our capital and development expenditures, any restrictions imposed by present or future debt instruments and changes in federal tax policies, if any.

Equity Compensation Plans

See “Equity Compensation Plans” under Part III-Item 12 “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” for disclosure regarding our equity compensation plans.

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Item 6.    Selected Financial Data

The following table sets forth selected consolidated financial data, other financial data and other data. The selected financial data for the fiscal years ended June 30, 2001 and 2002, the six months ended December 31, 2002 and the years ended December 31, 2003, 2004 and 2005 are derived from our audited consolidated financial statements. The selected consolidated financial data for the six months ended December 31, 2001 and for the twelve months ended December 31, 2002 are derived from our unaudited consolidated financial statements and include all adjustments, consisting of normal and recurring adjustments, that we considered necessary for a fair presentation of our financial position and results of operation as of and for such periods. You should read this information with our consolidated financial statements and the related notes and Item 7 entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operation,” all of which are included elsewhere in this report.

	Fiscal Year Ended June 30,					Six Months Ended December 31,						Twelve Months Ended December 31, 2002			Fiscal Year Ended December 31,
	2001		2002			2001			2002(1)						2003(4)			2004(4)		2005(4)(5)
						(unaudited)						(unaudited)
	(in thousand, except for per share data and “Other data”)
Statement of operations data:
Revenues:
Home and community based services	$	24,572	$	28,565		$	13,435		$	16,614		$	31,745		$	42,294		$	73,106	$	115,466
Foster care services		—		2,646			—			4,811			7,456			10,513			13,178		15,795
Management fees		98		1,616			364			1,315			2,567			6,469			10,682		14,447
Total revenues		24,670		32,827			13,799			22,740			41,768			59,276			96,966		145,708
Operating expenses:
Client service expense		21,619		27,848			12,151			20,145			35,842			45,284			71,884		108,939
General and administrative expense		1,780		2,869			1,045			2,496			4,319			6,209			12,179		18,178
Depreciation and amortization		364		480			138			361			704			904			1,325		2,094
Goodwill amortization		162		—			—			—			—			—			—		—
Total operating expenses		23,925		31,197			13,334			23,002			40,865			52,397			85,388		129,211
Operating income (loss)		745		1,630			465			(262	)		903			6,879			11,578		16,497
Non-operating (income) expenses
Interest expense, net		336		755			133			837			1,460			1,562			258		765
Put warrant accretion		—		—			—			3,569			3,569			631			—		—
Write-off of deferred financing costs		—		—			—			—			—			412			—		—
Equity in earnings of unconsolidated affiliate		—		(214	)		(97	)		(129	)		(247	)		(64	)		—		—
Income (loss) before income taxes		409		1,089			429			(4,539	)		(3,879	)		4,338			11,320		15,732
(Benefit) provision for income taxes		15		(254	)		(127	)		180			52			1,692			4,235		6,307
Net income (loss)		394		1,343			556			(4,719	)		(3,931	)		2,646			7,085		9,425
Preferred stock dividends		242		386			193			193			387			3,749			—		—
Net income (loss) available to common stockholders	$	152	$	957		$	363		$	(4,912	)	$	(4,318	)	$	(1,103	)	$	7,085	$	9,425

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	Fiscal Year Ended June 30,				Six Months Ended December 31,					Twelve Months Ended December 31, 2002			Fiscal Year Ended December 31,
	2001		2002		2001		2002(1)						2003(4)			2004(4)		2005(4)(5)
					(unaudited)					(unaudited)
	(in thousand, except for per share data and “Other data”)
Net income (loss) per share data:
Diluted	$	0.09	$	0.35	$	0.16	$	(2.42	)	$	(2.19	)	$	(0.25	)	$	0.76	$	0.95
Weighted average shares outstanding:
Diluted		1,672		3,496		3,180		2,029			1,970			4,432			9,355		9,885
Other financial data:
Managed entity revenue(2) (unaudited)	$	2,238	$	30,778	$	9,485	$	24,798		$	46,092		$	62,795		$	121,038	$	151,037
Other data(3) (unaudited):
States served		7		16		9		16			16			18			21		25
Locations		43		84		45		88			88			99			151		204
Employees		615		1,158		611		1,303			1,303			1,721			3,583		4,930
Direct		615		754		599		880			880			1,098			1,886		2,531
Managed		—		404		12		423			423			623			1,697		2,399
Contracts		61		155		95		158			158			202			312		527
Direct		61		108		91		111			111			134			196		281
Managed		—		47		4		47			47			68			116		246
Clients		3,697		10,785		8,492		10,730			10,730			13,371			29,066		35,646
Direct		3,697		3,763		3,713		4,375			4,375			5,729			15,421		18,893
Managed		—		7,022		4,779		6,355			6,355			7,642			13,645		16,753

	As of June 30, 2002			As of December 31,
				2002			2003		2004		2005
Balance sheet data:
Cash and cash equivalents	$	761		$	1,019		$	15,004	$	10,657	$	8,994
Total assets(6)		24,045			24,794			53,288		75,921		119,013
Total current liabilities		8,879			9,384			7,316		10,590		19,543
Long-term obligations		11,003			10,831			2,239		733		14,241
Other liabilities		—			3,569			—		—		3,983
Mandatorily redeemable convertible preferred stock		5,459			5,652			—		—		—
Total stockholders’ equity (deficit)		(1,296	)		(4,642	)		43,733		64,598		81,246

(1) In May 2003, we changed our fiscal year end from June 30 to December 31. As a result, the six months ended December 31, 2002 is presented as a transitional period.

(2) Managed entity revenue represents revenues of the not-for-profit social services organizations we manage. Although these revenues are not our revenues, because we provide substantially all administrative functions for these entities and a significant portion of our management fees is based on a percentage of their revenues, we believe that the presentation of managed entity revenue provides investors with an additional measure of the size of the operations under our administration and can help them understand trends in our management fee revenue.

(3) “States served,” “Locations,” “Employees” and “Contracts” data are as of the end of the period for owned and managed entities. “Clients” data represents the number of clients served during the last month of the period presented for owned and managed entities. “States served” excludes the District of Columbia. “Direct” refers to the employees, contracts and clients related to contracts made directly with payers. “Managed” refers to the employees, contracts and clients related to management agreements with

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not-for-profit organizations. Employees are designated according to their primary employer although employees may provide services under both direct and managed contracts.

(4) Several acquisitions were completed in the fiscal years ended December 31, 2003, 2004 and 2005, which affected the comparability of the information reflected in the selected financial data. See the subheading “Acquisitions” and the year-to-year analysis included in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operation” of this report for information regarding the affect these transactions had on our financial condition and results of operations for the periods presented.

(5) Home and community based services revenue for 2005 included approximately $3.6 million of revenue under our annual block purchase contract in excess of the contractual amount. Approximately $1.6 million of the amount recognized as home and community based services revenue in excess of the contractual amount has been collected through supplemental payments. The supplemental payments received from the payer are in addition to the annual contract amounts we are entitled to receive under our annual block purchase contract for services rendered and are at the discretion of the payer. Due to the discretionary nature of the supplemental payments and despite the fact that we have been awarded such payments historically under our annual block purchase contract, historical supplemental payments are not necessarily indicative of future supplemental payments that we may receive.

(6) Includes our deposit with the sellers in December 2003 of the $820,000 cash purchase price associated with our January 1, 2004 acquisition of the remaining 50% interest in Rio Grande Management Company.

Item 7.     Management’s Discussion and Analysis of Financial Condition and Results of Operation

The following discussion and analysis of our financial condition and results of operation should be read in conjunction with Item 6, entitled, “Selected Financial Data” and our consolidated financial statements and related notes included in Item 8 of this report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Certain risks, uncertainties and other factors, including but not limited to those set forth in Item 1A, entitled, “Risk Factors” and elsewhere in this report may cause actual results to differ materially from those projected in the forward-looking statements.

Overview of our business

We provide government sponsored social services directly and through not-for-profit social services organizations whose operations we manage. As a result of, and in response to, the large and growing population of eligible beneficiaries of government sponsored social services, increasing pressure on governments to control costs and increasing acceptance of privatized social services, we have increased our capacity to provide services in previously underserved geographic areas through the development of new programs and by consummating strategic acquisitions. As of December 31, 2005, we provided services directly and through the entities we manage to approximately 35,600 clients from 204 locations in 25 states and the District of Columbia. Our goal is to be the provider of choice to the social services industry. Focusing on our core competencies in the delivery of home and community based counseling, foster care and not-for-profit managed services, we believe we are well positioned to offer the highest quality of service to our clients and provide a viable alternative to state and local governments’ current service delivery systems.

Our industry is highly fragmented, competitive and dependent upon government funding. We depend on our experience, financial strength and broad presence to compete vigorously in each service offering. Challenges for us include competing with local incumbent social services providers in some of the areas we seek to enter and in rural areas where significant growth opportunities exist, finding and retaining qualified employees. We seek strategic acquisitions as one way to enter competitive markets.

Our business is highly dependent upon our obtaining contracts with government sponsored entities. When we are awarded a contract to provide services, we may incur expenses such as leasing office space, purchasing office equipment and hiring personnel before we receive any contract payments, and, under some of the large contracts we are awarded, we are required to invest significant sums of money before receiving any contract payments. We are also required to recruit and hire qualified staff to perform the services under contract. We

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strive to control these start-up costs by leveraging our existing infrastructure to maximize our resources and manage our growth effectively. However, with each contract we are awarded, we face the challenge of quickly and effectively building a client base to generate revenue to recover these costs.

Effective May 16, 2005, we began reinsuring a substantial portion of our general and professional liability and workers’ compensation costs and the general and professional liability and workers’ compensation costs of certain designated entities we manage under reinsurance programs through our wholly-owned captive insurance subsidiary, Social Services Providers Captive Insurance Company, or SPCIC. In addition, effective July 1, 2005, we began self-funding a substantial portion of our employee health insurance program which we also offer to employees of certain entities we manage. These decisions were made based on current conditions in the insurance marketplace that have led to increasingly higher levels of self-insurance retentions, increasing number of coverage limitations and fluctuating insurance premium rates.

On December 6, 2005, our board of directors, or Board, upon recommendation of the Compensation Committee of the Board, approved the acceleration of the vesting dates of all unvested stock options previously awarded to eligible employees, directors and consultants, including stock options granted to executive officers and non-employee directors, under our 2003 Stock Option Plan, effective December 29, 2005 for all of our active employees, directors and consultants at December 29, 2005. All other terms of the stock options previously awarded remained the same. The purpose of accelerating the vesting of outstanding unvested options is to enable us to avoid recognizing stock based compensation expense associated with these options in future periods after the adoption of Statement of Financial Accounting Standards No. 123R, “Share-Based Payment”, or SFAS 123R, in January 2006. See note 11, entitled, “Stock Option and Incentive Plans”, to our consolidated financial statements included in Item 8 of this report for additional information regarding the acceleration of the vesting dates of all unvested stock options.

Additional information regarding the follow-on offering of our common stock is included in the liquidity and capital resources discussion below.

Our working capital requirements are primarily funded by cash from operations. In addition, effective June 28, 2005, we amended our loan and security agreement with CIT Healthcare LLC, or CIT (formerly known as Healthcare Business Credit Corporation), to provide for a $25.0 million revolving line of credit and a $25.0 million acquisition term loan. Borrowings from our credit facilities with CIT provide funding for general corporate purposes and acquisitions.

How we earn our revenue

Our revenue is derived from our provider contracts with state and local government agencies and government intermediaries and from our management contracts with not-for-profit social services organizations. The government entities that pay for our services include welfare, child welfare and justice departments, public schools and state Medicaid programs. Under a majority of the contracts where we provide services directly, we are paid an hourly fee. In other such situations, we receive a set monthly amount or we are paid amounts equal to the costs we incur to provide agreed upon services. These revenues are presented in our consolidated statements of operations as either revenue from home and community based services or foster care services.

Where we contract to manage the operations of not-for-profit social services organizations, we receive a management fee that is either based upon a percentage of the revenue of the managed entity or a predetermined fee. These revenues are presented in our consolidated statements of operations as management fees. Because we provide substantially all administrative functions for these entities and our management fees are largely dependent upon their revenues, we also monitor for management and disclosure purposes the revenues of our managed entities. We refer to the revenues of these entities as managed entity revenue. In addition, from time to time, we provide short-term consulting services to other social services organizations for which we receive consulting fees that are a fixed amount per contract. Any such consulting revenues are presented in our consolidated statement of operations as management fees.

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How we grow our business and evaluate our performance

Our business grows internally, through organic expansion into new markets, increases in the number of clients served under contracts we or our managed entities are awarded, and externally through acquisitions.

We typically pursue organic expansion into markets that are contiguous to our existing markets or where we believe we can quickly establish a significant presence. When we expand organically into a market, we typically have no clients or perform no management services in the market and are required to incur start-up costs including the costs of space, required permits and initial personnel. These costs are expensed as incurred and our new offices can be expected to incur losses for a period of time until we adequately grow our revenue from clients or management fees.

We also pursue strategic acquisitions in markets where we see opportunities but where we lack the contacts and/or personnel to make a successful organic entry. Unlike organic expansion which involves start-up costs that may dilute earnings, expansion through acquisitions is generally accretive to our earnings. However, we bear financing risk and where debt is used, the risk of leverage in expanding through acquisitions. We also must integrate the acquired business into our operations which could disrupt our business and we may not be able to realize operating and economic efficiencies upon integration. Finally, our acquisitions involve purchase prices in excess of the fair value of tangible assets and cash or receivables. This excess purchase price is allocated to intangible assets and is subject to periodic evaluation and impairment or other write downs that are charges against our earnings.

In all our markets we focus on several key performance indicators in managing our business. Specifically, we focus on growth in the number of clients served, as that particular metric is the key driver of our revenue growth. We also focus on the number of employees as that is our most important variable cost and the key to the management of our operating margins.

Acquisitions

Since December 31, 2004, we have completed the following acquisitions:

• On June 13, 2005, we acquired all of the equity interest in Children’s Behavioral Health, Inc., or CBH, a Pennsylvania provider of home and school based social services for children. The purchase price of approximately $13.6 million consisted of $10.0 million in cash, 117,371 shares of our unregistered common stock valued at $3.0 million, and an unsecured, subordinated promissory note in the principal amount of approximately $619,000 after deducting certain credits related to working capital adjustments. This acquisition expanded our presence to a number of new counties within Pennsylvania and significantly increased the children’s services component of our business

• On August 22, 2005, we purchased all of the equity interest in Maple Services, LLC, a Colorado limited liability corporation, and Maple Star Nevada, a Nevada corporation. Maple Services, LLC is a for-profit management company that provides management services to Oregon and Colorado not-for-profit providers of foster care services and Maple Star Nevada provides therapeutic foster care services in several Nevada locations. The purchase price of $8.4 million (less $840,000 which was placed into escrow as security for any indemnification obligations for one year from August 22, 2005 and less certain additional adjustments contained in the purchase agreement) consisted of cash. In addition, we may be obligated to pay an additional amount up to $2.0 million under an earn out provision as such term is defined in the purchase agreement. These acquisitions expanded our presence into Colorado and Oregon through the two not-for-profit entities formerly managed by Maple Services LLC, and added foster care services to our existing roster of services in Nevada.

• On September 20, 2005, we acquired all of the equity interests in Transitional Family Services, Inc. and AlphaCare Resources, Inc., collectively referred to as AlphaCare. AlphaCare provides in-home and professional therapy services in several Georgia locations and administers one of the largest family preservation programs in the State of Georgia. The purchase price consisted of cash of approximately

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$5.1 million (less $472,692 which was placed into escrow as security for any indemnification obligations for 18 months from September 20, 2005 and less certain additional adjustments contained in the purchase agreement). In addition, we may be obligated to pay to the sellers an additional amount under an earn out provision in the purchase agreement. These acquisitions not only expanded our geographic footprint but also helped position us to take advantage of the growing trend within the state of Georgia for in-home delivery of mental health services.

• Effective October 1, 2005, we acquired all of the equity interests in Drawbridges Counseling Services, LLC, a provider of home based and case management services in Kentucky and Oasis Comprehensive Foster Care Services LLC, a foster care child placement agency licensed in Kentucky, collectively referred to as Drawbridges. We acquired these agencies for a purchase price of $450,000 (subject to certain working capital adjustments), which consisted of $400,000 in cash and a one year $50,000 unsecured, subordinated promissory note. These acquisitions provided us an entrée into the state of Kentucky.

• On February 1, 2006, we acquired all of the equity interest in A to Z In-Home Tutoring, LLC, or A to Z, a Tennessee based provider of home based educational tutoring. The purchase price included $500,000 in cash and approximately $800,000 in debt excluding a $250,000 bridge loan owing to us by A to Z at the date of acquisition. In accordance with certain provisions in the purchase agreement, we may make earn out payments based on future financial performance. The total purchase price including earn out payments will not exceed $8.0 million. This acquisition expands the Company’s home and community based social services to include educational tutoring. This acquisition expands our home based social services to include educational tutoring.

• On February 27, 2006, we acquired all of the equity interest in Family Based Strategies, Inc., or FBS, a North Carolina based provider of home based and case management services. The purchase price included $300,000 in cash less any negative working capital and a $75,000 loan owing to us by FBS at the date of acquisition. The purchase price will be paid upon the final determination of FBS’s working capital. In accordance with certain provisions in the purchase agreement, we may make an earn out payment in the second quarter of 2008 based on the financial performance of FBS over the period from March 1, 2006 to December 31, 2007. This acquisition expands our presence in North Carolina and provides us an entrée into the state of New Jersey.

The cash portion of the purchase price of these acquisitions was partially funded from our credit facility with CIT.

We continue to selectively identify and pursue attractive acquisition opportunities and have developed a pipeline of potential acquisition candidates. There are no assurances, however, that we will complete acquisitions in the future or that any completed acquisitions will prove profitable for us.

Critical accounting policies and estimates

General

In preparing our financial statements in accordance with accounting principles generally accepted in the United States we are required to make estimates and judgments that affect the amounts reflected in our financial statements. We base our estimates on historical experience and on various other assumptions we believe to be reasonable under the circumstances. However, actual results may differ from these estimates under different assumptions or conditions.

Critical accounting policies are those policies most important to the portrayal of our financial condition and results of operations. These policies require our most difficult, subjective or complex judgments, often employing the use of estimates about the effect of matters inherently uncertain. Our most critical accounting policies pertain to revenue recognition, accounts receivable and allowance for doubtful accounts, accounting for business combinations, goodwill and other intangible assets, our management agreement relationships and loss reserves for certain reinsurance and self-funded insurance programs.

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Revenue recognition

We recognize revenue generally at the time services are rendered at predetermined amounts stated in our contracts and when the collection of these amounts is considered to be probable.

At times we may receive funding for certain services in advance of services actually being rendered. These amounts are reflected in the accompanying consolidated balance sheets as deferred revenue until the actual services are rendered.

As services are rendered, documentation is prepared describing each service, time spent, and billing code under each contract to determine and support the value of each service provided. This documentation is used as a basis for billing under our contracts. The billing process and documentation submitted under our contracts vary among our payers. The timing, amount and collection of our revenues under these contracts are dependent upon our ability to comply with the various billing requirements specified by each payer. Failure to comply with these requirements could delay the collection of amounts due to us under a contract or result in adjustments to amounts billed.

The performance of our contracts is subject to the condition that sufficient funds are appropriated, authorized and allocated by each state, city or other local government. If sufficient appropriations, authorizations and allocations are not provided by the respective state, city or other local government, we are at risk of immediate termination or renegotiation of the financial terms of our contracts.

Fee-for-service contracts.    Revenues related to services provided under fee-for-service contracts are recognized as revenue at the time services are rendered and collection is determined to be probable. Such services are provided at established billing rates. Fee-for-service contracts represented approximately 66.5% and 61.8% of our revenue for the years ended December 31, 2004 and 2005.

Cost based service contracts.    Revenues from our cost based service contracts are generally recorded at one-twelfth of the annual contract amount less allowances for certain contingencies such as projected costs not incurred, excess cost per service over the allowable contract rate and/or insufficient encounters. This policy results in recognizing revenue from these contracts based on allowable costs incurred. The annual contract amount is based on projected costs to provide services under the contracts with adjustments for changes in the total contract amount. We annually submit projected costs for the coming year which assist the contracting payers in establishing the annual contract amount to be paid for services provided under the contracts. After June 30, which is the contracting payers’ year end, we submit cost reports which are used by the contracting payers to determine the amount, if any, by which funds paid to us for services provided under the contracts were greater than the allowable costs to provide these services. Completion of this review process may take several years from the date we submit the cost report. In cases where funds paid to us exceed the allowable costs to provide services under contract, we may be required to pay back the excess funds.

Our cost reports are routinely audited on an annual basis. We periodically review our provisional billing rates and allocation of costs and provide for estimated adjustments from the contracting payers. We believe that adequate provisions have been made in our consolidated financial statements for any adjustments that might result from the outcome of any cost report audits. Differences between the amounts provided and the settlement amounts are recorded in our consolidated statement of operations in the year of settlement. Cost based service contracts represented approximately 10.8% and 16.2% of our revenue for the years ended December 31, 2004 and 2005.

Annual block purchase contract.    Effective July 1, 2005, our annual block purchase contract with The Community Partnership of Southern Arizona, referred to as CPSA, requires us to provide or arrange for behavioral health services to eligible populations of beneficiaries as defined in the contract. We must provide a complete range of behavioral health clinical, case management, therapeutic and administrative services. There is no contractual limit to the number of eligible beneficiaries that may be assigned to us, or a specified limit to the level of services that may be provided to these beneficiaries. Therefore, we are at-risk if the costs of providing necessary services exceed the associated reimbursement.

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We are required to regularly submit service encounters to CPSA electronically. On an on-going basis and at the end of CPSA’s June 30 fiscal year, CPSA is obligated to monitor the level of service encounters. If at any time the encounter data is not sufficient to support the year-to-date payments made to us, CPSA has the right to prospectively reduce or suspend payments to us.

For revenue recognition purposes, our service encounter value (which represents the value of actual services rendered) must equal or exceed 90% of the revenue recognized under our annual block purchase contract. The remaining 10% of revenue recognized each reporting period represents payment for network overhead administrative costs incurred in order to fulfill our obligations under the contract. Administrative costs include, but are not limited to, intake services, clinical liaison oversight for each behavioral health recipient, cultural liaisons, financial assessments and screening, data processing and information systems, staff training, quality and utilization management functions, coordination of care and subcontract administration.

We recognize revenue from our annual block purchase contract corresponding to the service encounter value. If our service encounter value is less than 90% of the amounts received from CPSA, we recognize revenue equal to the service encounter value plus the administrative component and defer revenue for any excess amounts received such that the ratio of service encounter value to revenue recognized equals 90%.

If our service encounter value equals 90% of the amounts received from CPSA, we recognize revenue at the contract amount, which is one-twelfth of the established annual contract amount each month.

If our service encounter value exceeds 90% of the contract amount, we recognize revenue equal to the amount that yields a ratio of the service encounter value to revenue of 90%, and only if collection of any additional revenue over the contractual amount is considered to be probable. As of December 31, 2005, the amount of revenue recognized from this contract in excess of the contract amount for the first six months of the contract term was approximately $2.3 million. CPSA has a history of making additional payments to us beyond the stated contractual amounts. In addition, CPSA has not reduced, withheld, or suspended any payments and we believe our encounter data is sufficient to have earned all amounts recorded as revenue under this contract.

The terms of the contract may be reviewed prospectively and amended as necessary to ensure adequate funding of our contractual obligations. Our revenues under the annual block purchase contract and for the year ended December 31, 2004 and 2005 represented 11.6 and 12.1% of our total revenues, respectively.

Management agreements.    We maintain management agreements with a number of not-for-profit social services organizations whereby we provide certain management services for these organizations. In exchange for our services, we receive a management fee that is either based on a percentage of the revenues of these organizations or a predetermined fee. Management fees earned under our management agreements represented approximately 10.3% and 8.3% of our revenue for the years ended December 31, 2004 and 2005.

We recognize management fee revenues from our management agreements as such amounts are earned, as defined by the respective management agreement, and collection of such amount is considered probable. We assess the likelihood of whether any of our management fee revenues may need to be returned to help our managed entities fund their working capital needs. If the likelihood is other than remote, we defer the recognition of all or a portion of the management fees received. To the extent we defer management fees as a means of funding any of our managed entities’ losses from operations, such amounts are not recognized as management fee revenues until they are ultimately collected from the operating income of the managed entities.

In addition, as part of our reinsurance program, we reinsure a substantial portion of the general and professional liability and workers’ compensation cost of certain designated entities we manage through SPCIC. Further, we offer health insurance coverage to employees of certain entities we manage under our self-funded health insurance program. In exchange for this liability coverage, we receive a reimbursement equal to the pro-rata share of certain of our managed entities’ costs to participate in our reinsurance and self-funded health insurance programs. We consider these arrangements to be among the array of management services we provide

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to certain of our managed entities. As a result, we record amounts received from these managed entities as management fees revenue. Revenues related to these arrangements totaled approximately $1.1 million for the year ended December 31, 2005, and represented less than 1.0% of our revenue for the same period.

Consulting agreements.    From time to time we may enter into consulting agreements with other entities that provide government sponsored social services. Under the agreements, we evaluate and make recommendations with respect to their management, administrative and operational services. We may continue to enter into consulting agreements in the future. In exchange for these consulting services, we receive a fixed fee that is either payable upon completion of the services or on a monthly basis. These consulting agreements are generally short-term in nature and are subject to termination by either party at any time, for any reason, upon advance written notice. Revenues related to these services are recognized at the time such consulting services are rendered and collection is determined to be probable. Fees earned pursuant to our consulting agreements are classified as management fees revenue in our consolidated statements of operations and represented less than 1.0% of our revenue for the years ended December 31, 2004 and 2005.

The costs associated with generating our management fee and consulting fee revenues are accounted for in client service expense and in general and administrative expense in our consolidated statements of operations.

Accounts receivable and allowance for doubtful accounts

We evaluate the collectibility of our accounts receivable on a monthly basis. We determine the appropriate allowance for doubtful accounts based upon specific identification of individual accounts and review of aging trends. Any account receivable older than 365 days is generally deemed uncollectible and written off or fully reserved for.

We consider payer correspondence and payer assurances when evaluating the collectibility of accounts receivable. Amounts where collection is considered to be probable are deemed to be collectible. If the financial condition of our payers were to deteriorate, additions to our allowance for doubtful accounts may be required. In circumstances where we are aware of a specific payer’s inability to meet its financial obligation to us, we record a specific addition to our allowance for doubtful accounts to reduce the net recognized receivable to the amount we reasonably expect to collect.

Under certain of our contracts, billings do not coincide with revenue recognized on the contract due to payer billing system delays, delays related to our integration of new acquisitions and certain supplemental payments related to our annual block purchase contract in Arizona. Unbilled accounts receivable represent revenue recorded in excess of amounts formally invoiced. Unbilled amounts are expected to be collected within one year.

Our write-off experience for the years ended December 31, 2004 and 2005 was less than 1.0% of revenue.

Accounting for business combinations, goodwill and other intangible assets

We analyze the carrying value of goodwill at the end of each fiscal year and between annual valuations if events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying value. Such circumstances could include, but are not limited to: (1) a significant adverse change in legal factors or in business climate, (2) unanticipated competition, or (3) an adverse action or assessment by a regulator. When determining whether goodwill is impaired, we compare the fair value of the reporting unit to which the goodwill is assigned to the reporting unit’s carrying value, including goodwill. We use valuation techniques consistent with a market approach by deriving a multiple of our EBITDA (earnings before interest, taxes, depreciation and amortization) based on the market value of our common stock at year end and then applying this multiple to each reporting unit’s EBITDA for the year to determine the fair value of the reporting unit. If the carrying value of a reporting unit exceeds its fair value, then the amount of the impairment loss is measured. The impairment loss would be calculated by comparing the implied fair value of reporting unit goodwill to its carrying value. In calculating the implied fair value of reporting unit goodwill, the fair value of

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the reporting unit is allocated to all of the other assets and liabilities of that unit based on their fair values. The excess of the fair value of a reporting unit over the amount assigned to its other identifiable assets and liabilities is the implied fair value of goodwill. An impairment loss would be recognized when the carrying value of goodwill exceeds its implied fair value. Our evaluation of goodwill completed as of December 31, 2005 resulted in no impairment losses.

When we consummate an acquisition we separately value all acquired identifiable intangible assets apart from goodwill in accordance with Statement of Financial Accounting Standards No. 141, “Business Combinations”. In connection with our acquisitions, we allocated a portion of the purchase consideration to certain management contracts and customer relationships based on the expected direct or indirect contribution to future cash flows on discounted cash flow basis over the useful life of the assets.

We assess whether certain relevant factors limit the period over which acquired assets are expected to contribute directly or indirectly to future cash flows for amortization purposes. We determine an appropriate useful life for acquired customer relationships based on the expected period of time we will provide services to the payer.

While we use discounted cash flows to value intangible assets, we have elected to use the straight-line method of amortization to determine amortization expense. Under certain conditions we may assess the recoverability of the unamortized balance of our long-lived assets based on undiscounted expected future cash flows. If the review indicates that the carrying value is not fully recoverable, the excess of the carrying value over the fair value of any long-lived asset is recognized as an impairment loss.

Accounting for management agreement relationships

Due to the nature of our business and the requirement or desire by certain payers to contract with not-for-profit social services organizations, we sometimes enter into management contracts with not-for-profit social services organizations where we provide them with business development, administrative, program and other management services. These not-for-profit organizations contract directly or indirectly with state and local agencies to supply a variety of community based mental health and foster care services to children and adults. Each of these organizations is separately incorporated and organized with its own independent board of directors.

Our management agreements with these not-for-profit organizations generally:

• require us to provide management, accounting, advisory, supportive, consultative and administrative services;

• require us to provide the necessary resources to effectively manage the business and services provided;

• require that we hire, supervise and terminate personnel, review existing personnel policies and assist in adopting and implementing progressive personnel policies such as employee enrichment programs; and

• compensate us with a management fee in exchange for the services provided.

All of our management services are subject to the approval or direction of the managed entities’ board of directors.

The accounting for our relationships with these organizations is based on a number of judgments regarding certain facts related to the control of these organizations and the terms of our management agreements. Any significant changes in the facts upon which these judgments are based could have a significant impact on our accounting for these relationships. We have concluded that our management agreements do not meet the provisions of Emerging Issues Task Force 97-2, “Application of FASB Statement No. 94 and APB Opinion No. 16 to Physician Practice Management Entities and Certain other Entities with Consolidated Management Agreements,” or the provisions of the Financial Accounting Standards Board Interpretation No. 46(R),

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“Consolidation of Variable Interest Entities”, as revised, or Interpretation No. 46(R), thus the operations of these organizations are not consolidated with our operations. We will evaluate the impact of the provisions of Interpretation No. 46(R), if any, on future acquired management agreements.

Loss reserves for certain reinsurance and self-funded insurance programs

We maintain reserves for obligations related to our reinsurance programs for our general and professional liability and workers’ compensation coverage and our self-funded health insurance program provided to our employees and employees of certain entities we manage. As of December 31, 2005, we had reserves of approximately $1.2 million for the general and professional liability and workers’ compensation programs and approximately $658,000 in reserve for our self-funded health insurance program which began July 1, 2005. We utilize analyses prepared by third party administrators and independent actuaries based on historical claims information with respect to our general and professional liability coverage and our judgment based on our past experience and industry experience to support the required liability and related expense associated with our workers’ compensation coverage and health insurance coverage. With respect to our self-funded health insurance program, we also consider historical and projected medical utilization data when estimating our health insurance program liability and related expense. We record a provision for losses incurred but not reported, based on the recommendations of an independent actuary and management’s judgment using its past experience and industry experience. We record claims expense by plan year based on the lesser of the aggregate stop loss (if applicable) or the developed losses as calculated by independent actuaries with respect to our general and professional liability coverage and our past experience and industry experience with respect to our workers’ compensation coverage and health insurance coverage.

We continually analyze our reserves for incurred but not reported claims, and for reported but not paid claims related to our reinsurance and self-funded insurance programs and believe these reserves to be adequate. However, significant judgment is involved in assessing these reserves such as assessing historical paid claims, average lags between the claims’ incurred date, reported dates and paid dates, and the frequency and severity of claims. We are at risk for differences between actual settlement amounts and recorded reserves and any resulting adjustments are included in expense once a probable amount is known. Any significant increase in the number of claims or costs associated with claims made under these programs above our reserves could have a material adverse effect on our financial results.

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Results of operations

The following table sets forth the percentage of consolidated total revenues represented by items in our consolidated statements of operations for the periods presented:

	Year Ended December 31,
	2003		2004		2005
Revenues:
Home and community based services	71.4	%	75.4	%	79.2	%
Foster care services	17.7		13.6		10.8
Management fees	10.9		11.0		10.0
Total revenues	100.0		100.0		100.0
Operating expenses:
Client service expense	76.4		74.1		74.8
General and administrative expense	10.5		12.6		12.5
Depreciation and amortization	1.5		1.4		1.4
Total operating expenses	88.4		88.1		88.7
Operating income	11.6		11.9		11.3
Non-operating (income) expense:
Interest expense, net	2.6		0.2		0.5
Put warrant accretion	1.1		—		—
Write-off of deferred financing costs	0.7		—		—
Equity in earnings of unconsolidated affiliate	(0.1	)	—		—
Income before income taxes	7.3		11.7		10.8
Provision for income taxes	2.8		4.4		4.3
Net income	4.5	%	7.3	%	6.5	%

Year ended December 31, 2005 compared to year ended December 31, 2004

Revenues

	Year Ended December 31,				Percent Change
	2004		2005
Home and community based services	$	73,106,046	$	115,466,600	57.9	%
Foster care services		13,178,098		15,795,179	19.9	%
Management fees		10,681,500		14,446,589	35.2	%
Total revenue	$	96,965,644	$	145,708,368	50.3	%

Home and community based services.    The acquisition of Pottsville Behavioral Counseling Group, or Pottsville, in April 2004 and equity interests in three entities, collectively referred to as the Aspen companies, comprising of Choices Group, Inc., Aspen MSO, LLC (now known as Providence Community Services, LLC) and College Community Services, in July 2004 contributed approximately $13.9 million in home and community based services revenue for 2005 as compared to 2004 as the operations of these acquisitions were included only from the date of acquisition. In addition, we acquired CBH in June 2005, Maple Star Nevada in August 2005, AlphaCare in September 2005 and Drawbridges in October 2005 which added, on a cumulative basis, approximately $6.3 million to our home and community based services revenue for 2005. Further, services in the District of Columbia which began in June 2004 yielded additional home and community based services revenue of approximately $2.1 million for 2005 as compared to the prior year because the operations in the District of

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Columbia were included for only the last six months of 2004. Also, we recognized approximately $3.6 million of home and community based services revenue in excess of the contractual amount under our annual block purchase contract with CPSA for 2005. Approximately $1.6 million of the total amount recognized as home and community based services revenue under this contract in excess of the contract amount has been collected through supplemental payments. The supplemental payments received from CPSA are in addition to the annual contract amounts we were entitled to receive under our annual block purchase contract for services rendered and are at the discretion of CPSA. Due to the discretionary nature of the supplemental payments and despite the fact that we have been awarded such payments historically under our annual block purchase contract, historical supplemental payments are not necessarily indicative of future supplemental payments that we may receive. Excluding the acquisitions completed in 2004 and 2005, start up services in the District of Columbia in 2004 and the home and community based services revenue recognized in excess of the contractual amount under our contract with CPSA in 2005, our home and community based services provided additional revenue of approximately $16.5 million for 2005, as compared to 2004 due to client volume increases in new and existing locations. Due to the nature of government funded social services, rates paid for social services provided generally do not fluctuate substantially from year to year. Thus, fluctuations in rates for our home and community based services have a nominal affect on our home and community based services revenue.

Foster care services.    In our traditional home and community based markets such as Arizona and Virginia and in Delaware, where we are expanding our foster care services, our cross-selling efforts yielded an additional $1.8 million of foster care services revenue for 2005 as compared to 2004. We expect cross-selling activities to continue and provide additional revenues in the future as we focus on continuous expansion of our foster care services. The acquisition of Maple Star Nevada resulted in an increase in foster care services revenue of approximately $1.9 million from period to period. Partially offsetting the increase in foster care services revenue in 2005 were decreases in our Tennessee and Nebraska markets where we have experienced a decrease in the number of clients placed in foster homes due to systemic changes at the state level and lower inventory of licensed foster homes. In Tennessee certain changes at the state level have led to a shorter length of stay per client and a lower number of clients eligible to receive care which resulted in a decrease in foster care services revenue of approximately $507,000 for 2005 as compared to 2004. In Nebraska the inventory of licensed foster homes has declined leading to a decrease in the number of clients placed in foster homes and a decrease in foster care services revenue of approximately $361,000 for 2005 as compared to 2004. We are exploring opportunities to permanently place foster care clients through adoption programs in Tennessee which we expect will mitigate the decline in foster care clients and the decrease in foster care services revenue. In addition, we are increasing our efforts to recruit additional homes in Nebraska which we expect will increase our foster care service offering. Further offsetting the increase in foster care services revenue in 2005 was a decrease in our Florida market where a number of our foster care clients have transitioned from a higher level of foster care services to a lower level of foster care services for which we receive a lower rate. These lower rates led to a decrease of approximately $171,000 in funds from the contracting payers to provide foster care services for 2005 as compared to 2004.

Management fees.    Revenue for entities we manage but do not consolidate for financial reporting purposes (managed entity revenue) increased to $151.0 million for 2005 as compared to $121.0 million for 2004. The combined effects of business growth and the acquisition of the management agreements with Care Development of Maine, or CDOM, FCP, Inc., or FCP, The ReDCo Group, or ReDCo, Maple Star Colorado, Inc. and Maple Star Oregon, Inc. yielded approximately $1.5 million in additional management fees revenue for 2005 as compared to 2004, net of a decrease in management fees revenue from our amended management services agreement with Rio Grande Behavioral Health Services, Inc., or Rio Grande, described below. In addition, we entered into several short-term consulting agreements in 2005 which added another $1.3 million to management fees revenue for 2005. Revenues from consulting fees are not indicative of future revenues from consulting services that we may provide in the future. Further, we earned an additional $1.1 million for 2005 under our reinsurance and self-funded health insurance programs in which certain of the entities we manage participate. No such amounts were recorded in 2004 as our reinsurance and self-funded health insurance programs did not exist until 2005.

On June 30, 2004, Rio Grande, received a notice canceling one of its provider health maintenance organization network contracts effective July 31, 2004. Subsequently, Rio Grande commenced negotiations for a

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new contract. Rio Grande and the payer agreed to continue their relationship under new terms. In connection with this agreement, we amended the management services agreement between us and Rio Grande to change the management fee charged to Rio Grande for certain management services from a per member per month based fee to a fixed fee per month. The fixed fee was comparable to the previous per member per month based fee and remained at this predetermined level until January 1, 2005, at which time the fixed fee was reduced. The new fixed fee had the effect of decreasing our management fees revenue from this management services agreement by approximately $431,000 for 2005 when compared to 2004. Partially offsetting this decrease, however, was a management fee of $250,000 received in 2005 under the amended management services agreement with Rio Grande for start-up costs related to implementing pending changes to the Rio Grande behavioral health network described below.

Prior to July 1, 2005, the State of New Mexico contracted with three health maintenance organization’s and Rio Grande directly to administer a substantial portion of the state’s behavioral health services to recipients including Medicaid eligible recipients in southern New Mexico. The three health maintenance organizations, in turn, contracted with Rio Grande which had subcontracts with several not-for-profit providers in southern New Mexico (many of which comprise the Rio Grande behavioral health network) to provide behavioral health services to Medicaid eligible recipients. In addition, Rio Grande contracted with us to provide it with certain management services.

Effective July 1, 2005, the State of New Mexico modified its behavioral health services delivery system, whereby it contracts with one administrative services entity to administer new and renewing contracts for behavioral health services.

In response to the modification of the State of New Mexico’s behavioral health services delivery system, the not-for-profit providers of the Rio Grande behavioral health network began contracting directly with the administrative services entity chosen by the State of New Mexico. The then existing provider subcontracts with Rio Grande were not renewed; however, the not-for-profit providers contracted with Rio Grande for certain administrative services. In addition, six of the not-for-profit providers signed management services agreements with us. The management fees pursuant to these management services agreements are based on a flat fee and in total is comparable to the per member per month based management fee we previously charged to Rio Grande. Management fees revenue related to Rio Grande was approximately $1.4 million for 2005 and approximately $1.6 million for 2004.

Operating expenses

Client service expense.    Client service expense includes the following for 2004 and 2005:

	Year Ended December 31,				Percent Change
	2004		2005
Payroll and related costs	$	53,068,983	$	80,943,278	52.5	%
Purchased services		10,703,214		15,624,427	46.0	%
Other operating expenses		8,111,310		12,371,229	52.5	%
Total client service expense	$	71,883,507	$	108,938,934	51.5	%

Payroll and related costs.    To support our growth, provide high quality service and meet increasing compliance requirements expected by the government agencies with which we contract to provide services, we must hire and retain employees that possess higher degrees of education, experience and licensures. As we enter new markets, we expect payroll and related costs to continue to increase. As a result of increasing client numbers requiring us to hire additional service personnel, our payroll and related costs increased for 2005, as compared to 2004, as we added new direct care providers, administrative staff and other employees. In addition, we added new employees in connection with the acquisition of Pottsville, the Aspen companies, CBH, Maple Star Nevada, AlphaCare and Drawbridges which resulted in an increase in payroll and related costs of approximately

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$13.9 million for 2005. We continually evaluate client census, case loads and client eligibility to determine our staffing needs under each contract in order to optimize the quality of service we provide while managing the payroll and related costs to provide these services. Determining our staffing needs may not directly coincide with the generation of revenue as we are required at times to increase our capacity to provide services prior to starting new contracts. Alternatively, we may lag behind in client referrals as we may have difficulty recruiting employees to staff our contracts. Furthermore, acquisitions may cause fluctuations in our payroll and related costs as a percentage of revenue from period to period as we attempt to merge new operations into our service delivery system. As a percentage of revenue, payroll and related costs increased from 54.7% for 2004 to 55.6% for the same current year period primarily due to our efforts to increase the number of employees to service our growth.

Purchased services.    Increases in the number of referrals requiring pharmacy, support services and out-of-home placement under our annual block purchase contract and increases in foster parent payments accounted for the increase in purchased services for the 2005 as compared to 2004. We strive to manage our purchased services costs by constantly seeking alternative treatments to costly services that we do not provide. Although we manage and provide alternative treatments to clients requiring out-of-home placements and other purchased services, we sometimes cannot control the number of referrals requiring out-of-home placement and support services under our annual block purchase contract. Despite the increase in purchased services during 2005, as a percentage of revenue, purchased services remained relatively constant near 11.0% from period to period.

Other operating expenses.    As a result of our organic growth during the last twelve months, we added several new locations that contributed to an increase in other operating expenses for 2005 when compared to 2004. The acquisition of the Pottsville, Aspen companies, CBH, Maple Star Nevada, AlphaCare and Drawbridges added approximately $2.3 million to other operating expenses for 2005 as compared to 2004. As a percentage of revenue other operating expenses remained relatively constant at approximately 8.5% from period to period.

General and administrative expense.

Year Ended December 31,			Percent Change
2004	2005
$12,178,927	$	18,178,436	49.3	%

The addition of corporate staff to adequately support our growth and provide services under our management agreements, higher rates of pay for employees, insurance costs related to certain managed entities we cover under our reinsurance and self-funded health insurance programs as well as increased professional services fees accounted for an increase of approximately $4.0 million of corporate administrative expenses for 2005. Also contributing to the increase in general and administrative expense were costs associated with meetings of our board of directors and employee training and continuing education as well as investor relations costs such as costs associated with meetings and presentations to investors. In addition, as a result of the acceleration of vesting of stock options and the granting of stock options to a significant consultant of the company in 2005 under our 2003 Stock Option Plan, stock based compensation expense for 2005 increased approximately $457,000 over 2004. Furthermore, as a result of our growth during the last twelve months, rent and facilities management increased $1.7 million in part due to our acquisition activities. We adjusted our reserves for general and professional liability, workers’ compensation liability and self-funded health insurance programs to be in line with an independent actuary estimate under our reinsurance programs and, with respect to our self-funded health insurance program liability, projected medical utilization data. These adjustments resulted in a decrease in general and administrative expense of approximately $188,000 for 2005 as compared to 2004. As a percentage of revenue, general and administrative expense remained relatively constant at 12.5%.

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Depreciation and amortization.

Year Ended December 31,			Percent Change
2004	2005
$1,325,420	$	2,093,753	58.0	%

The increase in depreciation and amortization from period to period primarily resulted from the amortization of customer relationships of approximately $404,000 related to the acquisition of Pottsville, the Aspen companies, CBH, Maple Star Nevada, AlphaCare and Drawbridges. Also contributing to the increase in depreciation and amortization was the amortization of the fair value of the acquired management agreements with CDOM, FCP, ReDCo and Maple Star Nevada and increased depreciation expense due to the addition of software and computer equipment during the last twelve months. As a percentage of revenues, depreciation and amortization remained constant at 1.4% from period to period.

Non-operating (income) expense

Interest expense.    During 2005, we acquired several businesses which we primarily funded through borrowings under our acquisition line of credit with CIT that resulted in a higher level of debt for 2005 as compared to 2004. As a result, interest expense increased approximately $600,000 for 2005 as compared to 2004.

Provision for income taxes

The provision for income taxes is based on our estimated annual effective income tax rate for the full fiscal year equal to approximately 40.1%. Our estimated effective income tax rate differs from the federal statutory rate primarily due to nondeductible permanent differences such as meals, entertainment, fines, penalties and stock based compensation expense and state income taxes. At December 31, 2005, we have future tax benefits of $1.6 million related to $4.0 million of available federal net operating loss carryforwards which expire in years 2012 through 2023 and $5.8 million of state net operating loss carryforwards which expire in 2006 through 2020. Approximately $3.7 million of the federal net operating loss carryforwards result from the Camelot Care Corporation acquisition in 2002. The future use of these net operating loss carryforwards is limited on an annual basis.

Our valuation allowance includes $239,000 of state net operating loss carryforwards and $63,000 of federal net operating loss carryforwards for which we have concluded that it is more likely than not that these net operating loss carryforwards will not be realized in the ordinary course of operations.

Year ended December 31, 2004 compared to year ended December 31, 2003

Revenues

	Year Ended December 31,				Percent Change
	2003		2004
Home and community based services	$	42,293,856	$	73,106,046	72.9	%
Foster care services		10,513,100		13,178,098	25.3	%
Management fees		6,469,206		10,681,500	65.1	%
Total revenue	$	59,276,162	$	96,965,644	63.6	%

Home and community based services.    The acquisition of Dockside Services, Inc., or Dockside, in January 2004 contributed $3.0 million to our home and community based services revenue for 2004. We added 193 clients as a result of this acquisition and also positioned ourselves for cross selling of foster care services and expansion into other markets in the states of Indiana and Michigan. Our new home and community based services contracts in Fort Pierce and West Palm Beach, Florida collectively yielded $4.6 million in home and

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community based services revenue for 2004. The acquisition of Pottsville in May 2004 provided $1.4 million in home and community based services revenue for 2004. We added 257 clients as a result of this acquisition and entered into the Pennsylvania market. The acquisition of the Aspen companies in July 2004 contributed $10.4 million in home and community based services for 2004. We added approximately 5,000 clients as a result of this acquisition and entered into the California and Nevada markets. Excluding the acquisition of Dockside, Pottsville, the Fort Pierce and West Palm Beach contracts and the Aspen companies, our home and community based services provided additional revenue of approximately $11.4 million for 2004, as compared to 2003 due to client volume increases in new and existing locations. We experienced a net increase of approximately 4,400 new home and community based clients during 2004 as compared to 2003, with increases at our existing locations and as a result of the new locations that we opened in North Carolina and Tennessee.

Foster care services.    Foster care services revenue contributed an additional $2.7 million to total revenue for 2004 as compared to 2003. This increase was primarily attributable to client volume growth in our current markets, commencement of operations in Delaware, which yielded $610,000 in 2004, and cross-selling efforts in our traditional home and community based markets such as Arizona, Florida and Virginia where we added approximately $1.4 million.

Management fees.    Revenue for entities we manage but do not consolidate for financial reporting purposes (managed entity revenue) increased to $121.0 million for 2004 as compared to $62.8 million for 2003. Management fee revenue as a percentage of managed entity revenue decreased to 8.2% for 2004 compared to 10.3% for 2003 primarily due to the effect of a predetermined monthly fee we charged ReDCo, a managed entity, and comparatively lower management fee percentages related to the management agreements with CDOM and FCP that we acquired in June 2004. The combined effects of business growth, the acquisition of the remaining 50% interest in Rio Grande Management, and the acquisition of the management agreements with CDOM, FCP and ReDCo yielded approximately $2.2 million in additional management fee revenue for 2004, as compared to 2003. Furthermore, in February 2004, we began to manage the provision of services in the Fort Myers, Florida market by Camelot Community Care, Inc. pursuant to a contract awarded to it by the State of Florida. This contract accounted for an increase in management fee revenue of $1.3 million for 2004, as compared to 2003. In addition, under five short-term consulting contracts that we entered into during 2004, we generated $734,000 in consulting fees.

Operating expenses

Client service expense.    Client service expense includes the following for 2003 and 2004:

	Year Ended December 31,				Percent Change
	2003		2004
Payroll and related costs	$	31,886,567	$	53,068,983	66.4	%
Purchased services		8,214,143		10,703,214	30.3	%
Other operating expenses		5,183,292		8,111,310	56.5	%
Total client service expense	$	45,284,002	$	71,883,507	58.7	%

Payroll and related costs.    To support our growth, provide high quality service and meet increasing compliance requirements expected by the government agencies with which we contract to provide services, we must hire and retain employees that possess higher degrees of education, experience and licensures. As we enter new markets, we expect payroll and related costs to continue to increase. As a result of our organic growth, our payroll and related costs increased for 2004, as compared to 2003, as we added 316 new direct care providers, administrative staff and other employees. In addition, we added 396 new employees in connection with the acquisition of Dockside, Pottsville and the Aspen companies which resulted in an increase in payroll and related costs of approximately $9.6 million for 2004. We continually evaluate client census, case loads and client eligibility to determine our staffing needs under each contract in order to optimize the quality of service we provide while managing the payroll and related costs to provide these services. Determining our staffing needs

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may not directly coincide with the generation of revenue as we are required at times to increase our capacity to provide services prior to starting new contracts. Alternatively, we may lag behind increases in client referrals as we may have difficulty recruiting employees to staff our contracts. Furthermore, acquisitions may cause fluctuations in our payroll and related costs as a percentage of revenue from period to period as we attempt to merge new operations into our service delivery system. As a percentage of revenue, payroll and related expense increased from 53.8% for 2003 to 54.7% for 2004 primarily due to our efforts to increase the number of employees to service our growth.

Purchased services.    Increases in foster parent payments (resulting from an increase in the number of foster care clients) and an increase in the number of referrals requiring pharmacy and support services partially offset by a decrease in the number of referrals requiring out-of-home placement accounted for the increase in purchased services for 2004. We strive to manage our purchased services costs by constantly seeking alternative treatments to costly services that we do not provide. Although we manage and provide alternative treatments to clients requiring out-of-home placements and other purchased services, we sometimes cannot control the number of referrals requiring out-of-home placement and support services under our annual block contract. Despite the increase in purchased services for 2004, as a percentage of revenue, purchased services decreased from 13.9% for 2003 to 11.0% for 2004. Increases in revenue from both organic growth and acquisitions outpaced the growth in purchased services for 2004.

Other operating expenses.    As a result of our organic growth during 2004, we added new locations in North Carolina and Tennessee that contributed to an increase in other operating expenses for 2004 when compared to 2003. The acquisition of Dockside, Pottsville and the Aspen companies added approximately $1.4 million to other operating expenses for 2004. As a percentage of revenue other operating expenses decreased from 8.7% for 2003 to 8.4% for 2004 primarily due to our revenue growth rate.

General and administrative expense.

Year Ended December 31,			Percent Change
2003	2004
$6,209,162	$	12,178,927	96.1	%

The addition of corporate staff to adequately support our growth and provide services under our management agreements, higher rates of pay for employees as well as increased accounting and legal fees, information systems improvements, directors and officers’ insurance, general and professional liability insurance and professional services fees accounted for an increase of $4.4 million of corporate administrative expenses for 2004. Also contributing to the increase in general and administrative expense were investor relations costs such as costs associated with meetings and presentations to investors as well as professional fees related to increased services provided for Securities and Exchange Commission filings, report reviews and regulatory compliance. Furthermore, as a result of our growth during 2004, rent and facilities management increased $1.6 million in part due to our acquisition activities. As a percentage of revenue, general and administrative expense increased to 12.5% for 2004 from 10.3% for 2003 primarily as a result of the addition of corporate staff and additional professional services fees related to services provided for Securities and Exchange Commission filings.

Depreciation and amortization.

Year Ended December 31,			Percent Change
2003	2004
$903,617	$	1,325,420	46.7	%

The increase in depreciation and amortization from period to period primarily resulted from the amortization of customer relationships of $221,000 related to the acquisition of Dockside, Pottsville and the Aspen companies. Also contributing to the increase in depreciation and amortization was the amortization of the fair value of the

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acquired management agreements with Rio Grande, CDOM, FCP and ReDCo and increased depreciation expense due to the addition of software and computer equipment during 2004. As a percentage of revenues, depreciation and amortization decreased from 1.5% for 2003 to 1.4% for 2004 primarily due to a higher revenue growth rate.

Non-operating (income) expense

Interest expense, net.    Due to a lower level of debt for 2004, pursuant to the repayment of all of the amounts that were borrowed under our loan and security agreements with Healthcare Business Credit Corporation (now known as CIT Healthcare LLC), and from our mezzanine lenders, interest expense decreased in 2004 as compared to 2003. As a percentage of revenue, interest expense from period to period decreased from 2.6% for 2003 to 0.2% for 2004.

Provision for income taxes

The provision for income taxes is based on our estimated annual effective income tax rate for the full fiscal year equal to approximately 37.4%. Our estimated effective income tax rate differs from the federal statutory rate primarily due to nondeductible permanent differences and state income taxes. At December 31, 2004, we have future tax benefits of $1.8 million related to $5.1 million of available federal net operating loss carryforwards which expire in years 2012 through 2021 and $5.4 million of state net operating loss carryforwards which expire in 2006 through 2020. Approximately $5.1 million of the federal net operating loss carryforwards result from the Camelot acquisition. The future use of these net operating loss carryforwards is limited on an annual basis.

Our valuation allowance includes $239,000 of state net operating loss carryforwards and $63,000 of federal net operating loss carryforwards for which we have concluded that is more likely than not that these net operating loss carryforwards will not be realized in the ordinary course of operations.

Quarterly results

The following table presents quarterly historical financial information for the eight quarters ended December 31, 2005. The information for each of these quarters is unaudited and has been prepared on a basis consistent with our audited consolidated financial statements appearing elsewhere in this report. We believe the quarterly information contains all adjustments, consisting only of normal recurring adjustments, necessary to fairly present this information when read in conjunction with our audited consolidated financial statements and related notes appearing elsewhere in this report. Our operating results have varied on a quarterly basis and may fluctuate significantly in the future. Results of operations for any quarter are not necessarily indicative of results for a full fiscal year.

Supplemental quarterly financial data

	Quarter ended
	March 31, 2004		June 30, 2004		September 30, 2004			December 31, 2004
Revenues	$	18,454,661	$	20,678,947	$	28,219,366	(2)	$	29,612,670
Operating income		1,913,335		2,494,966		3,567,391			3,602,098
Net income		1,102,008		1,459,347		2,107,405			2,416,304
Earnings (loss) per share:
Basic	$	0.13	$	0.15	$	0.22		$	0.25
Diluted	$	0.13	$	0.15	$	0.22		$	0.25
Managed entity revenue (1)	$	20,300,653	$	29,161,077	$	35,087,700		$	36,488,321
Management fees	$	2,221,814	$	2,689,522	$	2,967,973		$	2,802,191

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	Quarter ended
	March 31, 2005		June 30, 2005			September 30, 2005			December 31, 2005
Revenues	$	32,033,259	$	35,219,678	(3)	$	37,347,137	(4)	$	41,108,294	(5)
Operating income		3,528,149		4,050,518			4,628,538			4,290,040
Net income		2,094,319		2,377,605			2,582,235			2,371,287
Earnings per share:
Basic	$	0.22	$	0.25		$	0.27		$	0.24
Diluted	$	0.22	$	0.24		$	0.26		$	0.24
Managed entity revenue (1)	$	35,929,056	$	37,372,982		$	39,558,259		$	38,176,287
Management fees	$	2,499,210	$	2,798,149		$	4,269,272		$	4,879,958

(1) Managed entity revenue represents revenues of the not-for-profit social services organizations we manage. Although these revenues are not our revenues, because we provide substantially all administrative functions for these entities and a significant portion of our management fees is based on a percentage of their revenues, we believe that the presentation of managed entity revenue provides investors with an additional measure of the size of the operations under our administration and can help them understand trends in our management fee revenue.

(2) The acquisition of the Aspen companies in July 2004 contributed additional revenue of $5.2 million for the quarter ended September 30, 2004.

(3) Revenues for the quarter ended June 30, 2005 included $1.3 million in supplemental payments under our annual block purchase contract with CPSA. These supplemental payments are in addition to the amount we were due under the annual block purchase contract and were at the discretion of CPSA. Accordingly, these supplemental payments are not indicative of future supplemental payments. Additionally, the acquisition of CBH in June 2005, contributed additional revenue of approximately $329,000 for the quarter ended June 30, 2005.

(4) The acquisition of Maple Star Nevada in August 2005 and AlphaCare in September 2005 contributed additional revenue of approximately $1.1 million for the quarter ended September 30, 2005. In addition, revenues for the quarter ended September 30, 2005 included approximately $467,000 of consulting fees under several short-term consulting agreements entered into in September 2005 and approximately $283,000 of supplemental payments under our annual block purchase contract with CPSA.

(5) Revenues for the quarter ended December 31, 2005 included approximately $762,000 of consulting fees under three short-term consulting agreements entered into in the quarter ended December 31, 2005. Revenues from consulting fees are not indicative of future revenues from consulting services that we may provide in the future. Operating income includes stock based compensation expense of approximately $600,000 related to the acceleration of vesting of all unvested stock options outstanding as of December 31, 2005 and the grant of stock options to a significant consultant under our 2003 Stock Option Plan. Further, we recognized approximately $2.0 million of revenue in excess of the contractual amount under our annual block purchase contract with CPSA.

Seasonality

Our quarterly operating results and operating cash flows normally fluctuate as a result of seasonal variations in our business, principally due to lower client demand for our home and community based services during the holiday and summer seasons. Historically, these seasonal variations have had a nominal affect on our operating results and operating cash flows. As we have grown our home and community based services business our exposure to seasonal variations has grown and will continue to grow, particularly with respect to our school based services, educational services and tutoring services with the acquisition of CBH and A to Z. We experience lower home and community based services revenue when school is not in session. Our expenses, however, do not vary significantly with these changes and, as a result, such expenses do not fluctuate significantly on a quarterly basis. We expect quarterly fluctuations in operating results and operating cash flows to continue as a result of the uneven seasonal demand for our home and community based services. In addition, as we enter new markets, we

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could be subject to additional seasonal variations along with any competitive response to our entry by other social services providers.

Liquidity and capital resources

Sources of cash for the year ended December 31, 2005 were from operations, cash received upon exercise of stock options and our loan and security agreement. Our balance of cash and cash equivalents was approximately $9.0 million at December 31, 2005, down from $10.7 million at December 31, 2004, primarily due to our acquisition activity in 2005 partially offset by cash provided by operating activities and proceeds from the issuance of stock related to the exercise of vested stock options in 2005. Of the total amount of cash at December 31, 2005, approximately $2.0 million is held by SPCIC to fund the activities and obligations of SPCIC. In addition, SPCIC is precluded from freely transferring funds through inter-company advances, loans or cash dividends. At December 31, 2005 and 2004, our total debt was approximately $18.3 million and $1.1 million, respectively.

Cash flows

Operating activities.    Net cash from operations of $8.4 million for 2005, was provided primarily from net income of $9.4 million and the add back of non-cash depreciation and amortization expense, deferred financing costs amortization, stock compensation expense, the tax effect of stock option deduction and deferred income taxes of approximately $3.9 million. Working capital increased for 2005, with approximately $9.1 million provided by increases in our billed and unbilled accounts receivable, management fee receivable, consulting fee receivable, other receivables and prepaid expenses partially offset by an approximately $5.0 million increase in accounts payable, accrued expenses and reinsurance liability reserves due to increased amounts for purchased services expense, income tax liability, accrued payroll, accrued foster parent payments and the required reserves related to our reinsurance programs. Revenue which was deferred in prior periods was earned in 2005 related to our operations in Arizona and California and resulted in a decrease in deferred revenue of approximately $765,000. Our cash generated from operations can be affected by a number of risks. See “Item 1.A. Risk Factors” for a discussion of factors that can negatively impact the amount of cash we generate from operations.

Investing activities.    Net cash used in investing activities totaled approximately $28.8 million for 2005, and included net acquisition costs of approximately $24.3 million related to CBH, Maple Star Nevada, Maple Services, LLC, AlphaCare and Drawbridges and adjustments to the costs related to the acquisition of Dockside and the Aspen companies and additional contract acquisition costs of approximately $2.2 million related to the acquisition of the management agreement with CDOM. Additionally, we paid approximately $1.8 million to secure a standby letter of credit to guarantee available funds to pay claims losses of SPCIC under our general and professional liability and workers’ compensation reinsurance programs partially offset by the release of restricted funds in the amount of approximately $786,000. These funds were invested in certificates of deposit that expired in July 2005 and provided financial assurance that we would fulfill certain contracted obligations. The released funds of approximately $786,000 plus accrued interest of approximately $32,000 were added to our operating cash at December 31, 2005. Further, we accepted two promissory notes; the first in the amount of approximately $100,000 (net of principal payments of approximately $39,000 as of December 31, 2005) in settlement of a claim and the second in the amount of $225,000 to provide a bridge loan to A to Z prior to our acquisition of all of its equity interest in February 2006. Finally, we spent approximately $917,000 for property and equipment.

Financing activities.    For 2005, we generated cash of approximately $18.6 million in financing activities. We had net borrowings of $17.0 million under our credit facility in connection with our acquisition activity and issued common stock related to the exercise of vested stock options which provided net proceeds of $2.5 million. Partially offsetting the increase in cash from financing activities was the repayment of amounts due under our notes payable related to the acquisition of Dockside of $300,000 and capital lease agreements of approximately $135,000. In addition, we paid approximately $200,000 to CIT and outside legal counsel in connection with the amendment of our loan and security agreement and settled a federal income tax obligation of approximately $172,000 arising from non-deductible costs related to our initial public offering in 2003.

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Obligations and commitments

Credit facilities.    On June 28, 2005, we entered into a second amended and restated loan and security agreement, or Second Amended Loan Agreement, with CIT. The Second Amended Loan Agreement provides for an increase in the amount we may borrow under our revolving line of credit from $10.0 million to $25.0 million and an increase in the amount we may borrow under our acquisition term loan from $10.0 million to $25.0 million subject to certain conditions. The amount we may borrow under the revolving line of credit is subject to the availability of a sufficient amount of eligible accounts receivable at the time of borrowing. Advances under the acquisition term loan are subject to CIT’s approval and are payable in consecutive monthly installments as determined under the Second Amended Loan Agreement.

Borrowings under the Second Amended Loan Agreement bear interest at a rate equal to the sum of the annual rate in effect in the London Interbank market, or LIBOR, applicable to one month deposits of U.S. dollars on the business day preceding the date of determination plus 3.5%–4.0% in the case of the revolving line of credit and 4.0%–4.5% in the case of the acquisition term loan subject to certain adjustments based upon our debt service coverage ratio. In addition, we are subject to a 0.5% fee per annum on the unused portion of the available funds as well as certain other administrative fees.

The Second Amended Loan Agreement also extends the maturity date of the revolving line of credit and acquisition term loan to June 28, 2010.

In order to secure payment and performance of all obligations in accordance with the terms and provisions of the Second Amended Loan Agreement, CIT retained its interests in the collateral described in the first amended and restated loan and security agreement dated as of September 30, 2003, including our management agreements with various not-for-profit entities, and the assets of our subsidiaries. If certain events of default occur including, but not limited to, failure to pay any installment of principal or interest when due, failure to pay any other charges, fees, expenses or other monetary obligations owing to CIT when due or other particular covenant defaults, as more fully described in the Second Amended Loan Agreement, CIT may declare all unpaid principal and any accrued and unpaid interest and all fees and expenses immediately due. Under the Second Amended Loan Agreement, any initiation of bankruptcy or related proceedings, assignment or sale of any asset or failure to remit any payments received by us on account to CIT will accelerate all unpaid principal and any accrued and unpaid interest and all fees and expenses. In addition, if we default on our indebtedness including the promissory notes issued in connection with completed business acquisitions, it could trigger a cross default under the Second Amended Loan Agreement whereby CIT may declare all unpaid principal and accrued and unpaid interest, other charges, fees, expenses or other monetary obligations immediately due.

We agreed with CIT to subordinate our management fee receivable pursuant to management agreements established with our managed entities, which have stand-alone credit facilities with CIT, to the claims of CIT in the event one of these managed entities defaults under its credit facility. Additionally, any other monetary obligations of these managed entities owing to us are subordinated to the claims of CIT in the event one of these managed entities defaults under its credit facility.

Additionally, based on certain provisions of our Second Amended Loan Agreement and security agreement, all of our collections on account related to our operating activities are swept into lockbox accounts to insure payment of outstanding obligations to CIT. Any amounts so collected which exceed amounts due CIT under our Second Amended Loan Agreement are remitted to us pursuant to a weekly settlement process. From time to time our reporting period cut-off date falls between settlement dates with CIT resulting in a receivable from CIT in an amount equal to the excess of collections on account related to our operating activities and amounts due CIT under our Second Amended Loan Agreement as of our reporting period cut-off date. As of December 31, 2005, the amount due us from CIT under this arrangement totaled approximately $2.3 million and was classified as “Other receivables” in our consolidated balance sheet.

The remaining provisions of the Second Amended Loan Agreement remained substantially the same as those set forth in the first amended and restated loan and security agreement.

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At December 31, 2005, we had net borrowings of approximately $17.0 million under the acquisition term loan and no borrowings under the revolving line of credit. We borrowed this amount to pay for acquisitions that we believe fit within our growth strategy as described in “Item 1.Business” under the captions “Our growth strategy” and “Our acquisition history.” We had available credit of $12.5 million on our revolving line of credit, and we were in compliance with all covenants at December 31, 2005.

Promissory notes.    In connection with our acquisition of Dockside, we issued two unsecured subordinated promissory notes each in the principal amount of $500,000 to the sellers in partial consideration for the purchase of all of Dockside’s outstanding stock. Each note bears interest equal to 6% per annum with interest payable quarterly beginning April 2004 and principal payments of $100,000 beginning April 2005. All principal and accrued but unpaid interest is due July 2007.

In partial consideration for the purchase of all of CBH’s outstanding stock, we issued to the seller an unsecured subordinated promissory note in the principal amount of approximately $776,000 which was subsequently adjusted downward to $619,000 after deducting certain credits related to working capital adjustments in accordance with the purchase agreement. The promissory note bears interest of 5% with interest payable semi-annually beginning December 1, 2005 and all unpaid principal and any accrued and unpaid interest due June 2010.

We issued a one year $50,000 unsecured, subordinated promissory note to the seller in connection with the acquisition of Drawbridges in October 2005. The promissory note bears interest of 6% with all accrued interest and unpaid principal due October 1, 2006. The principal and accrued but unpaid interest may be adjusted downward to zero for certain working capital adjustments as provided for in the purchase agreement.

Failure to pay any installment of principal or interest when due or the initiation of bankruptcy or related proceedings by us related to the unsecured, subordinated promissory notes issued to the former stockholders of Dockside, CBH and Drawbridges, constitutes an event of default under the promissory note provisions. If a failure to pay any installment of principal or interest when due remains uncured after the time provided by the promissory notes, the unpaid principal and any accrued and unpaid interest may become due immediately. In such event, a cross default could be triggered under the Second Amended Loan Agreement. In the case of bankruptcy or related proceedings initiated by us, the unpaid principal and any accrued and unpaid interest becomes due immediately.

Contingent obligations.    We may be obligated to pay, in the third fiscal quarter of 2006, an additional amount up to $2.0 million under an earn out provision as such term is defined in the purchase agreement related to the purchase of Maple Star Nevada. If the earn out provision is met, the contingent consideration will be paid in cash. If the contingency is resolved in accordance with the related provisions of the purchase agreement and the additional consideration becomes distributable, we will record the fair value of the consideration issued as an additional cost to acquire Maple Star Nevada.

In connection with the acquisition of AlphaCare, we may be obligated to pay to the sellers, in the second fiscal quarter of 2007, an additional amount under an earn out provision pursuant to a formula specified in the purchase agreement that is based upon certain factors, including the EBITDA of certain programs of AlphaCare. If the earn out provision is met, the contingent consideration will be paid one-third in cash, one-third by delivery of an unsecured, subordinated promissory note and the balance in shares of our unregistered common stock, the value of which will be determined in accordance with the provisions of the purchase agreement. If the contingency is resolved in accordance with the related provisions of the purchase agreement and the contingent consideration becomes distributable, we will record the fair value of the consideration paid, issued or issuable as an additional cost to acquire AlphaCare.

In connection with the acquisition of A to Z, we may be obligated to pay to the former members of A to Z in each of 2007, 2008 and 2009, an additional amount under an earn out provision pursuant to a formula specified in

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the purchase agreement that is based upon the future financial performance of A to Z. If the earn out provision is met in 2007, the contingent consideration will be paid in cash, and if the earn out provision is met in 2008 or 2009, the contingent consideration will be paid in a combination of cash and shares of our unregistered common stock, the value of which will be determined in accordance with the provisions of the purchase agreement. The total purchase price including earn out payments will not exceed $8.0 million. When and if the earn out provision is triggered and paid, we will record the fair value of the consideration paid, issued or issuable as an additional cost acquire A to Z.

We may be obligated to pay, in the second fiscal quarter of 2008, an additional amount under an earn out provision as such term is defined in the purchase agreement related to the purchase of FBS. If the earn out provision is met, the contingent consideration will be paid in cash. If the contingency is resolved in accordance with the related provisions of the purchase agreement and the additional consideration becomes distributable, we will record the fair value of the consideration issued as an additional cost to acquire FBS.

Management agreements

We maintain management agreements with a number of not-for-profit social services organizations that require us to provide management and administrative services for each organization. In exchange for these services, we receive a management fee that is either based upon a percentage of the revenues of these organizations or a predetermined fee. Management fees generated under our management agreements represented 10.3% and 8.3% of our revenue for the years ended December 31, 2004 and 2005. Fees generated under short term consulting agreements represented less than 1.0% of our revenue for the years ended December 31, 2004 and 2005. (See “—Critical accounting policies and estimates—Revenue recognition”). In accordance with our management agreements with these not-for-profit organizations, we have obligations to manage their business and services.

Management fee receivable at December 31, 2004 and 2005 totaled $5.0 million and $6.6 million, respectively, and management fee revenue was recognized on all of these receivables. In order to enhance liquidity of the entities we manage, we may allow the managed entities to defer payment of their respective management fees. In addition, since government contractors who provide social or similar services to government beneficiaries sometimes experience collection delays due to either lack of proper documentation of claims, government budgetary processes or similar reasons outside the contractors’ control (either directly or as managers of other contracting entities), we generally do not consider a management fee receivable to be uncollectible due solely to its age until it is 365 days old.

The following is a summary of the aging of our management fee receivable balances as of December 31, 2004 and March 31, June 30, September 30 and December 31, 2005:

At	Less than 30 days		30-60 days		60-90 days		90-180 days		Over 180 days
December 31, 2004	$	886,440	$	866,315	$	949,436	$	1,945,326	$	375,888
March 31, 2005	$	843,523	$	848,517	$	807,170	$	2,210,418	$	345,159
June 30, 2005	$	1,048,493	$	797,148	$	922,168	$	2,194,287	$	360,053
September 30, 2005	$	1,320,176	$	944,815	$	801,541	$	2,148,061	$	825,846	(1)
December 31, 2005	$	1,548,203	$	909,661	$	849,320	$	2,355,861	$	960,137	(1)

(1) We relaxed our management fee receivable collection policy during the second half of 2005 to enable Camelot Community Care, Inc. to fund certain performance bonds related to new business opportunities in its Florida market. The result of relaxing our collection policy led to an increase in our balance of management fee receivable over 180 days at September 30 and December 31, 2005 as compared to December 31, 2004, March 31 and June 30, 2005. We believe that the collection of the management fees owed to us by Camelot Community Care, Inc. is probable based on their projected cash flows at December 31, 2005.

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We adhere to a strict revenue recognition policy regarding our management fee revenue and related receivables. Each month we examine each of our managed entities with regard to its solvency, outlook and ability to pay us any outstanding management fees. If the likelihood that we will not be paid is other than remote, we defer the recognition of these management fees until we are certain that payment is probable. In keeping with our corporate policy regarding our accounts receivable, we generally reserve as uncollectible 100% of any management fee receivable that is older than 365 days.

Our days sales outstanding for our managed entities increased from 181 days at December 31, 2004 to 183 days at December 31, 2005.

In addition, Camelot Community Care, Inc. which represented approximately $3.9 million, or 59.1%, of our total management fee receivable at December 31, 2005, and Intervention Services Inc., referred to as ISI, which represented approximately $782,000, or 11.8%, of our total management fee receivable at December 31, 2005, each obtained its own stand-alone line of credit from CIT in September 2003. The loan agreements between CIT and these not-for-profit organizations permit them to use their credit facilities to pay our management fees, provided they are not in default under these facilities at the time of the payment. As of December 31, 2005, Camelot Community Care, Inc. had availability of approximately $1.2 million under its line of credit as well as $5.3 million in cash and cash equivalents and ISI had availability of approximately $299,000 under its line of credit as well as $64,000 in cash and cash equivalents.

The remaining $1.9 million balance of our total management fee receivable at December 31, 2005 was due from Rio Grande including certain members of the Rio Grande behavioral health network, ReDCo, CDOM, FCP, Family Preservation Community Services, Inc., or FPCS (which was formerly known as Family Preservation Services of South Carolina), and the two not-for-profit foster care providers formerly managed by Maple Services, LLC.

We have deemed payment of all of the foregoing receivables to be probable based on our collection history with these entities as the long-term manager of their operations.

Transactions with Camelot Community Care, Inc.    On February 3, 2006, the board of directors of Camelot Community Care, Inc. granted us a year end management incentive bonus of $125,000 for management service rendered in 2005. The bonus amount was added to the management fee receivable at December 31, 2005. In addition, we amended our management agreement to include a reduction of our management fee beginning January 1, 2006. The agreement will decrease our management fees by approximately $200,000 on an annual basis for the remaining term of the agreement.

Transactions with FPCS.    In June 1999, we were issued a promissory note by FPCS, a managed entity, in the amount of $461,342. The note bears interest at a rate of 9% per annum and was due in June 2004. On February 20, 2003, a new promissory note in the same amount was issued by FPCS which extended the due date for repayment of principal and unpaid accrued interest to February 2008 and lowered the interest rate to 5% per annum. The balance of the note at December 31, 2005 was approximately $407,000. In addition, effective March 1, 2006, we amended our management services agreement with FPCS to increase the management fee to reimburse us for the compensation costs for FPCS’s State Director who became our employee on that day.

Transactions with Rio Grande.    We amended our management services agreement with Rio Grande to lower its management fee for services rendered in 2005 as a result of changes made to the Rio Grande Behavioral Health provider network in New Mexico in 2005. The lower management fee under the amended management services agreement with Rio Grande was partially offset by management fees from management services agreements entered in to by us, as the manager, and certain providers which comprised the Rio Grande Behavioral Health provider network in 2005. In addition, we were awarded a one time fee of $200,000 in 2005 by Rio Grande for reorganization start-up costs under the amended management services agreement related to the changes made to the Rio Grande Behavioral Health provider network in 2005.

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Transactions with FCP.    We entered in to an agreement with FCP under which we reduced our management fee below the fee provided for under the original management service agreement for management services rendered from July 1, 2004 to June 30, 2005 to enable FCP to fund certain expenses incurred by FCP during its fiscal year ended June 30, 2005. For management services provided by us in excess of services contemplated by the management services agreement during the period July 1, 2004 and June 30, 2005, FCP agreed to an increase in the management fee above the fee provided for under the original management service agreement charged to them by us for FCP’s fiscal year ending June 30, 2006. The management fee under the original management services agreement will be applied to FCP in its subsequent fiscal years beginning July 1, 2006 over the remaining term of the management services agreement.

Transactions with ReDCo.    In connection with the acquisition of Pottsville and the establishment of a management agreement with ReDCo, we loaned $875,000 to ReDCo to fund certain long-term obligations of the entity in exchange for a promissory note for the same amount. The note assumes interest equal to a fluctuating interest rate per annum based on a weighted-average daily Federal Funds Rate. The terms of the promissory note require ReDCo to make quarterly interest payments over twenty-one months commencing June 30, 2004 with the principal and any accrued and unpaid interest due upon maturity on March 31, 2006. On January 25, 2006, the promissory note was amended extending the maturity date to September 2007. The promissory note is collateralized by a subordinated lien to ReDCo’s primary lender on substantially all of ReDCo’s assets. Additionally, in October 2005, ReDCo agreed to pay us $500,000 under an amendment to the management agreement. The aggregate amounts due to us from ReDCo under these arrangements totaled approximately $1.4 million at December 31, 2005.

Transactions with Maple Star Colorado, Inc and Maple Star Oregon, Inc.    Upon our acquisition of Maple Services, LLC, Mr. McCusker, our chief executive officer, Mr. Deitch, our chief financial officer, and Mr. Norris, our chief operating officer, became members of the board of directors of the two not-for-profit organizations (Maple Star Colorado, Inc. and Maple Star Oregon, Inc.) formerly managed by Maple Services, LLC. Maple Star Colorado, Inc. and Maple Star Oregon, Inc., while not-for-profit organizations are not federally tax exempt organizations. We provided management services to Maple Star Colorado, Inc. and Maple Star Oregon, Inc. under management agreements for consideration in the aggregate amount of approximately $715,000 for the year ended December 31, 2005. In addition, the board of directors of Maple Star Oregon, Inc. granted us management incentive bonuses from the date we acquired Maple Services, LLC to December 31, 2005. The bonus amounts were added to management fee receivable and aggregated to approximately $291,000 at December 31, 2005.

Management incentive bonus payments granted by any managed entity are discretionary subject to the approval of the board of directors of the managed entity and are not indicative of future bonus amounts that may be paid or become payable to us.

Loss reserves for certain reinsurance and self-funded insurance programs

General and professional liability and workers’ compensation

Prior to April 12, 2005, we had general and professional liability coverage with a $500,000 self-insured retention for each claim through a third party insurer. In addition, prior to May 16, 2005 we had first dollar coverage for workers’ compensation costs with third party insurers. Effective May 16, 2005, we began reinsuring a third party insurer for a substantial portion of our general and professional liability and workers’ compensation costs and the general and professional liability and workers’ compensation costs of certain designated entities managed by us under reinsurance programs through our wholly-owned captive insurance subsidiary SPCIC, incorporated and licensed under the laws of the State of Arizona. We established SPCIC in order to better manage risks and the annual expenditures for general and professional liability and workers’ compensation insurance coverage. It is expected that the formation of SPCIC will enable us to provide for: (1) long-term stable insurance programs, (2) increased control over claims management and risk control administration and (3) reduced overall insurance costs associated with general and professional liability and workers’ compensation insurance coverage. We primarily utilize SPCIC as a risk management and cost containment tool.

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Our general and professional liability and workers’ compensation reinsurance programs are fronted by two third party insurers for a predetermined amount: one for general and professional liability and one for workers’ compensation liability. These third party insurers also provide coverage to certain designated entities managed by us. SPCIC reinsures both of these third party insurers for claims as described below.

SPCIC reinsures the third party insurer for general and professional liability exposures for the first dollar of each and every loss up to $250,000 per loss with no annual aggregate limit. The reinsurance premium for the first policy year ending April 12, 2006 of approximately $785,000 covers the reinsured portion of the actuarially determined expected losses for the same period of approximately $512,000 and the operations budget of SPCIC of approximately $273,000. The third party insurer provides general and professional liability coverage up to $750,000 per occurrence in excess of the $250,000 reinsured limit with an annual aggregate limit of $3.0 million for both the general liability and professional liability portions of the coverage. We utilize analyses prepared by third party administrators and independent actuaries based on historical claims information to support the required liability and related expense. If our actual reinsured losses and the reinsured losses of certain designated entities we manage were to exceed the reinsured portion of the actuarially determined expected losses of approximately $512,000 in the first policy year ending April 12, 2006, our additional exposure would be recognized as an increase to our general and administrative expense in our consolidated statements of operations in the period such exposure became known.

We also purchased an umbrella liability insurance policy with an effective date of July 1, 2005, providing additional coverage in the amount of $1.0 million per occurrence and $1.0 million in the aggregate in excess of the policy limits of the general and professional liability policy. The general and professional liability policy limits, combined with the umbrella policy, are now $2.0 million per occurrence with an annual aggregate limit of $4.0 million.

Under our workers’ compensation reinsurance program, SPCIC reinsures a third party insurer for the first $250,000 per occurrence with no annual aggregate limit. The third party insurer provides workers’ compensation coverage up to statutory limits. The reinsurance premium for the first policy year ending May 15, 2006 of approximately $774,000 equals the reinsured portion of the expected losses for the same period based upon our judgment using our past experience and industry experience. If our actual reinsured losses and the reinsured losses of certain designated entities we manage were to exceed the reinsured portion of the expected losses of approximately $774,000 in the first policy year ending May 15, 2006, our additional exposure would be recognized as an increase to our payroll and related costs in our consolidated statements of operations in the period such exposure became known. Our reserve levels are evaluated on a quarterly basis. Any necessary adjustments are recognized as an adjustment to general and administrative expense in our consolidated statements of operations.

We record a provision for losses incurred but not reported, based on the recommendations of an independent actuary and our judgment using our past experience and industry experience. At the end of each fiscal year, insurance regulations require that we record reserve levels equal to or greater than an independent actuary’s estimate of expected losses. On December 31, 2005, the end of SPCIC’s fiscal year, we decreased our expected loss reserves by an immaterial amount to equal the independent actuary’s estimate of expected losses of approximately $702,000.

SPCIC has restricted cash of $1.8 million at December 31, 2005, which is restricted to secure the reinsured claims losses of SPCIC under the general and professional liability and workers’ compensation reinsurance programs. The full extent of claims may not be fully determined for years. Therefore, the estimates of potential obligations are based on recommendations of an independent actuary and our judgment using historical data, and industry and our experience. Although we believe that the amounts accrued for losses incurred but not reported under the terms of our reinsurance programs are sufficient, any significant increase in the number of claims or costs associated with these claims made under these programs could have a material adverse effect on our financial results.

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Any obligations above our reinsurance program limits are our responsibility. Approximately 28% of the total liability assumed by SPCIC under its reinsurance programs is related to the designated entities managed by us that are covered under SPCIC’s reinsurance programs.

Health insurance

Effective July 1, 2005, we began offering our employees and employees of certain entities we manage an option to participate in a self-funded health insurance program. Health claims under this program are self-funded with a stop-loss umbrella policy with a third party insurer to limit the maximum potential liability for individual claims to $150,000 per person and for total claims up to $8.0 million for the program year ending June 30, 2006. Health insurance claims are paid as they are submitted to the plan administrator. Beginning July 1, 2005, we maintain accruals for claims that have been incurred but not yet reported to the plan administrator and therefore have not been paid. The incurred but not reported reserve is based on the historical claim lag period and current payment trends of health insurance claims which is generally 1 – 2 months. The liability for the self-funded health plan of approximately $658,000 as of December 31, 2005 is recorded in “Reinsurance liability reserve” in the accompanying consolidated balance sheet.

We charge our employees and employees of certain entities we manage a portion of the costs of our self-funded and non self-funded health programs, and we determine this charge at the beginning of each plan year based upon historical and projected medical utilization data. Any difference between our projections and our actual experience is borne by us. We estimate potential obligations for liabilities under this program to reserve what we believe to be a sufficient amount to cover liabilities based on our past experience. Any significant increase in the number of claims or costs associated with claims made under this program above what we reserve could have a material adverse effect on our financial results.

Tax return examination

In 2005, the Internal Revenue Service examined our tax return for the period July 1, 2003 to December 31, 2003. The examination concluded in December 2005 with no material effect to our financial position or results of operations.

Contractual cash obligations.

The following is a summary of our future contractual cash obligations as of December 31, 2005:

	At December 31, 2005
Contractual cash obligations (000’s)	Total		Less than 1 Year		1-3 Years		3-5 Years		After 5 Years
Debt	$	18,324	$	4,083	$	7,567	$	6,674	$	—
Interest		3,703		1,404		1,796		503		—
Purchased services commitments		161		161		—		—		—
Leases		12,891		4,112		5,394		2,406		979
Total	$	35,079	$	9,760	$	14,757	$	9,583	$	979

Follow-on registered offering of common stock

We have filed a registration statement relating to a proposed underwritten offering of up to 1.5 million shares of our common stock (not including up to an additional 225,000 shares of our common stock that may be issued by us upon exercise of the underwriters’ over-allotment option). Additionally, we have filed a shelf registration statement with respect to another 1.0 million shares of our common stock, which we may offer and sell on a delayed basis or continuous basis pursuant to rule 415 under the Securities Act of 1933. If these offerings are completed, we intend to use the net proceeds we receive to repay amounts outstanding under our credit facility and the balance for general corporate purposes, including possible future acquisitions.

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We expect our liquidity needs on a short-term basis will be satisfied by cash flow from operations, the net proceeds from the sale of equity securities and borrowings under our debt facilities.

Recently issued accounting pronouncements

In December 2004, the Financial Accounting Standards Board finalized SFAS 123R, effective for public companies for annual periods beginning after June 15, 2005. SFAS 123R requires all companies to measure compensation cost for all share-based payments (including employee stock options) at the grant-date fair value of the award. Retroactive application of the requirements of SFAS 123R is permitted, but not required. We adopted the provisions of SFAS 123R beginning January 1, 2006 using the modified prospective method. The financial statement impact will be dependent on future stock based awards and their related vesting provisions. No financial statement impact is expected related to stock based awards outstanding at December 31, 2005 due to the acceleration of vesting of all unvested stock based awards in 2005.

In May 2005, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections”, or SFAS 154, which replaces APB Opinion No. 20, “Accounting Changes”, and SFAS 3, “Reporting Accounting Changes in Interim Financial Statements”, and changes the requirement for the accounting for and reporting of a change in accounting principle. SFAS 154 applies to all voluntary changes in accounting principle. In addition, absent specific transition provisions of an accounting pronouncement, the provisions of SFAS 154 should be followed. APB Opinion No. 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. SFAS 154 requires retrospective application to prior periods’ financial statements of voluntary changes in accounting principle. SFAS 154 also requires that a change in depreciation, amortization, or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate effected by a change in accounting principle. SFAS 154 is effective for changes and error corrections made in fiscal years beginning after December 15, 2005. We are required to adopt the provisions of SFAS 154 beginning January 1, 2006. We do not expect that the adoption of SFAS 154 will have a material impact on our financial statements.

Forward-Looking Statements

Certain statements contained in this report on Form 10-K, such as any statements about our confidence or strategies or our expectations about revenues, results of operations, profitability, contracts or market opportunities, constitute forward-looking statements within the meaning of section 27A of the Securities Act of 1933 and section 21E of the Securities Exchange Act of 1934. These forward-looking statements are based on our current expectations, assumptions, estimates and projections about our business and our industry. You can identify forward-looking statements by the use of words such as “may,” “should,” “will,” “could,” “estimates,” “predicts,” “potential,” “continue,” “anticipates,” “believes,” “plans,” “expects,” “future,” and “intends” and similar expressions which are intended to identify forward-looking statements.

The forward-looking statements contained herein are not guarantees of our future performance and are subject to a number of known and unknown risks, uncertainties and other factors, some of which are beyond our control and difficult to predict and could cause our actual results or achievements to differ materially from those expressed, implied or forecasted in the forward-looking statements. These risks and uncertainties include, but are not limited to the risks described under Part I Item 1A of this report.

All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements contained above and throughout this report. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date the statement was made. We do not intend to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

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Item 7A.    Quantitative and Qualitative Disclosures About Market Risk

Interest rate and market risk

As of December 31, 2005, we had net borrowings of approximately $17.0 million under our acquisition term loan and no borrowings under our revolving line of credit. Borrowings under the Second Amended Loan Agreement bear interest at a rate equal to the sum of the annual rate in effect in the London Interbank market, or LIBOR, applicable to one month deposits of U.S. dollars on the business day preceding the date of determination plus 3.5%–4.0% in the case of the revolving line of credit and 4.0%–4.5% in the case of the acquisition term loan subject to certain adjustments based upon our debt service coverage ratio. In accordance with the provisions of our Second Amended Loan Agreement, we may activate an increase in the available credit under our revolving line of credit up to $25.0 million. A 1% increase in interest rates related to our borrowings under our Second Amended Loan Agreement for 2005 would have resulted in an immaterial increase to interest expense.

In connection with our acquisition of Dockside, we issued two subordinated promissory notes each in the principal amount of $500,000 to the sellers. The notes bear a fixed interest rate of 6%. Also, in connection with our acquisition of CBH, we issued a subordinated promissory note in the principal amount of approximately $619,000 (net of certain working capital adjustments) to the seller. The note bears a fixed interest rate of 5%. Further, in connection with our acquisition of Drawbridges on October 1, 2005, we issued a subordinated promissory note in the principal amount of $50,000 to the seller. The note bears a fixed interest rate of 6%.

We have not used derivative financial instruments to alter the interest rate characteristics of our debt instruments. We assess the significance of interest rate market risk on a periodic basis and may implement strategies to manage such risk as we deem appropriate.

Concentration of credit risk

We provide and manage government sponsored social services to individuals and families pursuant to 527 contracts. Among these contracts there are certain contracts under which we generate a significant portion of our revenue. We generated approximately $17.7 million, or 12.1% of our revenues for 2005, pursuant to the annual block purchase contract in Arizona with The Community Partnership of Southern Arizona, an Arizona not-for-profit organization. This contract is subject to statutory and regulatory changes, possible prospective rate adjustments and other administrative rulings, rate freezes and funding reductions. Reductions in amounts paid by this contract for our services or changes in methods or regulations governing payments for our services could materially adversely affect our revenue.

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Item 8.    Financial Statements and Supplementary Data

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Management’s Report on Internal Control Over Financial Reporting	57
Report of Independent Registered Public Accounting Firm	59
Report of Independent Registered Public Accounting Firm	60
Consolidated Balance Sheets at December 31, 2005 and 2004	62
For the years ended December 31, 2005, 2004 and 2003:
Consolidated Statements of Operations	63
Consolidated Statements of Stockholders’ Equity (Deficit)	64
Consolidated Statements of Cash Flows	65
Notes to Consolidated Financial Statements	67

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Management’s Report on Internal Control Over Financial Reporting

Our management has the responsibility for establishing and maintaining adequate internal control over financial reporting for the registrant, as such term is defined in Exchange Act Rules 13a-15(f). Under the supervision and with the participation of our principal executive officer and principal financial officer, we conducted an assessment, as of December 31, 2005, of the effectiveness of our internal control over financial reporting based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control- Integrated Framework.

We designed our internal control over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

We completed the following acquisitions in 2005, which we excluded from the evaluation of the effectiveness of our internal control over financial reporting.

Acquired entity	Date of acquisition
Children’s Behavioral Health, Inc.	June 13, 2005
Maple Services, LLC and Maple Star Nevada	August 22, 2005
Transitional Family Services, Inc. and AlphaCare Resources, Inc.	September 20, 2005
Drawbridges Counseling Services, LLC and Oasis Comprehensive Foster Care Services LLC	October 1, 2005

The following table highlights the significance of the acquisitions completed in 2005 to our consolidated financial statements at December 31, 2005 (in thousands):

							Period from date of acquisition to December 31, 2005
	Assets			Liabilities			Revenue
Children’s Behavioral Health, Inc.	$	1,608		$	269		$	4,812
Maple Services, LLC and Maple Star Nevada	$	900		$	338		$	2,342
Transitional Family Services, Inc. and AlphaCare Resources, Inc.	$	154		$	107		$	773
Drawbridges Counseling Services, LLC and Oasis Comprehensive Foster Care Services LLC	$	32		$	48		$	222
Total of all acquisitions completed in 2005	$	2,694		$	762		$	8,149
The Providence Service Corporation (“PRSC”)	$	119,013		$	37,766		$	145,708
Percentage of PRSC		2	%		2	%		6	%

57

The Securities and Exchange Commission, or SEC, in response to questions regarding the interpretation of Release No. 34-47986, has acknowledged that it might not be possible to conduct an assessment of an acquired business’s internal control over financial reporting in the period between the acquisition date and the date of management’s assessment. In such instances, the SEC requires that we must identify the acquired business excluded and indicate the significance of the acquired business to our consolidated financial statements. Additionally, we must disclose any material change to our internal control over financial reporting due to the acquisition pursuant to the Securities and Exchange Act of 1934 Rule 13a-15(d). Furthermore, the SEC limits the period in which we may omit an assessment of the acquired business’s internal control over financial reporting to one year from the date of acquisition. We believe our exclusion of the acquired companies noted above from our assessment of internal control over financial reporting as of December 31, 2005 is consistent with the SEC’s requirements.

Based on our assessment, we concluded our internal control over financial reporting is effective as of December 31, 2005.

McGladrey & Pullen, LLP, an independent registered public accounting firm, who audited our consolidated financial statements included in this report on Form 10-K has issued an attestation report on our assessment of internal control over financial reporting. McGladrey & Pullen, LLP’s attestation report is also included in this report on Form 10-K.

58

Report of Independent Registered Public Accounting Firm

To the Board of Directors

The Providence Service Corporation

Tucson, AZ

We have audited management’s assessment, included in the accompanying Management’s Assessment of Internal Control Over Financial Reporting, that The Providence Service Corporation maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Providence Service Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that The Providence Service Corporation maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on “criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).” Also in our opinion, The Providence Service Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on “criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).”

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the 2005 and 2004 consolidated financial statements of The Providence Service Corporation and our report dated March 15, 2006 expressed an unqualified opinion.

/s/ McGladrey & Pullen, LLP

Phoenix, AZ

March 15, 2006

59

Report of Independent Registered Public Accounting Firm

To the Board of Directors

The Providence Service Corporation

Tucson, AZ

We have audited the consolidated balance sheets of The Providence Service Corporation and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders’ equity (deficit) and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of The Providence Service Corporation and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.

Our audits of the consolidated financial statements were conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States) and were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The consolidated supplemental schedule II listed in Item 15(a)(2) of this Form 10-K is presented for purposes of complying with the Securities and Exchange Commission’s rules and is not a part of the basic consolidated financial statements. The financial statement schedule is the responsibility of The Providence Service Corporation’s management. Our responsibility is to express an opinion based on our audits of the consolidated financial statement. In our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of The Providence Service Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 15, 2006 expressed an unqualified opinion on management’s assessment of the effectiveness of The Providence Service Corporation and subsidiaries’ internal control over financial reporting and an unqualified opinion on the effectiveness of The Providence Service Corporation’s internal control over financial reporting.

/s/ McGladrey & Pullen, LLP

Phoenix, AZ

March 15, 2006

60

Report of Independent Registered Public Accounting Firm

Board of Directors

The Providence Service Corporation

We have audited the accompanying consolidated statements of operations, stockholders’ equity (deficit), and cash flows of The Providence Service Corporation for the fiscal year ended December 31, 2003. Our audit also included the financial statement schedule listed in Item 15a(2). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated results of operations and cash flows of The Providence Service Corporation for the fiscal year ended December 31, 2003 in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

/s/ Ernst & Young LLP

Houston, Texas

February 13, 2004

61

The Providence Service Corporation

Consolidated Balance Sheets

	December 31,
	2004			2005
Assets
Current assets:
Cash and cash equivalents	$	10,657,483		$	8,994,243
Accounts receivable—billed, net of allowance of $221,000 in 2004 and $523,000 in 2005		18,152,078			19,971,707
Accounts receivable—unbilled		670,803			4,485,717
Management fee receivable		5,023,405			6,623,182
Other receivables		—			2,363,277
Restricted cash		785,825			1,950,000
Prepaid expenses and other		2,747,486			4,504,566
Notes receivable		—			288,495
Deferred tax asset		474,760			790,238
Total current assets		38,511,840			49,971,425
Property and equipment, net		2,315,911			2,384,776
Notes receivable from unconsolidated affiliates		1,282,341			1,318,981
Goodwill		24,717,145			44,731,646
Intangible assets, net		7,510,808			19,496,109
Deferred tax assets		606,694			—
Other assets		975,917			1,109,737
Total assets		75,920,656			119,012,674
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable		1,243,444			2,134,166
Accrued expenses		7,995,425			11,282,802
Deferred revenue		948,434			182,986
Reinsurance liability reserve		—			1,859,117
Current portion of capital lease obligations		102,507			—
Current portion of long-term obligations		300,000			4,083,333
Total current liabilities		10,589,810			19,542,404
Deferred tax liabilities		—			3,983,036
Capital lease obligations, less current portion		32,882			—
Long-term obligations, less current portion		700,000			14,240,902
Stockholders’ equity:
Common stock: Authorized 40,000,000 shares; $0.001 par value; 9,486,879 and 9,822,486 issued and outstanding (including treasury shares)		9,487			9,822
Additional paid-in capital		65,731,824			72,954,411
Retained earnings (deficit)		(844,601	)		8,580,845
		64,896,710			81,545,078
Less 146,905 treasury shares, at cost		298,746			298,746
Total stockholders’ equity		64,597,964			81,246,332
Total liabilities and stockholders’ equity	$	75,920,656		$	119,012,674

See accompanying notes

62

The Providence Service Corporation

Consolidated Statements of Operations

	Year ended December 31,
	2003			2004			2005
Revenues:
Home and community based services	$	42,293,856		$	73,106,046		$	115,466,600
Foster care services		10,513,100			13,178,098			15,795,179
Management fees		6,469,206			10,681,500			14,446,589
		59,276,162			96,965,644			145,708,368
Operating expenses:
Client service expense (1)		45,284,002			71,883,507			108,938,934
General and administrative expense (1)		6,209,162			12,178,927			18,178,436
Depreciation and amortization		903,617			1,325,420			2,093,753
Total operating expenses		52,396,781			85,387,854			129,211,123
Operating income		6,879,381			11,577,790			16,497,245
Other (income) expense:
Interest expense		1,639,932			432,729			1,033,019
Interest income		(77,805	)		(175,366	)		(268,182	)
Put warrant accretion		630,762			—			—
Write-off of deferred financing costs		412,035			—			—
Equity in earnings of unconsolidated affiliate		(63,501	)		—			—
Income before income taxes		4,337,958			11,320,427			15,732,408
Provision for income taxes		1,691,804			4,235,363			6,306,962
Net income		2,646,154			7,085,064			9,425,446
Preferred stock dividends		3,749,013			—			—
Net income (loss) available to common stockholders	$	(1,102,859	)	$	7,085,064		$	9,425,446
Earnings (loss) per common share:
Basic	$	(0.25	)	$	0.77		$	0.97
Diluted	$	(0.25	)	$	0.76		$	0.95
Weighted-average number of common shares outstanding:
Basic		4,432,043			9,216,988			9,667,416
Diluted		4,432,043			9,355,480			9,884,878

(1) Includes related party expenses of $334,000, $77,000 and $129,000 for the years ended December 31, 2003, 2004 and 2005, respectively.

See accompanying notes

63

The Providence Service Corporation

Consolidated Statements of Stockholders’ Equity (Deficit)

	Common Stock			Additional Paid-In Capital			Retained Earnings (Deficit)			Treasury Stock
	Shares	Amount								Shares	Amount			Total
Balance at December 31, 2002	2,029,053	$	2,029	$	2,300,822		$	(6,826,807	)	135,501	$	(118,562	)	$	(4,642,518	)
Sale of stock in initial public offering, net of offering costs	3,645,000		3,645		36,153,016			—		—		—			36,156,661
Conversion of preferred stock and exchange of preferred stock warrants	1,825,457		1,825		4,828,175			—		—		—			4,830,000
Exercise of warrants	460,837		461		4,199,539			—		—		—			4,200,000
Conversion of notes to shareholders	349,672		350		2,400,597			—		—		—			2,400,947
Common stock issued in connection with acquisition of business	171,430		171		1,714,119			—		—		—			1,714,290
Stock compensation and exercise of employee stock options	390		1		176,344			—		—		—			176,345
Preferred stock dividends	—		—		—			(3,749,013	)	—		—			(3,749,013	)
Net income	—		—		—			2,646,155		—		—			2,646,155
Balance at December 31, 2003	8,481,839		8,482		51,772,612			(7,929,665	)	135,501		(118,562	)		43,732,867
Sale of stock in public offering, net of offering costs	862,500		862		12,640,202			—		—		—			12,641,064
Stock compensation	—		—		143,693			—		—		—			143,693
Exercise of employee stock options	142,540		143		1,175,317			—		11,404		(180,184	)		995,276
Net income	—		—		—			7,085,064		—		—			7,085,064
Balance at December 31, 2004	9,486,879		9,487		65,731,824			(844,601	)	146,905		(298,746	)		64,597,964
Common stock issued in connection with acquisition of business	117,371		117		3,017,491			—		—		—			3,017,608
Adjustment to initial public offering costs	—		—		55,166			—		—		—			55,166
Settlement of taxes due related to initial public offering	—		—		(171,897	)		—		—		—			(171,897	)
Stock compensation	—		—		601,041			—		—		—			601,041
Exercise of employee stock options	218,236		218		3,720,786			—		—		—			3,721,004
Net income	—		—		—			9,425,446		—		—			9,425,446
Balance at December 31, 2005	9,822,486	$	9,822	$	72,954,411		$	8,580,845		146,905	$	(298,746	)	$	81,246,332

See accompanying notes

64

The Providence Service Corporation

Consolidated Statements of Cash Flows

	Year ended December 31,
	2003			2004			2005
Operating activities
Net income	$	2,646,155		$	7,085,064		$	9,425,446
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		533,963			712,044			928,136
Amortization		369,654			613,376			1,165,617
Amortization of deferred financing costs and discount on investment		65,935			102,110			121,563
Deferred income taxes		815,251			7,727			(68,444	)
Equity in earnings of unconsolidated affiliate		(63,501	)		—			—
Stock compensation		175,013			143,693			601,041
Tax benefit upon exercise of stock options		—			496,589			1,171,248
Put warrant accretion		630,762			—			—
Write-off of deferred financing costs upon retirement of debt		412,035			—			—
Changes in operating assets and liabilities, net of effects of acquisitions:
Billed and unbilled accounts receivable, net		(2,971,870	)		(6,178,346	)		(3,678,707	)
Management fee receivable		(1,506,773	)		(1,425,577	)		(1,596,027	)
Other receivable		—			—			(2,363,277	)
Reinsurance liability reserve		—			—			1,859,117
Prepaid expenses and other		(515,410	)		(1,924,331	)		(1,524,133	)
Accounts payable and accrued expenses		(335,736	)		1,965,200			3,178,369
Deferred revenue		—			402,327			(765,448	)
Net cash provided by operating activities		255,478			1,999,876			8,454,501
Investing activities
Purchase of property and equipment		(949,051	)		(874,869	)		(917,184	)
Purchase of intangibles		—			(1,606,444	)		(2,155,669	)
Acquisition of businesses, net of cash acquired		(2,971,881	)		(15,830,579	)		(24,335,421	)
Redemption (purchase) of held-to-maturity investments		(3,955,760	)		4,000,000			—
(Advances to) distributions received from unconsolidated affiliate		126,000			(875,000	)		—
Restricted cash for contract performance		(447,500	)		(513,325	)		(989,175	)
Purchase of short-term investments		—			—			(40,109	)
Working capital advances to third party		—			—			(225,000	)
Settlement note from former related party		—			—			(100,135	)
Net cash used in investing activities		(8,198,192	)		(15,700,217	)		(28,762,693	)
Financing activities
Net (payments) borrowings on revolving note		(3,212,917	)		(93,661	)		—
Payments of capital leases		(193,533	)		(92,501	)		(135,389	)
Proceeds from common stock issued pursuant to stock option exercise		—			498,687			2,549,756
Proceeds from common stock offering, net		36,217,376			12,641,064			—
Income tax adjustment related to initial public offering		—			—			(171,897	)
Proceeds from long-term debt		3,350,000			—			16,955,555
Debt financing costs		(204,858	)		(100,000	)		(199,940	)
Deferred follow-on public offering costs		—			—			(53,133	)
Repayments of short-term debt		—			(1,400,000	)		—
Repayments of long-term debt		(12,957,103	)		(2,100,000	)		(300,000	)
Payment of preferred stock dividend		(1,071,187	)		—			—
Net cash provided by financing activities		21,927,778			9,353,589			18,644,952
Net change in cash		13,985,064			(4,346,752	)		(1,663,240	)
Cash at beginning of period		1,019,171			15,004,235			10,657,483
Cash at end of period	$	15,004,235		$	10,657,483		$	8,994,243

See accompanying notes

65

The Providence Service Corporation

Supplemental Cash Flow Information

	Year ended December 31,
	2003			2004			2005
Supplemental cash flow information
Cash paid for interest	$	1,706,488		$	346,218		$	814,326
Cash paid for income taxes	$	517,332		$	3,651,882		$	5,539,549
Notes payable issued for acquisition of business	$	1,000,000		$	1,000,000		$	668,680
Acquisition of property and equipment under capital lease	$	219,924		$	—		$	—
Common stock issued for:
Acquisitions	$	1,714,290		$	—		$	3,017,608
Put warrant obligation	$	4,200,000		$	—		$	—
Mandatorily redeemable preferred stock	$	4,830,000		$	—		$	—
Conversion of convertible notes	$	2,400,947		$	—		$	—
Note payable for preferred dividends	$	3,500,000		$	—		$	—
Business acquisitions:
Purchase price	$	3,217,638		$	15,240,000		$	24,419,085
Costs of acquisition		38,408			711,113			211,288
Less cash acquired		(284,165	)		(120,534	)		(294,952	)
Acquisition of business, net of cash acquired	$	2,971,881		$	15,830,579		$	24,335,421

See accompanying notes

66

The Providence Service Corporation

Notes to Consolidated Financial Statements

December 31, 2005

1.    Summary of Significant Accounting Policies and Description of Business

Description of Business

The Providence Service Corporation (the “Company”) is a privatization company specializing in alternatives to institutional care. The Company responds to governmental privatization initiatives in adult and juvenile justice, corrections, social services, welfare systems, and education by providing home-based and community-based counseling services and foster care to at-risk families and children. These services are purchased primarily by state, city, and county levels of government, and are delivered under block purchase, cost based and fee-for-service arrangements. The Company also contracts with not-for-profit organizations to provide management services for a fee. The Company operates in Arizona, California, Colorado, Delaware, Florida, Georgia, Illinois, Indiana, Kentucky, Maine, Massachusetts, Michigan, Nebraska, Nevada, New Mexico, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, Tennessee, Texas, Virginia, West Virginia, and the District of Columbia.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of the Company and all of its wholly owned subsidiaries. Significant intercompany accounts and transactions have been eliminated in consolidation.

Cash Equivalents

Cash and cash equivalents include all cash balances and highly liquid investments with an initial maturity of three months or less. Investments in cash equivalents are carried at cost, which approximates fair value. The Company places its temporary cash investments with high credit quality financial institutions. At times such investments may be in excess of the Federal Deposit Insurance Corporation (FDIC) insurance limit.

Restricted Cash

At December 31, 2004 and 2005, the Company had approximately $961,000 and $2.0 million of restricted cash of which approximately $175,000 was included in noncurrent other assets at December 31, 2004 in the accompanying consolidated balance sheets. Of the $2.0 million of restricted cash at December 31, 2005, $175,000 serves as collateral for irrevocable standby letters of credit that provide financial assurance that the Company will fulfill its obligations with respect to certain contracts. Furthermore, $1.8 million serves as collateral for irrevocable standby letters of credit to secure any reinsured claims losses under the Company’s general and professional liability and workers’ compensation reinsurance programs. At December 31, 2005, the cash was held in custody by the Bank of Tucson. In addition, the cash is restricted as to withdrawal or use, and is currently invested in certificates of deposit.

Short-Term Investments

As part of its cash management program, the Company from time to time maintains short-term investments. These investments have a term to earliest maturity of less than one year and are comprised of certificates of deposit. These investments are carried at cost, which approximates market.

Concentration of Credit Risk

Contracts with governmental agencies and not-for-profit subrecipients of governmental agencies accounted for approximately 83%, 84% and 86% of the Company’s revenue for the years ended December 31, 2003, 2004 and 2005, respectively.

67

Fair Value of Financial Instruments

The carrying amounts of cash and cash equivalents, accounts receivable, notes receivable, notes receivable from unconsolidated affiliates and accounts payable approximate their fair value because of the relatively short-term maturity of these instruments. The fair value of the Company’s long-term obligations is estimated based on interest rates for the same or similar debt offered to the Company having same or similar remaining maturities and collateral requirements. The carrying amount of the long-term obligations approximates their fair value at December 31, 2004 and 2005.

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable are stated at the amount the Company expects to collect. The Company evaluates the collectibility of its accounts receivable on a monthly basis. The Company determines the appropriate allowance for doubtful accounts based upon specific identification of individual accounts and review of aging trends. Any account receivable older than 365 days is generally deemed uncollectible and written off or fully allowed for.

The Company considers payer correspondence and payer assurances when evaluating the collectibility of accounts receivable. Amounts where collection is considered to be probable are deemed to be collectible. If the financial condition of the Company’s payers were to deteriorate, additions to the Company’s allowance for doubtful accounts may be required. In circumstances where the Company is aware of a specific payer’s inability to meet its financial obligation to it, the Company records a specific addition to its allowance for doubtful accounts to reduce the net recognized receivable to the amount the Company reasonably expects to collect. The Company’s write-off experience for the years ended December 31, 2003, 2004 and 2005 was less than 1.0% of revenue.

Under certain of the Company’s contracts, billings do not coincide with revenue recognized on the contract due to payer billing system delays, delays related to the Company’s integration of new acquisitions and certain supplemental payments related to the Company’s annual block purchase contract in Arizona. Unbilled accounts receivable represent revenue recorded in excess of amounts formally invoiced. Unbilled amounts are expected to be collected within one year.

Property and Equipment

Property and equipment are stated at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the assets. Maintenance and repairs are charged to earnings when they are incurred. Upon the disposition of any asset, its accumulated depreciation is deducted from the original cost, and any gain or loss is reflected in current earnings.

Impairment of Long-Lived Assets

Goodwill

The Company analyzes the carrying value of goodwill at the end of each fiscal year and between annual valuations if events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying value. Such circumstances could include, but are not limited to: (1) a significant adverse change in legal factors or in business climate, (2) unanticipated competition, or (3) an adverse action or assessment by a regulator. When determining whether goodwill is impaired, the Company compares the fair value of the reporting unit to which the goodwill is assigned to the reporting unit’s carrying amount, including goodwill. The Company uses valuation techniques consistent with a market approach by deriving a multiple of the Company’s EBITDA (earnings before interest, taxes, depreciation and amortization) based on the market value of the Company’s common stock at year end and then applying this multiple to each reporting unit’s EBITDA for the year to determine the fair value of the reporting unit. If the carrying amount of a reporting unit exceeds its fair value, then the amount of the impairment loss must be measured. The impairment loss would be calculated by comparing the implied fair value of reporting unit goodwill to its carrying amount. In calculating

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the implied fair value of reporting unit goodwill, the fair value of the reporting unit is allocated to all of the other assets and liabilities of that unit based on their fair values. The excess of the fair value of a reporting unit over the amount assigned to its other assets and liabilities is the implied fair value of goodwill. An impairment loss would be recognized when the carrying amount of goodwill exceeds its implied fair value. The Company’s annual evaluation of goodwill completed as of December 31, 2005 resulted in no impairment loss.

Intangible assets subject to amortization

The Company separately values all acquired identifiable intangible assets apart from goodwill. The Company allocated a portion of the purchase consideration to certain management contracts and customer relationships acquired in 2004 and 2005 based on the expected direct or indirect contribution to future cash flows on a discounted cash flow basis over the useful life of the assets.

The Company assesses whether certain relevant factors limit the period over which acquired assets are expected to contribute directly or indirectly to future cash flows for amortization purposes. With respect to acquired management contracts, the useful life is limited by the stated terms of the agreements. The Company determines an appropriate useful life for acquired customer relationships based on the expected period of time we will provide services to the payer.

While the Company uses discounted cash flows to value intangible assets, the Company has elected to use the straight-line method of amortization to determine amortization expense. Under certain conditions the Company may assess the recoverability of the unamortized balance of its long-lived assets based on undiscounted expected future cash flows. Should the review indicate that the carrying value is not fully recoverable, the excess of the carrying value over the fair value of any intangible asset is recognized as an impairment loss.

Deferred Financing Costs

The Company capitalizes certain expenses incurred in connection with its long-term debt obligations and amortizes them over the term of the respective debt agreements. Deferred financing costs, net of amortization, totaling approximately $348,000 and $427,000 at December 31, 2004 and 2005, are included in “Other assets” in the accompanying consolidated balance sheets.

Revenue Recognition

The Company recognizes revenue generally at the time services are rendered at predetermined amounts stated in the Company’s contracts and when the collection of these amounts is considered to be probable.

At times the Company may receive funding for certain services in advance of services actually being rendered. These amounts are reflected in the accompanying consolidated balance sheets as deferred revenue until the actual services are rendered.

Fee-for-service contracts.    Revenues related to services provided under fee-for-service contracts are recognized as revenue at the time services are rendered and collection is determined to be probable. Such services are provided at established billing rates.

Cost based service contracts.    Revenues from the Company’s cost based service contracts are generally recorded at one-twelfth of the annual contract amount less allowances for certain contingencies such as projected costs not incurred, excess cost per service over the allowable contract rate and/or insufficient encounters. This policy results in recognizing revenue from these contracts based on allowable costs incurred. The annual contract amount is based on projected costs to provide services under the contracts with adjustments for changes in the total contract amount. The Company annually submits projected costs for the coming year which assist the contracting payers in establishing the annual contract amount to be paid for services provided under the

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contracts. After June 30, which is the contracting payers’ year end, the Company submits cost reports which are used by the contracting payers to determine the amount, if any, by which funds paid to the Company for services provided under the contracts were greater than the allowable costs to provide these services. Completion of this review process may take several years from the date the Company submits the cost report. In cases where funds paid to the Company exceed the allowable costs to provide services under contract, the Company may be required to pay back the excess funds.

The Company’s cost reports are routinely audited on an annual basis. The Company periodically reviews its provisional billing rates and allocation of costs and provides for estimated adjustments from the contracting payers. The Company believes that adequate provisions have been made in its consolidated financial statements for any adjustments that might result from the outcome of any cost report audits. Differences between the amounts provided and the settlement amounts are recorded in the Company’s consolidated statement of operations in the year of settlement.

Annual block purchase contract.    Effective July 1, 2005, the Company’s annual block purchase contract with The Community Partnership of Southern Arizona (“CPSA”), requires the Company to provide or arrange for behavioral health services to eligible populations of beneficiaries as defined in the contract. The Company must provide a complete range of behavioral health clinical, case management, therapeutic and administrative services. There is no contractual limit to the number of eligible beneficiaries that may be assigned to the Company, or a specified limit to the level of services that may be provided to these beneficiaries. Therefore, the Company is at-risk if the costs of providing necessary services exceed the associated reimbursement.

The Company is required to regularly submit service encounters to CPSA electronically. On an on-going basis and at the end of CPSA’s June 30 fiscal year, CPSA is obligated to monitor the level of service encounters. If at any time the encounter data is not sufficient to support the year-to-date payments made to the Company, CPSA has the right to prospectively reduce or suspend payments to the Company.

For revenue recognition purposes, the Company’s service encounter value (which represents the value of actual services rendered) must equal or exceed 90% of the revenue recognized under its annual block purchase contract. The remaining 10% of revenue recognized each reporting period represents payment for network overhead administrative costs incurred in order to fulfill the Company’s obligations under the contract. Administrative costs include, but are not limited to, intake services, clinical liaison oversight for each behavioral health recipient, cultural liaisons, financial assessments and screening, data processing and information systems, staff training, quality and utilization management functions, coordination of care and subcontract administration.

The Company recognizes revenue from its annual block purchase contract corresponding to the service encounter value. If the Company’s service encounter value is less than 90% of the amounts received from CPSA, the Company recognizes revenue equal to the service encounter value plus the administrative component and defers revenue for any excess amount received such that the ratio of service encounter value to revenue recognized equals 90%.

If the Company’s service encounter value equals 90% of the amounts received from CPSA, the Company recognizes revenue at the contract amount, which is one-twelfth of the established annual contract amount each month.

If the Company’s service encounter value exceeds 90% of the contract amount, the Company recognizes revenue equal to the amount that yields a ratio of the service encounter value to revenue of 90%, and only if collection of any additional revenue over the contractual amount is considered to be probable. As of December 31, 2005, the amount of revenue recognized from this contract in excess of the contract amount for the first six months of the contract term (July 1, 2005 to December 31, 2005) was approximately $2.3 million. CPSA has a history of making additional payments to the Company beyond the stated contractual amounts. In addition, CPSA has not reduced, withheld, or suspended any payments and the Company believes its encounter data is sufficient to have earned all amounts recorded as revenue under this contract.

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The terms of the contract may be reviewed prospectively and amended as necessary to ensure adequate funding of the Company’s contractual obligations.

Management agreements.    The Company maintains management agreements with a number of not-for-profit social services organizations whereby the Company provides certain management and administrative services for these organizations. In exchange for its services, the Company receives a management fee that is either based on a percentage of the revenues of these organizations or a predetermined fee.

The Company recognizes management fee revenues from its management agreements as such amounts are earned, as defined by the respective management agreement, and collection of such amount is considered probable. The Company assesses the likelihood of whether any of its management fee revenues may need to be returned to help the Company’s managed entities fund their working capital needs. If the likelihood is other than remote, the Company defers the recognition of all or a portion of the management fees received. To the extent the Company defers management fees as a means of funding any of its managed entities’ losses from operations, such amounts are not recognized as management fee revenues until they are ultimately collected from the operating income of the not-for-profit entities.

In addition, as part of the Company’s reinsurance program, the Company reinsures a substantial portion of the general and professional liability and workers’ compensation cost of certain designated entities it manages through its wholly-owned captive insurance subsidiary, Social Services Providers Captive Insurance Company (“SPCIC”). Further, the Company offers health insurance coverage to employees of certain entities it manages under the Company’s self-funded health insurance program. In exchange for this liability coverage the Company receives a reimbursement equal to the pro-rata share of certain of its managed entities’ costs to participate in the Company’s reinsurance and self-funded health insurance programs. The Company considers these arrangements to be among the array of management services it provides to certain of the Company’s managed entities. As a result, the Company records amounts received from these managed entities as management fees revenue.

Consulting agreements.    From time to time the Company may enter into consulting agreements with other entities that provide government sponsored social services. Under the agreements, the Company evaluates and makes recommendations with respect to their management, administrative and operational services. The Company may continue to enter into consulting agreements in the future. In exchange for these consulting services, the Company receives a fixed fee that is either payable upon completion of the services or on a monthly basis. These consulting agreements are generally short-term in nature and are subject to termination by either party at any time, for any reason, upon advance written notice. Revenues related to these services are classified as management fees revenue in the Company’s consolidated financial statements and are recognized at the time such consulting services are rendered and collection is determined to be probable.

The costs associated with generating the Company’s management fee and consulting fee revenues are accounted for in client service expense and in general and administrative expense in the accompanying consolidated statements of operations.

Income Taxes

Deferred income taxes are determined by the liability method in accordance with SFAS No. 109, Accounting for Income Taxes. Under this method, deferred tax assets and liabilities are determined based on differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Company records a valuation allowance which includes amounts for state and federal net operating loss carryforwards as more fully described in note 12 below for which the Company has concluded that it is more likely than not that these net operating loss carryforwards will not be realized in the ordinary course of operations.

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Stock Compensation Arrangements

The Company follows the intrinsic value method of accounting for stock-based compensation plans. The following table reflects net income and earnings per share had the Company’s stock options been accounted for using the fair value method:

	Year ended December 31,
	2003			2004		2005
Net income (loss) available to common stockholders as reported	$	(1,102,859	)	$	7,085,064	$	9,425,446
Add—Recorded employee stock based compensation, net of federal income tax benefit		106,758			143,693		298,414
Less—Estimated fair value of employee stock options assumed vested during the period, net of federal income tax benefit		376,055			934,646		6,866,961
Adjusted net income (loss) available to common stockholders	$	(1,372,156	)	$	6,294,111	$	2,856,899
Earnings (loss) per share:
Basic—as reported	$	(0.25	)	$	0.77	$	0.97
Basic—as adjusted	$	(0.31	)	$	0.68	$	0.30
Diluted—as reported	$	(0.25	)	$	0.76	$	0.95
Diluted—as adjusted	$	(0.31	)	$	0.68	$	0.29

On December 6, 2005, the Company’s board of directors approved the acceleration of the vesting dates of all unvested stock options outstanding as of December 29, 2005 as more fully described in note 11.

Loss Reserves for Certain Reinsurance and Self-Funded Insurance Programs

General and Professional Liability and Workers’ Compensation

Prior to April 12, 2005, the Company had general and professional liability coverage with a $500,000 self-insured retention for each claim through a third party insurer. In addition, prior to May 16, 2005 the Company had first dollar coverage for workers’ compensation costs with third party insurers. Effective May 16, 2005, the Company began reinsuring a third party insurer for a substantial portion of its general and professional liability and workers’ compensation costs and the general and professional liability and workers’ compensation costs of certain designated entities managed by the Company under reinsurance programs through its wholly-owned captive insurance subsidiary SPCIC, incorporated and licensed under the laws of the State of Arizona. The Company established SPCIC in order to better manage risks and the annual expenditures for general and professional liability and workers’ compensation insurance coverage. It is expected that the formation of SPCIC will enable the Company to provide for: (1) long-term stable insurance programs, (2) increased control over claims management and risk control administration and (3) reduced overall insurance costs associated with general and professional liability and workers’ compensation insurance coverage. The Company primarily utilizes SPCIC as a risk management and cost containment tool.

The Company’s general and professional liability and workers’ compensation reinsurance programs are fronted by two third party insurers for a predetermined amount; one for general and professional liability and one for workers’ compensation liability. These third party insurers also provide coverage to certain designated entities managed by the Company. SPCIC reinsures both of these third party insurers for certain claims as described below.

SPCIC reinsures the third party insurer for general and professional liability exposures for the first dollar of each and every loss up to $250,000 per loss with no annual aggregate limit. The reinsurance premium for the first policy year ending April 12, 2006 of approximately $785,000 covers the reinsured portion of the actuarially determined expected losses for the same period of approximately $512,000 and the operations budget of SPCIC

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of approximately $273,000. The third party insurer provides general and professional liability coverage up to $750,000 per occurrence in excess of the $250,000 reinsured limit with an annual aggregate limit of $3.0 million for both the general liability and professional liability portions of the coverage. The Company utilizes analyses prepared by third party administrators and independent actuaries based on historical claims information to support the required liability and related expense. If the Company’s actual reinsured losses and the reinsured losses of certain designated entities it manages were to exceed the reinsured portion of the actuarially determined expected losses of approximately $512,000 in the first policy year ending April 12, 2006, the Company’s additional exposure would be recognized as an increase to the Company’s general and administrative expense in its consolidated statements of operations in the period such exposure became known.

The Company also purchased an umbrella liability insurance policy with an effective date of July 1, 2005, providing additional coverage in the amount of $1.0 million per occurrence and $1.0 million in the aggregate in excess of the policy limits of the general and professional liability policy. The general and professional liability policy limits, combined with the umbrella policy, are now $2.0 million per occurrence with an annual aggregate limit of $4.0 million.

Under the Company’s workers’ compensation reinsurance program, SPCIC reinsures a third party insurer for the first $250,000 per occurrence with no annual aggregate limit. The third party insurer provides workers’ compensation coverage up to statutory limits. The reinsurance premium for the first policy year ending May 15, 2006 of approximately $774,000 equals the reinsured portion of the expected losses for the same period based upon management’s judgment using the Company’s past experience and industry experience. If the Company’s actual reinsured losses and the reinsured losses of certain designated entities it manages were to exceed the reinsured portion of the expected losses of approximately $774,000 in the first policy year ending May 15, 2006, the Company’s additional exposure would be recognized as an increase to the Company’s payroll and related costs in its consolidated statements of operations in the period such exposure became known. The Company’s reserve levels are evaluated on a quarterly basis. Any necessary adjustments are recognized as an adjustment to general and administrative expense in the Company’s consolidated statements of operations.

The Company records a provision for losses incurred but not reported, based on the recommendations of an independent actuary and management’s judgment using its past experience and industry experience. At the end of each fiscal year, insurance regulations require that the Company record reserve levels equal to or greater than an independent actuary’s estimate of expected losses. On December 31, 2005, the end of SPCIC’s fiscal year, the Company decreased its expected loss reserves by an immaterial amount to equal the independent actuary’s estimate of expected losses of approximately $702,000.

SPCIC has restricted cash of $1.8 million at December 31, 2005, which is restricted to secure the reinsured claims losses of SPCIC under the general and professional liability and workers’ compensation reinsurance programs. The full extent of claims may not be fully determined for years. Therefore, the estimates of potential obligations are based on recommendations of an independent actuary and management’s judgment using historical data, and industry and the Company’s experience. Although management believes that the amounts accrued for losses incurred but not reported under the terms of its reinsurance programs are sufficient, any significant increase in the number of claims or costs associated with these claims made under these programs could have a material adverse effect on the Company’s financial results.

Any obligations above the Company’s reinsurance program limits are the responsibility of the Company. Approximately 28% of the total liability assumed by SPCIC under its reinsurance programs is related to the designated entities managed by the Company that are covered under SPCIC’s reinsurance programs.

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The following table summarizes the Company’s insurance coverage under its reinsurance programs:

Reinsurance program	Policy year ending	Reinsurance liability (Per loss with no annual aggregate limit)		Expected loss during policy year		Third-party coverage (Annual aggregate limit)
General and professional liability	April 12, 2006	$	250,000	$	512,000	$ 4,000,000
Workers’ compensation liability	May 15, 2006	$	250,000	$	774,000	Up to applicable
						statutory limits

Health Insurance

Effective July 1, 2005, the Company began offering its employees and employees of certain entities it manages an option to participate in a self-funded health insurance program. Health claims under this program are self-funded with a stop-loss umbrella policy with a third party insurer to limit the maximum potential liability for individual claims to $150,000 per person and for total claims up to $8.0 million for the program year ending June 30, 2006. Health insurance claims are paid as they are submitted to the plan administrator. Beginning July 1, 2005, the Company maintains accruals for claims that have been incurred but not yet reported to the plan administrator and therefore have not been paid. The incurred but not reported reserve is based on the historical claim lag period and current payment trends of health insurance claims which is generally 1 – 2 months. The liability for the self-funded health plan of approximately $658,000 as of December 31, 2005 is recorded in “Reinsurance liability reserve” in the accompanying consolidated balance sheet.

The Company charges its employees and employees of certain entities it manages a portion of the costs of its self-funded and non self-funded health programs, and it determines this charge at the beginning of each plan year based upon historical and projected medical utilization data. Any difference between the Company’s projections and its actual experience is borne by the Company. The Company is estimating potential obligations for liabilities under this program to reserve what it believes to be a sufficient amount to cover liabilities based on its past experience. Any significant increase in the number of claims or costs associated with claims made under this program above what the Company reserves could have a material adverse effect on its financial results.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Some of the more significant estimates impact accounts receivable, long-lived assets and loss reserves for the Company’s reinsurance and self-funded insurance programs.

Reclassification

Certain amounts have been reclassified in prior periods in order to conform with the current period presentation.

New Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board finalized Statement of Financial Accounting Standards No. 123R, “Share-Based Payment”, (“SFAS 123R”) effective for public companies for annual periods beginning after June 15, 2005. SFAS 123R requires all companies to measure compensation cost for all share-based payments (including employee stock options) at the grant-date fair value of the award. Retroactive application of the requirements of SFAS 123R is permitted, but not required. The Company adopted the provisions of SFAS 123R beginning January 1, 2006 using the modified prospective method. The financial statement impact will be dependent on future stock based awards and their related vesting provisions. No financial statement impact is expected related to stock based awards outstanding at December 31, 2005 due to the acceleration of vesting of all unvested stock based awards in 2005.

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In May 2005, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections”, (“SFAS 154”) which replaces APB Opinion No. 20, “Accounting Changes”, and SFAS 3, “Reporting Accounting Changes in Interim Financial Statements”, and changes the requirement for the accounting for and reporting of a change in accounting principle. SFAS 154 applies to all voluntary changes in accounting principle. In addition, absent specific transition provisions of an accounting pronouncement, the provisions of SFAS 154 should be followed. APB Opinion No. 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. SFAS 154 requires retrospective application to prior periods’ financial statements of voluntary changes in accounting principle. SFAS 154 also requires that a change in depreciation, amortization, or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate effected by a change in accounting principle. SFAS 154 is effective for changes and error corrections made in fiscal years beginning after December 15, 2005. The Company is required to adopt the provisions of SFAS 154 beginning January 1, 2006 and does not expect that the adoption of this statement will have a material impact on its financial statements.

Segment Disclosures

The Company, through its operating companies or through companies it manages, provides home and community based counseling, foster care, and provider network services to at risk families and children. For the reasons discussed below, all of the Company’s operating companies have been aggregated into one reporting segment, under SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. Accordingly, the accompanying consolidated financial statements reflect the operating results of the Company’s reporting segment.

The Company’s operating companies provide the same services to a common customer group, principally individuals and families. All of the operating companies follow the same operating procedures and methods in managing their operations and each operating company operates in a similar regulatory environment. While management of the Company evaluates performance and allocates resources based on the operating results of the individual operating companies, the operating companies are aggregated into one reporting segment for financial reporting purposes because management believes that the operating companies exhibit similar long-term financial performance, and have similar economic characteristics.

2.    Other Receivables

Based on certain provisions of the Company’s loan and security agreement with CIT Healthcare LLC, or CIT (formerly known as Healthcare Business Credit Corporation) , all of the Company’s collections on account related to its operating activities are swept into lockbox accounts to insure payment of outstanding obligations to CIT. Any amounts so collected which exceed amounts due CIT under the Company’s loan and security agreement are remitted to the Company pursuant to a weekly settlement process. From time to time the Company’s reporting period cut-off date falls between settlement dates with CIT resulting in a receivable from CIT in an amount equal to the excess of collections on account related to the Company’s operating activities and amounts due CIT under the Company’s loan and security agreement as of the Company’s reporting period cut-off date. As of December 31, 2005, the amount due the Company from CIT under this arrangement totaled approximately $2.3 million and was classified as “Other receivables” in the Company’s consolidated balance sheet.

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3.    Prepaid Expenses and Other

Prepaid expenses and other comprise the following:

	December 31,
	2004		2005
Prepaid payroll	$	1,498,028	$	1,799,643
Prepaid insurance		585,312		890,343
Prepaid income taxes		—		420,724
Consulting fee receivable		300,000		875,394
Other		364,146		518,462
Total prepaid expenses and other	$	2,747,486	$	4,504,566

4.    Acquisitions

The following acquisitions have been accounted for using the purchase method of accounting and the results of operations are included in the Company’s consolidated financial statements from the date of acquisition. The cost of these acquisitions has been allocated to the assets and liabilities acquired based on a preliminary evaluation of their respective fair values and may change when the final valuation of certain intangible assets is determined except for the acquisitions of Rio Grande Management Company, LLC (“Rio Grande Management”), Dockside Services, Inc. (“Dockside”), Pottsville Behavioral Counseling Group, Inc. (“Pottsville”) and Choices Group, Inc., Aspen MSO, LLC (now known as Providence Community Services, LLC) and College Community Services, a California mutual benefit corporation (collectively referred to as the “Aspen companies”) where the cost of the acquisition has been allocated to the assets and liabilities acquired based on a final valuation of their respective fair values and the excess of the purchase price over the fair value of the net identifiable assets has been allocated to goodwill.

In addition, the Company performed an analysis of its acquisitions and determined that each transaction, except for those transactions where the Company acquired all of the rights under existing management agreements with Care Development of Maine, FCP, Inc., and The ReDCo Group, should be accounted for as a business combination as such term is defined in Emerging Issues Task Force (EITF) Issue No. 98-3, “Determining Whether a Nonmonetary Transaction Involves Receipt of Productive Assets or of a Business.”

Effective January 1, 2004, the Company acquired the remaining 50% member interest in and became the sole member of Rio Grande Management, for cash of $820,000 which was prepaid in December 2003. Rio Grande Management was formed in September 2001 by the Company and the ten agencies whose members comprise the board of directors of Rio Grande Behavioral Health Services, Inc., a not-for-profit organization that provides community based social and mental health network services in New Mexico. As a result of this acquisition, the Company acquired the entire membership interest in Rio Grande Management which had a management agreement with the not-for-profit organization pursuant to which Rio Grande Management managed the not-for-profit organization’s operations in return for a fixed management fee per month. The purchase price allocation as shown below is allocated to 50% of the equity investment in Rio Grande Management. The carrying value of the 50% equity investment in Rio Grande Management was the same as the underlying net book value of Rio Grande Management.

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The following represents the Company’s allocation of the purchase price:

Consideration:
Cash	$	820,000
Acquisition costs		5,000
	$	825,000
Allocated to:
Property and equipment	$	6,667
Intangibles		326,000
Goodwill		492,333
	$	825,000

The above goodwill is tax deductible.

On January 1, 2004, the Company acquired all of the outstanding stock of Dockside for cash of $3.4 million (less $300,000 which was placed into escrow as security for any working capital adjustments) and $1.0 million in promissory notes, for a total purchase price of $4.4 million. In August 2004, the working capital adjustments were finalized resulting in an amount due to the Company of $27,930 which was received by the Company in September 2004. This acquisition expands the Company’s operations in the states of Indiana and Michigan.

The following represents the Company’s allocation of the purchase price:

Consideration:
Cash	$	3,400,000
Notes payable		1,000,000
Acquisition costs		40,574
	$	4,440,574
Allocated to:
Property and equipment	$	28,984
Deferred tax liability		(488,120	)
Intangibles		1,237,000
Goodwill		3,662,710
	$	4,440,574

The above goodwill is not tax deductible.

On May 3, 2004, the Company acquired all of the outstanding stock of Pottsville, a Pennsylvania based social services provider, for cash in the amount of $1.8 million (less $184,000 which was placed into escrow as security for any working capital adjustments or any indemnification obligations). In October 2004, the working capital adjustments were finalized resulting in no amounts due to the Company. The acquisition of Pottsville expands the Company’s home and community based services into the Pennsylvania market.

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The following represents the Company’s allocation of the purchase price:

Consideration:
Cash	$	1,840,000
Acquisition costs		262,441
	$	2,102,441
Allocated to:
Property and equipment	$	132,329
Deferred tax liability		(180,332	)
Intangibles		457,000
Goodwill		1,693,444
	$	2,102,441

The above goodwill is not tax deductible.

In conjunction with the acquisition of Pottsville, the Company entered into a management agreement with The ReDCo Goup (“ReDCo”), a Pennsylvania not-for-profit social services organization, whereby the Company provides certain management services to ReDCo in return for a predetermined management fee.

Effective June 24, 2004, the Company acquired all of the rights under existing management agreements with Care Development of Maine (“CDOM”) and FCP, Inc. (“FCP”) from Care Development, Inc., a Maine not-for-profit corporation, for cash in the amount of $1.5 million. In May 2005, the Company paid an additional $1.8 million and in October 2005 it paid another $327,000 pursuant to terms of a definitive agreement in connection with this acquisition. CDOM and FCP are not-for-profit organizations providing foster care and community based services in the States of Maine and Massachusetts, respectively. The acquisition of the management agreements with these organizations expands the Company’s foster care and community based services in Maine and opens a new market in Massachusetts.

The cost of acquiring the management agreements with ReDCo, CDOM and FCP has been allocated to intangible assets as contract acquisition costs and is being amortized on a straight-line basis concurrent with the life of the agreements.

On July 21, 2004, the Company acquired all of the equity interests in the Aspen companies for cash of $10.0 million (less $1.0 million which was placed into escrow as security for any indemnification obligations and any working capital adjustments). In September 2005, the working capital adjustments were finalized resulting in an amount due to the Company of $677,000 which was received by the Company in September 2005. Including the funds received from the settlement of escrow, the Company received approximately $2.0 million in working capital. The acquisition was retroactively effective as of July 1, 2004 in accordance with the terms of the purchase agreement. The acquisition of the Aspen companies establishes operations in California and Nevada and adds drug court treatment to the Company’s array of social services.

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The following represents the Company’s allocation of the purchase price:

Consideration:
Cash	$	10,000,000
Acquisition costs		418,750
	$	10,418,750
Allocated to:
Working capital	$	2,064,896
Deferred tax liability		(880,085	)
Intangibles		3,511,900
Goodwill		5,722,039
	$	10,418,750

A portion of the above goodwill is tax deductible.

On June 13, 2005, the Company acquired all of the equity interest in Children’s Behavioral Health, Inc. (“CBH”), a Pennsylvania provider of home and school based social services for children. The purchase price of approximately $13.6 million consisted of $10.0 million in cash, 117,371 shares of the Company’s unregistered common stock valued at $3.0 million, and an unsecured, subordinated promissory note in the principal amount of approximately $619,000 after deducting certain credits related to working capital adjustments. The number of shares of the Company’s unregistered common stock issued in this transaction was based upon the value of $3.0 million divided by the arithmetic average of the closing sales price per share of the Company’s common stock as reported on the NASDAQ market for the 10 trading days immediately preceding the date of this transaction. This acquisition expanded the Company’s presence to a number of new counties within Pennsylvania and significantly increased the children’s services component of the Company’s business.

The following represents the Company’s preliminary allocation of the purchase price:

Consideration:
Cash	$	10,000,000
Note ($1.5 million less approximately $881,000 for certain working capital adjustments)		618,680
Common shares		3,017,608
Acquisition costs		449,056
	$	14,085,344
Allocated to:
Working capital	$	714,033
Deferred tax liability		(2,237,690	)
Intangibles		5,078,000
Goodwill		10,531,001
	$	14,085,344

Currently, the above goodwill is not expected to be tax deductible.

On August 22, 2005, the Company purchased all of the equity interest in Maple Services, LLC, a Colorado limited liability corporation, and Maple Star Nevada, a Nevada corporation. Maple Services, LLC is a for-profit management company that provides management services to Oregon and Colorado not-for-profit providers of foster care services and Maple Star Nevada provides therapeutic foster care services in several Nevada locations. The purchase price of $8.4 million (less $840,000 which was placed into escrow as security for any

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indemnification obligations for one year from August 22, 2005 and less certain additional adjustments contained in the purchase agreement) consisted of cash. In December 2005, certain working capital adjustments were finalized resulting in an amount payable by the Company of approximately $492,000 which was paid by the Company in December 2005. These acquisitions were retroactively effective as of August 1, 2005 and expanded the Company’s presence into Colorado and Oregon (through the two not-for-profit entities formerly managed by Maple Services, LLC) and added foster care services to the Company’s existing roster of services in Nevada.

The following represents the Company’s preliminary allocation of the purchase price:

Consideration:
Cash	$	8,400,000
Additional consideration paid		492,163
Estimated costs of acquisition		188,584
	$	9,080,747
Allocated to:
Working capital	$	1,289,471
Deferred tax liability		(1,060,804	)
Intangibles		2,928,000
Goodwill		5,924,080
	$	9,080,747

Currently, a portion of the above goodwill is expected to be tax deductible.

On September 20, 2005, the Company acquired all of the equity interests in Transitional Family Services, Inc. and AlphaCare Resources, Inc., (collectively “AlphaCare”). AlphaCare provides in-home and professional therapy services in several Georgia locations and administers one of the largest family preservation programs in the State of Georgia. The purchase price consisted of cash of approximately $5.1 million (less $472,692 which was placed into escrow as security for any indemnification obligations for 18 months from September 20, 2005 and less certain additional adjustments contained in the purchase agreement). These acquisitions not only expanded the Company’s geographic footprint but also helped position it to take advantage of the growing trend within the state of Georgia for in-home delivery of mental health services.

The following represents the Company’s preliminary allocation of the purchase price:

Consideration:
Cash	$	5,126,922
Estimated costs of acquisition		212,762
	$	5,339,684
Allocated to:
Working capital	$	111,825
Deferred tax liability		(164,117	)
Intangibles		2,826,000
Goodwill		2,565,976
	$	5,339,684

Currently, a portion of the above goodwill is expected to be tax deductible.

Effective October 1, 2005, the Company acquired all of the equity interests in Drawbridges Counseling Services, LLC, a provider of home based and case management services in Kentucky and Oasis Comprehensive Foster Care Services LLC, a foster care child placement agency licensed in Kentucky, collectively referred to as

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Drawbridges. These agencies were acquired for a purchase price of $450,000 (subject to certain working capital adjustments), which consisted of $400,000 in cash and a one year $50,000 unsecured, subordinated promissory note. The promissory note bears interest of 6% with principal and any accrued but unpaid interest due October 1, 2006. These acquisitions provided the Company an entrée into the state of Kentucky.

The following represents the Company’s preliminary allocation of the purchase price:

Consideration:
Cash	$	400,000
Promissory note		50,000
Estimated costs of acquisition		24,932
	$	474,932
Allocated to:
Intangibles	$	167,000
Goodwill		307,932
	$	474,932

Currently, the above goodwill is expected to be tax deductible.

The cash portion of the purchase price of these acquisitions was partially funded from the Company’s credit facility with CIT.

Goodwill and Intangibles

The amount allocated to intangibles represents acquired customer relationships and management contracts. The Company valued customer relationships and management contracts acquired in these acquisitions based on expected future cash flows resulting from the underlying contracts with state and local agencies to provide social services in the case of customer relationships and management and administrative services provided to the managed entities with respect to acquired management contracts.

The following table summarizes the allocation of purchase price to intangible assets at December 31, 2004 and 2005 for intangible assets acquired in 2004 and 2005:

	Estimated Useful Life	Gross Carrying Amount
		December 31,
		2004		2005
Intangible assets acquired in 2004
Management contracts	10 Yrs	$	1,947,444	$	4,102,962
Customer relationships	15 Yrs		5,127,900		5,127,900
Customer relationships	10 Yrs		33,000		—
Restrictive covenants	3 Yrs		30,000		30,000
Total intangible assets acquired in 2004		$	7,138,344	$	9,260,862
Intangible assets acquired in 2005
Management contracts	10 Yrs			$	1,457,750
Customer relationships	15 Yrs				9,515,000
Restrictive covenants	5 Yrs				35,000
Total intangible assets acquired in 2005				$	11,007,750

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No significant residual value is estimated for these intangible assets. Amortization expense will be recognized on a straight-line basis over the estimated useful life.

Changes in goodwill were as follows:

Balance at December 31, 2003	$	13,429,270
Rio Grande Management acquisition		492,333
Dockside acquisition		3,666,259
Pottsville acquisition		1,693,444
Aspen Companies acquisition		5,032,978
Subsequent recognition of certain deferred tax assets and liabilities related to the acquisition of Camelot Care Corporation in March 2002 and Cypress Management Service, Inc. in January 2003		402,861
Balance at December 31, 2004		24,717,145
Adjustment to costs of the Dockside acquisition		(3,549	)
Adjustment to costs of the Aspen Companies acquisition		689,061
CBH acquisition		10,531,001
Maple Star acquisition		5,924,080
AlphaCare acquisition		2,565,976
Drawbridges acquisition		307,932
Balance at December 31, 2005	$	44,731,646

The total amount of goodwill that is deductible for income tax purposes at December 31, 2004 and 2005 is as follows:

	2004		2005
Deductible goodwill	$	1,596,808	$	6,461,012

The following unaudited pro forma information presents a summary of the consolidated results of operations of the Company as if the acquisition of CBH, Maple Star Nevada, AlphaCare and Drawbridges had occurred on January 1, 2004. The pro forma financial information is not necessarily indicative of the results of operations that would have occurred had the transactions been effected on January 1, 2004.

	Year ended December 31,
	2004		2005
Revenue	$	114,917,309	$	155,431,947
Net income	$	7,659,385	$	9,520,675
Diluted earnings per share	$	0.81	$	0.96

5.    Detail of Certain Balance Sheet Accounts

Property and equipment consisted of the following:

	Estimated Useful Life	December 31,
		2004		2005
Land	—	$	40,000	$	20,000
Building	39 years		557,187		230,000
Furniture and equipment	3-7 years		4,688,767		6,018,686
			5,285,954		6,268,686
Less accumulated depreciation			2,970,043		3,883,910
		$	2,315,911	$	2,384,776

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Depreciation expense was approximately $534,000, $712,000 and $928,000 for the years ended December 31, 2003, 2004 and 2005, respectively.

Intangible assets consisted of the following:

		December 31,
		2004					2005
	Estimated Useful Life	Gross Carrying Amount		Accumulated Amortization			Gross Carrying Amount		Accumulated Amortization
Management contracts	10 Yrs	$	2,919,044	$	(372,931	)	$	6,532,312	$	(885,238	)
Customer relationships	15 Yrs		5,127,900		(218,730	)		14,642,900		(841,133	)
Customer relationships	10 Yrs		33,000		(2,475	)		—		—
Non-compete agreement	2 Yrs		300,000		(300,000	)		—		—
Restrictive covenants	5 Yrs		—		—			35,000		(2,732	)
Restrictive covenants	3 Yrs		30,000		(5,000	)		30,000		(15,000	)
Total		$	8,409,944	$	(899,136	)	$	21,240,212	$	(1,744,103	)

No significant residual value is estimated for these intangible assets. Amortization expense was approximately $247,000, $613,000 and $1.2 million for the years ended December 31, 2003, 2004 and 2005, respectively. The total amortization expense is estimated to be approximately $1.7 million for each of 2006, 2007, 2008, 2009 and 2010, based on completed acquisitions as of December 31, 2005.

Accrued expenses consisted of the following:

	December 31,
	2004		2005
Accrued compensation	$	5,253,919	$	6,843,736
Other		2,741,506		4,439,066
	$	7,995,425	$	11,282,802

6.    Long-Term Obligations

The Company’s long-term obligations were as follows:

	December 31,
	2004		2005
6% unsecured, subordinated notes to former stockholders of acquired company, interest payable quarterly beginning April 2004 with equal quarterly principal payments of $100,000 beginning April 2005 through July 2007	$	1,000,000	$	700,000
5% unsecured, subordinated note to former stockholder of acquired company, interest payable semi-annually beginning December 2005 and all unpaid principal and any accrued and unpaid interest due June 2010		—		618,680
6% unsecured, subordinated note to former stockholder of acquired company, accrued interest and principal due October 2006		—		50,000
$25,000,000 revolving note, LIBOR plus 3.5%- 4.0% (effective rate of 7.9% at
December 31, 2005) through June 2010		—		—
$25,000,000 term note, LIBOR plus 4.0%-4.5% with interest payable monthly with each installment of principal through June 2010		—		16,955,555
		1,000,000		18,324,235
Less current portion		300,000		4,083,333
	$	700,000	$	14,240,902

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Annual maturities of long-term obligations as of December 31, 2005 are as follows:

Year	Amount
2006	$	4,083,333
2007	$	3,933,333
2008	$	3,633,333
2009	$	3,633,333
2010	$	3,040,903

On June 28, 2005, the Company entered into a second amended and restated loan and security agreement (“Second Amended Loan Agreement”) with CIT. The Second Amended Loan Agreement provides for an increase in the amount the Company may borrow under the revolving line of credit from $10.0 million to $25.0 million and an increase in the amount it may borrow under the acquisition term loan from $10.0 million to $25.0 million subject to certain conditions. The amount the Company may borrow under the revolving line of credit is subject to the availability of a sufficient amount of eligible accounts receivable at the time of borrowing. Advances under the acquisition term loan are subject to CIT’s approval and are payable in consecutive monthly installments as determined under the Second Amended Loan Agreement.

Borrowings under the Second Amended Loan Agreement bear interest at a rate equal to the sum of the annual rate in effect in the London Interbank market (“LIBOR”), applicable to one month deposits of U.S. dollars on the business day preceding the date of determination plus 3.5%–4.0% in the case of the revolving line of credit and 4.0%–4.5% in the case of the acquisition term loan subject to certain adjustments based upon the Company’s debt service coverage ratio. In addition, the Company is subject to a 0.5% fee per annum on the unused portion of the available funds as determined in accordance with certain provisions of the Second Amended Loan Agreement as well as certain other administrative fees.

The Second Amended Loan Agreement also extends the maturity date of the revolving line of credit and acquisition term loan to June 28, 2010.

In order to secure payment and performance of all obligations in accordance with the terms and provisions of the Second Amended Loan Agreement, CIT retained its interests in substantially all of the Company’s assets as described in the first amended and restated loan and security agreement dated as of September 30, 2003, including the Company’s management agreements with certain not-for-profit entities, and the assets of certain of the Company’s subsidiaries. If certain events of default including, but not limited to, failure to pay any installment of principal or interest when due, failure to pay any other charges, fees, expenses or other monetary obligations owing to CIT when due or other particular covenant defaults, as more fully described in the Second Amended Loan Agreement, occur, CIT may declare all unpaid principal and any accrued and unpaid interest and all fees and expenses immediately due. Under the Second Amended Loan Agreement, any initiation of bankruptcy or related proceedings, assignment or sale of any asset or failure to remit any payments received by the Company on account to CIT will accelerate all unpaid principal and any accrued and unpaid interest and all fees and expenses. In addition, if the Company defaults on its indebtedness including the promissory notes issued in connection with completed business acquisitions, it could trigger a cross default under the Second Amended Loan Agreement whereby CIT may declare all unpaid principal and accrued and unpaid interest, other charges, fees, expenses or other monetary obligations immediately due.

The Company agreed with CIT to subordinate its management fee receivable pursuant to management agreements established with certain of the Company’s managed entities, which have stand-alone credit facilities with CIT, to the claims of CIT in the event one of these managed entities defaults under its credit facility. Additionally, any other monetary obligations of these managed entities owing to the Company are subordinated to the claims of CIT in the event one of these managed entities defaults under its credit facility.

The remaining provisions of the Second Amended Loan Agreement remained substantially the same as those set forth in the first amended and restated loan and security agreement. The Company is required to

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maintain certain financial covenants under the Second Amended Loan Agreement. In addition, the Company is prohibited from paying cash dividends if there is a default under the facility or if the payment of any cash dividends would result in default.

At December 31, 2004 and 2005, the Company’s available credit under the revolving line of credit was $10.0 million and $12.5 million, respectively. In accordance with certain provisions of the Second Amended Loan Agreement, the Company may activate an increase in the available credit under the revolving line of credit subject to certain conditions up to $25.0 million.

7.    Common Stock

The Company adopted a second amended and restated certificate of incorporation and amended and restated bylaws commensurate with the consummation of the Company’s initial public offering on August 22, 2003. The Company’s second amended and restated certificate of incorporation provides that the Company’s authorized capital stock consists of 40,000,000 shares of common stock, $0.001 par value, and 10,000,000 shares of preferred stock, $0.001 par value. At December 31, 2004 and 2005, there were 9,486,879 and 9,822,486 shares of the Company’s common stock outstanding, respectively, (including 146,905 treasury shares) and no shares of preferred stock outstanding.

In 2005, the Company granted 922,800 ten year options (including 160,000 fully vested options to non-employee directors and executive officers as more fully described in note 11) under its 2003 Stock Option Plan (“2003 Plan”) to directors, executive officers and key employees to purchase the Company’s common stock at exercise prices equal to the market value of the Company’s common stock on the date of grant. The option exercise prices range from $19.60 to $30.57 and the options vested in equal installments over time ranging from three to four years prior to the acceleration of vesting described in note 11. In addition, the weighted-average fair value of the options granted in 2005 totaled $8.06 per share. In 2005, the Company issued 81,394 shares of its common stock in connection with the exercise of employee stock options under the Company’s Stock Option and Incentive Plan (the “1997 Plan”), and 136,842 shares of its common stock in connection with the exercise of employee stock options under the Company’s 2003 Plan.

Subject to the rights specifically granted to holders of any then outstanding shares of the Company’s preferred stock, the Company’s common stockholders are entitled to vote together as a class on all matters submitted to a vote of the Company’s stockholders and are entitled to any dividends that may be declared by the Company’s board of directors. The Company’s common stockholders do not have cumulative voting rights. Upon the Company’s dissolution, liquidation or winding up, holders of the Company’s common stock are entitled to share ratably in the Company’s net assets after payment or provision for all liabilities and any preferential liquidation rights of the Company’s preferred stock then outstanding. The Company’s common stockholders do not have preemptive rights to purchase shares of the Company’s stock. The issued and outstanding shares of the Company’s common stock are not subject to any redemption provisions and are not convertible into any other shares of the Company’s capital stock. All outstanding shares of the Company’s common stock are, and the shares of common stock to be issued in any future offering will be, upon payment therefore, fully paid and non-assessable. The rights, preferences and privileges of holders of the Company’s common stock will be subject to those of the holders of any shares of the Company’s preferred stock the Company may issue in the future.

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8.    Earnings Per Share

The following table details the computation of basic and diluted earnings per share:

	Year ended December 31,
	2003			2004		2005
Numerator:
Net income	$	2,646,155		$	7,085,064	$	9,425,446
Preferred stock dividends		3,749,014			—		—
Numerator for basic and diluted earnings per share—income (loss) available to common shareholders	$	(1,102,859	)	$	7,085,064	$	9,425,446
Denominator:
Denominator for basic earnings per share—weighted-average shares		4,432,043			9,216,988		9,667,416
Effect of dilutive securities:
Common stock options		—			138,492		217,462
Denominator for diluted earnings per share—adjusted weighted-average shares and assumed conversion		4,432,043			9,355,480		9,884,878
Basic earnings (loss) per share	$	(0.25	)	$	0.77	$	0.97
Diluted earnings (loss) per share	$	(0.25	)	$	0.76	$	0.95

All components of the diluted calculation were antidilutive for the year ended December 31, 2003.

For the years ended December 31, 2004 and 2005, employee stock options to purchase 6,510 and 7,587 shares of common stock were not included in the computation of diluted earnings per share as the exercise price of these options was greater than the average fair value of the common shares for the respective periods and, therefore, the effect of these options would be antidilutive.

9.    Leases

Sale-leaseback

On September 30, 2005, the Company entered into and closed on a sales agreement to sell its corporate office building in Tucson, Arizona for $520,000 and, under a separate agreement, leased the property back effective October 1, 2005. The buyer issued a promissory note to the Company in the principal amount of $470,000 less a down payment of $50,000. The 25 year note bears interest of 6.02% per annum and provides for interest only payments for the first 180 days. In accordance with a separate agreement, the Company and buyer may rescind the sales agreement and unwind the transaction within 180 days from September 30, 2005 if the appraised value of the property is less than the purchase price or the buyer does not pre-pay the note. For accounting and reporting purposes, the Company accounted for this transaction using the deposit method for its quarterly report for the quarter ended September 30, 2005. On December 21, 2005, the buyer obtained third-party financing and prepaid the promissory note issued to the Company. As a result the Company determined that this transaction meets the criteria for sale-leaseback accounting as of December 31, 2005.

The Company is accounting for the leaseback as an operating lease. The lease requires the Company to pay customary operating and repair expenses and to observe certain operating restrictions and covenants. The lease contains one automatic renewal term of seven years at the end of the initial term and five (7) year renewal options at lease termination. The monthly base rental payment under this lease in the amount of approximately $5,521 is subject to an annual 3% increase over the initial term of the lease. For the year ended December 31, 2005, the total rental expense incurred by the Company under this lease was $5,631. The minimum lease payments required by the lease are reflected in the future minimum payments under the non-cancellable operating leases table below.

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The gain of approximately $185,000 realized in this transaction has been deferred and is being amortized to income in proportion to rent charged over the initial term of the lease. Approximately $2,260 of the realized gain was recognized for the year ended December 31, 2005. At December 31, 2005, the remaining deferred gain of approximately $183,000 is shown as “Deferred revenue” in the Company’s consolidated balance sheet.

Capital and operating leases

Prior to the repayment of all amounts due under its capital lease agreements on August 4, 2005, the Company leased certain office equipment and furniture under agreements that were classified as capital leases. The cost of office equipment and furniture under these capital leases is included in the accompanying consolidated balance sheets as property and equipment and was $293,755 at December 31, 2004. Accumulated amortization of the leased equipment and furniture at December 31, 2004 was approximately $158,366. Amortization of assets under capital leases is included in depreciation and amortization expense in the accompanying consolidated statements of operations.

The Company leases many of its operating and office facilities for various terms under non-cancelable operating lease agreements. The leases expire in various years and provide for renewal options. In the normal course of business, it is expected that these leases will be renewed or replaced by leases on other properties.

The leases provide for increases in future minimum annual rental payments based on defined increases in the Consumer Price Index, subject to certain minimum increases. Several of these lease agreements contain provisions for periods in which rent payments are reduced. The total amount of rental payments due over the lease term is being charged to rent expense on a straight-line basis over the term of the lease. The difference between rent expense recorded and the amount paid is credited or charged to “Deferred rent obligation,” which is included in current liabilities in the accompanying consolidated balance sheets. Also, the lease agreements generally require the Company to pay executory costs such as real estate taxes, insurance, and repairs.

Future minimum payments under non-cancelable operating leases with initial terms of one year or more consisted of the following at December 31, 2005:

2006	$	4,112,081
2007		3,029,470
2008		2,364,551
2009		1,578,195
2010		827,988
Thereafter		978,275
	$	12,890,560

Rent expense related to operating leases was approximately $1.6 million, $3.0 million and $4.4 million, for the years ended December 31, 2003, 2004 and 2005, respectively.

10.    Retirement Plan

The Company maintains a qualified defined contribution plan under Section 401(k) of the Internal Revenue Code (“IRC”) for virtually all employees. Under the 401(k) plan, employees may elect to defer up to 15% of their compensation, subject to Internal Revenue Service limitations. The Company, at its discretion, may make a matching contribution to the plan. The Company’s contributions to the plan were approximately $51,000, $103,000 and $137,000, for the years ended December 31, 2003, 2004 and 2005, respectively.

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11.    Stock Option and Incentive Plans

The Company’s 1997 Plan and 2003 Plan provides for the issuance of options to key employees and directors. The 1997 Plan and the 2003 Plan authorized the issuance of options to purchase up to an aggregate of 428,572 and 1,400,000 shares of common stock, respectively. The 1997 Plan provided for the issuance of 142,857 options each exercisable for one share of common stock at $3.50 per share, 142,857 options each exercisable for one share of common stock at $4.73 per share, and 142,857 options each exercisable for one share of common stock at $7.00 per share. The 2003 Plan provides for the issuance of up to 1,400,000 options each exercisable for one share of common stock at the last reported sale price per share of the Company’s common stock on the Nasdaq National Market on the date of grant of the option. All options prior to the acceleration of vesting noted below expire ten years from the grant date. As of December 31, 2005, there were 79,971 options outstanding under the 1997 Plan, and 1,252,648 options outstanding under the 2003 Plan. No further options may be issued under the 1997 Plan.

On December 6, 2005, the board of directors (the “Board”) of the Company, upon recommendation of the Compensation Committee of the Board, approved the acceleration of the vesting dates of all unvested stock options previously awarded to eligible employees, directors and consultants, including stock options granted to executive officers and non-employee directors, under the Company’s 2003 Plan, effective December 29, 2005; provided the option holder was actively an employee, director or consultant of the Company on December 29, 2005. All other terms of the stock options previously awarded remained the same.

As a result of this action, options to purchase approximately 653,000 shares of the Company’s common stock vested in full effective December 29, 2005 as follows:

	Aggregate number of shares issuable under accelerated options	Weighted-average exercise price per share
Non-employee Directors	90,002	$	19.78
Significant consultant	15,000	$	28.50
Executive Officers as a group	129,584	$	20.51
Other employees	417,942	$	23.18
Total	652,528	$	22.30

The closing market price of the Company’s common stock on December 6, 2005 was $28.47, and approximately 562,000 options subject to this acceleration have economic value to the holder. As of December 29, 2005 there were options to purchase approximately 1.3 million shares of the Company’s common stock exercisable with a weighted-average exercise price of $21.56 per share outstanding.

As a result of the acceleration of vesting of these options, stock based compensation expense of approximately $549,000 was recognized in 2005, of which approximately $188,000 is attributable to stock options held by executive management and non-employee directors. All but approximately $84,000 of the stock based compensation expense for 2005 is expected to be tax deductible. In determining the amount of stock based compensation expense related to the acceleration of vesting of these options, the Company assumed an expected forfeiture rate for non-employee directors, significant consultant and executive officers as a group of 10% based on historical trends. Similarly, the Company assumed an expected forfeiture rate of 18% for other employees based on historical trends.

The purpose of accelerating the vesting of outstanding unvested options is to enable the Company to avoid recognizing stock based compensation expense associated with these options in future periods after the Company adopts SFAS 123R, in January 2006. As a result of the acceleration, the Company estimates that it will avoid stock based compensation expense of approximately $2.0 million in 2006 (approximately $0.20 per fully diluted share based on a 10,200,000 weighted-average share count), $1.3 million in 2007 and $450,000 in 2008.

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In addition, each non-employee director was awarded an option to purchase 10,000 shares of the Company’s common stock on December 6, 2005 under the Plan in lieu of receiving the award in January 2006 as part of its annual Board compensation for its service in 2006. In addition, the executive officers as a group were granted an aggregate of 110,000 options on December 6, 2005. The purpose of awarding these options to non-employee directors and the executive officers in December 2005 was to enable the Company to avoid recognizing stock based compensation expense associated with these options in future periods under SFAS 123R. Further, this action will not result in additional stock based compensation expense for 2005 as these options are 10 year, fully vested options with an exercise price equal to the closing market price of the Company’s common stock on the date of grant of $28.47.

The following table summarizes the transactions of the Company’s 1997 and 2003 Plans:

	Year ended December 31, 2003				Year ended December 31, 2004				Year ended December 31, 2005
	Number of Shares		Weighted Average Exercise Prices		Number of Shares		Weighted Average Exercise Prices		Number of Shares		Weighted Average Exercise Prices
Outstanding at beginning of period	306,916		$	5.00	443,336		$	7.65	686,101		$	14.11
Granted	140,000			13.43	390,000			18.17	922,800			24.74
Exercised	(381	)		3.50	(142,540	)		5.38	(218,236	)		12.13
Forfeited	(3,199	)		3.93	(4,695	)		6.84	(58,046	)		19.61
Outstanding at end of year	443,336		$	7.65	686,101		$	14.11	1,332,619		$	21.56
Exercisable at end of year	303,028		$	6.64	348,574		$	10.67	1,332,619		$	21.56
Weighted-average remaining contractual life				8.1 yrs				8.4 yrs				8.8 yrs
Weighted-average fair value of options granted			$	3.18			$	5.16			$	8.06
Available for grant at end of year				360,000				470,000				2,246

The following table summarizes information about fixed stock options outstanding at December 31, 2005:

	Options Outstanding				Options Exercisable
Exercise Prices	Number Outstanding at December 31, 2005	Weighted- Average Remaining Contractual Life	Weighted- Average Exercise Price		Number Exercisable at December 31, 2005	Weighted- Average Exercise Price
$3.5 – $7.00	79,971	4.61	$	4.91	79,971	$	4.91
$13.38 – $20.30	509,049	8.46	$	17.98	509,049	$	17.98
$20.62 – $30.57	743,599	9.58	$	25.80	743,599	$	25.80
	1,332,619	8.83	$	21.56	1,332,619	$	21.56

SFAS No. 123 requires the Company to disclose pro forma information regarding net income (loss) as if the Company had accounted for stock options granted under the fair value method. The fair value for these options was estimated at the date of grant using the “minimum value” method with the following weighted-average assumptions for the fiscal years ended December 31, 2003, 2004 and 2005, the fair value of options granted was estimated on the date of grant using the Black-Scholes option pricing model using the following assumptions: risk free interest rate of 1.5% for 2003 and 2004 and 4.1% for 2005, dividend yield of 0%, expected life of the options of five years and expected volatility of 43.0%, 35.3% and 34.4% for 2003, 2004 and 2005.

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Had compensation cost for the Company’s stock option plans been determined based upon the fair value at the grant date, consistent with the methodology prescribed under SFAS No. 123, the Company’s net income (loss) would have changed by the amortization of the estimated fair value of stock options over the applicable vesting period of such awards as presented in Note 1. Those pro forma disclosures may not be representative of similar future disclosures because additional options may be granted in future years and the computations used to estimate the fair value of the stock options are subject to significant subjective assumptions, any one or all of which may differ in material respects from actual amounts.

During 2002, the Company granted options to purchase 24,286, 4,857, and 95,238 shares of the Company’s common stock at exercise prices of $3.50, $4.73, and $7.00 per share, respectively, to certain employees. As a result, the Company had total deferred stock compensation of $469,000, of which $175,000 and $144,000 has been recognized as stock compensation expense for the years ended December 31, 2003 and 2004, as the exercise price of these options was less than the estimated fair value of the Company’s common stock at the grant date.

The aforementioned options prior to the acceleration of vesting noted above are 10 year options that vested based on a predetermined period of time.

Included in general and administrative expense are $175,000 and $144,000 of stock compensation expense for the years ended December 31, 2003 and 2004, respectively. For 2005, stock based compensation expense was classified as general and administrative expense and included approximately $549,000 related to the acceleration of vesting of all unvested stock options under the Company’s 2003 Plan as of December 29, 2005 and approximately $52,000 related to the grant of 20,000 options to purchase the Company’s common stock at the market price on the date of grant to a significant consultant in 2005 under the Company’s 2003 Plan based on the option’s fair value on the date of grant.

The Company’s board of directors may consider a new equity based plan to be proposed to the stockholders for approval at the Company’s annual meeting of stockholders in 2006.

12.    Income Taxes

The federal and state income tax provision is summarized as follows:

	Year ended December 31,
	2003		2004			2005
Federal:
Current	$	609,418	$	3,459,510		$	5,105,998
Deferred		789,027		273,858			(123,395	)
		1,398,445		3,733,368			4,982,603
State
Current		267,135	$	759,676		$	1,269,409
Deferred		26,224		(257,681	)		54,950
Total provision for income taxes	$	1,691,804	$	4,235,363		$	6,306,962

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A reconciliation of the provision for income taxes with amounts determined by applying the statutory U.S. federal income tax rate to income before income taxes is as follows:

	Year Ended December 31,
	2003			2004			2005
Statutory rates		34	%		35	%		35	%
Federal income tax at statutory rates	$	1,474,906		$	3,962,150		$	5,506,343
Change in valuation allowance		(225,840	)		19,314			—
State income taxes, net of federal benefit		207,528			291,849			753,722
Stock option expense		—			—			29,490
Put warrant obligation		214,459			—			—
Other		20,751			(37,950	)		17,407
Provision for income taxes	$	1,691,804		$	4,235,363		$	6,306,962
Effective income tax rate		39	%		37	%		40	%

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax assets and liabilities are as follows:

	December 31,
	2004			2005
Deferred tax assets:
Net operating loss carryforwards	$	2,103,000		$	1,610,000
Noncompete agreement		40,000			38,000
Accounts receivable		461,000			208,000
Property and equipment		—			—
Accrued items and prepaids		13,000			159,000
Nonqualified stock options		—			206,000
Other		40,000			—
		2,657,000			2,221,000
Deferred tax liabilities:
Cash to accrual adjustment for acquired entity		56,000			522,000
Property and equipment		48,000			68,000
Goodwill and intangibles		1,170,000			4,522,000
		1,274,000			5,112,000
Net deferred tax assets		1,383,000			(2,891,000	)
Less valuation allowance		(302,000	)		(302,000	)
Net deferred taxes	$	1,081,000		$	(3,193,000	)
Current deferred tax assets	$	475,000		$	790,000
Noncurrent deferred tax assets (liabilities), net of $302,000 valuation allowance for each of 2004 and 2005		606,000			(3,983,000	)
	$	1,081,000		$	(3,193,000	)

During the year ended December 31, 2005, $1.2 million of federal net operating losses and $0 of state net operating losses were utilized.

At December 31, 2005, the Company has future tax benefits of $1.6 million related to approximately $4.0 million of available federal net operating loss carryforwards which expire in years 2012 through 2023 and $5.8 million of state net operating loss carryforwards which expire in 2006 through 2020. Approximately $3.7 million

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of the federal net operating loss carryforwards result from the Camelot acquisition. As a result of statutory “ownership changes” (as defined for purposes of Section 382 of the Internal Revenue Code), the company’s ability to utilize its net operating losses is restricted. The Company is unable to utilize net operating losses of approximately $180,500 that expire in 2013 due to this restriction.

The net change in the total valuation allowance for the year ending December 31, 2005 was zero. The valuation allowance includes $239,000 of state net operating loss carryforwards and $63,000 of federal net operating loss carryforwards for which the Company has concluded that it is more likely than not that these net operating loss carryforwards will not be realized in the ordinary course of operations. The Company will continue to assess the valuation allowance and to the extent it is determined that the valuation allowance should be adjusted an appropriate adjustment will be recorded.

The Company recognized certain tax benefits related to stock option plans during 2004 and 2005 in the amount of $497,000 and $1,171,000. Such benefits were recorded as a reduction of income taxes payable and an increase in additional paid-in-capital. Also during 2004, the Company recognized certain tax benefits related to expenses related to its initial public offering in the amount of $485,000. Such benefits were recorded as a reduction of income taxes payable and an increase in additional paid-in-capital.

13.    Commitments and Contingencies

The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company’s consolidated financial position, results of operations, or liquidity.

The Company provides management services under long-term management agreements and has relationships with certain tax-exempt organizations under Section 501(c)(3) of the Internal Revenue Code. While actions of certain tax authorities have challenged whether similar relationships by other organizations may violate the federal tax-exempt status of not-for-profit organizations, management is of the opinion that its relationships with these tax-exempt organizations do not violate their tax-exempt status and any unfavorable outcomes would not have a material adverse effect on the Company’s consolidated financial position, results of operations, or liquidity.

On May 16, 2005, the Company began reinsuring a substantial portion of its general and professional liability and workers’ compensation insurance coverage under certain reinsurance programs through its wholly-owned captive insurance subsidiary, SPCIC, and, effective July 1, 2005, the Company began self-funding a substantial portion of its employee health insurance program as more fully described in note 1.

In connection with the acquisition of CBH on June 13, 2005, the Company issued 117,371 shares of its unregistered common stock and a promissory note in the principal amount of approximately $776,000, after deducting certain credits related to preliminary working capital adjustments of approximately $724,000, with a fixed interest rate of 5%. The number of shares of the Company’s unregistered common stock issued in connection with this transaction and the principal and accrued interest thereon related to the promissory note may subsequently be adjusted in accordance with the terms and conditions of the purchase agreement. Accordingly, with respect to the promissory note, the principal and accrued interest thereon was adjusted downward by approximately $158,000 to $619,000 as of December 31, 2005 and was recorded by the Company as a decrease in the cost to acquire CBH.

The Company may be obligated to pay, in the third fiscal quarter of 2006, an additional amount up to $2.0 million under an earn out provision as such term is defined in the purchase agreement related to the purchase of Maple Star Nevada. If the earn out provision is met, the contingent consideration will be paid in cash. If the contingency is resolved in accordance with the related provisions of the purchase agreement and the additional consideration becomes distributable, the Company will record the fair value of the consideration issued as an additional cost to acquire Maple Star Nevada.

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In connection with the acquisition of AlphaCare described in note 4, the Company may be obligated to pay to the sellers, in the second fiscal quarter of 2007, an additional amount under an earn out provision pursuant to a formula specified in the purchase agreement that is based upon certain factors, including the EBITDA of certain programs of AlphaCare. If the earn out provision is met, the contingent consideration will be paid one-third in cash, one-third by delivery of an unsecured, subordinated promissory note and the balance in shares of the Company’s unregistered common stock, the value of which will be determined in accordance with the provisions of the purchase agreement. If the contingency is resolved in accordance with the related provisions of the purchase agreement and the contingent consideration becomes distributable, the Company will record the fair value of the consideration paid, issued or issuable as an additional cost to acquire AlphaCare.

In 2005, the Internal Revenue Service examined the Company’s tax return for the period July 1, 2003 to December 31, 2003. The examination was concluded in December 2005 with no material effect to the Company’s financial position or results of operations.

14.    Transactions with Related Parties

In June 1999, the Company was issued a promissory note by a not-for-profit affiliate in the amount of $461,342. The note bears interest at a rate of 9% per annum and was due in June 2004. On February 20, 2003, a new promissory note in the same amount was issued by the not-for-profit affiliate which extends the due date for repayment of principal and unpaid accrued interest to February 2008 and lowered the interest rate to 5% per annum. Interest income of approximately $24,500, $20,400 and $20,400 was recorded for the years ended December 31, 2003, 2004 and 2005. The balance of the note at December 31, 2004 and 2005 was $407,341 and is reflected in the accompanying consolidated balance sheets as “Notes receivable from unconsolidated affiliates”. In addition, effective March 1, 2006, the Company amended its management services agreement with FPCS to increase the management fee to reimburse the Company for the compensation costs for FPCS’s State Director who became the Company’s employee on that day.

One of the Company’s directors, Mr. Geringer, is a holder of capital stock and the chairman of the board of Qualifacts Systems, Inc. Qualifacts is a specialized health care information technology provider that entered into a software license, maintenance and servicing agreement with the Company. This agreement became effective on March 1, 2002 and continues for five years. This agreement may be terminated by either party without cause upon 90 days written notice and for cause immediately upon written notice. Qualifacts provided the Company services and the Company incurred expenses in the amount of approximately $334,000, $77,000 and $77,000 for years ended December 31, 2003, 2004 and 2005 under this agreement. Effective January 10, 2006, a new software license, maintenance and servicing agreement between the Company and Qualifacts was entered into and continues for five years. This agreement replaces the agreement which began on March 1, 2002 and may be terminated by either party without cause upon 90 days written notice and for cause immediately upon written notice. The new agreement grants the Company access to additional software functionality and licenses for additional sites.

Upon the Company’s acquisition of Camelot and Cypress, Mr. McCusker, one of the Company’s directors and the Company’s chief executive officer, became an executive officer of Camelot Community Care, Inc. and Intervention Services, Inc., the not-for-profit, tax exempt organizations whose operations were managed by Camelot and Cypress respectively, at the time the Company acquired them (and are now managed by the Company), until he resigned from such positions in July 2003. The Company provided management services to Camelot Community Care, Inc. pursuant to the Company’s management agreement for consideration in the amount of $3.0 million, $5.6 million and $6.1 million for the years ended December 31, 2003, 2004 and 2005, respectively. The Company provided management services to Intervention Services, Inc. pursuant to the Company’s management agreement in the amount of $1.7 million, $1.5 million and $1.3 million for the years ended December 31, 2003, 2004 and 2005, respectively.

On February 3, 2006, the board of directors of Camelot Community Care, Inc. granted the Company a year end management incentive bonus of $125,000 for management services rendered in 2005. The bonus amount was added to management fee receivable in the accompanying consolidated balance sheet at December 31, 2005.

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The Company agreed to reduce its management fee beginning January 1, 2006 under its management services agreement with Camelot Community Care, Inc. The agreement will result in a reduction of the Company’s management fee for management and administrative services rendered of approximately $200,000 on an annual basis in the future.

The Company amended its management services agreement with Rio Grande Behavioral Health Services to lower its management fee for services rendered in 2005 as a result of changes made to the Rio Grande Behavioral Health provider network in New Mexico in 2005. The lower management fee under the amended management services agreement with Rio Grande Behavioral Health Services was partially offset by management fees from management services agreements entered in to by the Company, as the manager, and certain providers which comprised the Rio Grande Behavioral Health provider network in 2005. In addition, the Company was awarded a one time fee of $200,000 in 2005 by Rio Grande Behavioral Health Services for reorganization start-up costs under the amended management services agreement related to the changes made to the Rio Grande Behavioral Health provider network in 2005.

The Company entered in to an agreement with FCP under which the Company reduced its management fee below the fee provided for under the original management service agreement for management services rendered from July 1, 2004 to June 30, 2005 to enable FCP to fund certain expenses incurred by FCP during its fiscal year ended June 30, 2005. For management services provided by the Company in excess of services contemplated by the management services agreement during the period July 1, 2004 and June 30, 2005, FCP agreed to an increase in the management fee above the fee provided for under the original management service agreement charged to them by the Company for FCP’s fiscal year ending June 30, 2006. The management fee under the original management services agreement will be applied to FCP in its subsequent fiscal years beginning July 1, 2006 over the remaining term of the management services agreement.

Upon the Company’s acquisition of Maple Services, LLC, Mr. McCusker, Mr. Deitch, the Company’s chief financial officer, and Mr. Norris, the Company’s chief operating officer, became members of the board of directors of the two not-for-profit organizations (Maple Star Colorado, Inc. and Maple Star Oregon, Inc.) formerly managed by Maple Services, LLC. Maple Star Colorado, Inc. and Maple Star Oregon, Inc., while not-for-profit organizations are not federally tax exempt organizations. The Company provided management services to Maple Star Colorado, Inc. and Maple Star Oregon, Inc. under management agreements for consideration in the aggregate amount of approximately $715,000 for the year ended December 31, 2005. In addition, the board of directors of Maple Star Oregon, Inc. granted the Company management incentive bonuses from the date the Company acquired Maple Services, LLC to December 31, 2005. The bonus amounts were added to management fee receivable and aggregated to approximately $291,000 at December 31, 2005.

In connection with the acquisition of Pottsville and the establishment of a management agreement with ReDCo in May 2004, the Company loaned $875,000 to ReDCo to fund certain long-term obligations of ReDCo in exchange for a promissory note for the same amount. The note assumes interest equal to a fluctuating interest rate per annum based on a weighted-average of the daily Federal Funds Rate. The terms of the promissory note require ReDCo to make quarterly interest payments over twenty-one months commencing June 30, 2004 with the principal and any accrued and unpaid interest due upon maturity on March 31, 2006. On January 25, 2006, an amendment to the promissory note was issued by ReDCo which extends the due date for repayment of principal to September 2007. Interest income of approximately $9,000 and $29,000 was earned for the years ended December 31, 2004 and 2005, respectively. The promissory note is collateralized by a subordinated lien to ReDCo’s primary lender on substantially all of ReDCo’s assets. At December 31, 2004 and 2005, the balance of the note was $875,000 and is reflected in the accompanying consolidated balance sheets as “Notes receivable from unconsolidated affiliates”. Additionally, in October 2005, ReDCo agreed to pay the Company $500,000 under an amendment to the management agreement. The aggregate amounts due to the Company from ReDCo under these arrangements totaled approximately $1.4 million at December 31, 2005.

Beginning in 2004, the Company began using a twin propeller KingAir airplane operated by Las Montanas Aviation, LLC for business travel purposes on an as needed basis. Las Montanas Aviation, LLC is owned by

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Mr. McCusker. The Company reimburses Las Montanas Aviation, LLC for the actual cost of use currently equal to $1,095 per flight hour. For the years ended December 31, 2004 and 2005, the Company reimbursed Las Montanas Aviation, LLC approximately $12,800 and $52,000, respectively, for use of the airplane for business travel purposes.

Note 15.    Subsequent Events

On February 1, 2006, the Company acquired all of the equity interest in A to Z, a Tennessee based provider of home based educational tutoring. The purchase price included $500,000 in cash and approximately $800,000 in debt excluding a $250,000 bridge loan owing to the Company by A to Z at the date of acquisition. In connection with the acquisition of A to Z, the Company may be obligated to pay to the former members of A to Z in each of 2007, 2008 and 2009, an additional amount under an earn out provision pursuant to a formula specified in the purchase agreement that is based upon the future financial performance of A to Z. If the earn out provision is met in 2007, the contingent consideration will be paid in cash, and if the earn out provision is met in 2008 and 2009, the contingent consideration will be paid in a combination of cash and shares of the Company’s unregistered common stock, the value of which will be determined in accordance with the provisions of the purchase agreement. The total purchase price including earn out payments will not exceed $8.0 million. When and if the earn out provision is triggered and paid, the Company will record the fair value of the consideration paid, issued or issuable as an additional cost acquire A to Z. This acquisition expands the Company’s home and community based social services to include educational tutoring. The cash portion of the purchase price of this acquisition was partially funded from the Company’s credit facility with CIT.

On February 27, 2006, the Company acquired all of the equity interest in FBS, a North Carolina based provider of home based and case management services. The purchase price included $300,000 in cash less any negative working capital and a $75,000 loan owing to the Company by FBS at the date of acquisition. The purchase price will be paid upon the final determination of FBS’s working capital. In accordance with certain provisions in the purchase agreement, the Company may make an earn out payment in the second quarter of 2008 based on the financial performance of FBS over the period from March 1, 2006 to December 31, 2007. If the contingency is resolved in accordance with the related provisions of the purchase agreement and the additional consideration becomes distributable, the Company will record the fair value of the consideration issued as an additional cost to acquire FBS. This acquisition expands the Company’s presence in North Carolina and provides an entrée into the state of New Jersey.

The above acquisitions have been accounted for using the purchase method of accounting and the results of operations are included in the Company’s consolidated financial statements from the date of acquisition. The cost of these acquisitions has not been allocated to the assets and liabilities acquired as an evaluation of their respective fair values was not determined as of the date of this report on Form 10-K.

Item 9.     Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

None.

Item 9A.     Controls and Procedures

(a) Evaluation of disclosure controls and procedures

The Company, under the supervision and with the participation of its management, including its principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of the end of the period covered by this report (December 31, 2005). Based on this evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective in reaching a reasonable level of assurance that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time period specified in the Securities and Exchange Commission’s rules and forms.

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(b) Changes in internal controls

The principal executive officer and principal financial officer also conducted an evaluation of the Company’s internal control over financial reporting (“Internal Control”) to determine whether any changes in Internal Control occurred during the quarter ended December 31, 2005 that have materially affected or which are reasonably likely to materially affect Internal Control. Based on that evaluation, there has been no such change during the quarter ended December 31, 2005 covered by this report.

(c) Management’s report on internal control over financial reporting

Management’s report on internal control over financial reporting is presented in Part II, Item 8, of this report and is hereby incorporated by reference.

Item 9B.     Other Information

On March 13, 2006, the Company’s board of directors and the compensation committee thereof approved the Annual Incentive Compensation Plan and the Quarterly Incentive Bonus Plan for 2006.

Annual Incentive Compensation Plan

Each Named Executive Officer (as this term is defined under Item 11 of Part III of this report) is eligible to receive a bonus under the Annual Incentive Compensation Plan. The Annual Incentive Compensation Plan is designed as a team bonus and is not triggered unless the Company meets or exceeds its budgeted net income and earnings per share for fiscal 2006 (calculated after giving effect to any bonuses accrued under the Annual Incentive Compensation Plan and the Quarterly Incentive Bonus Plan). Individuals of the bonus team are eligible to receive a cash bonus as follows: (1) if net income and earnings per share exceeds budgeted target amounts by 1% to 5%, the cash bonus payable to each individual will be 25% of the individual’s 2006 base salary; and (2) if net income and earnings per share exceeds budgeted target amounts by more than 5%, the cash bonus payable to each individual will be 50% of the individual’s 2006 base salary.

Quarterly Incentive Bonus Plan

Each Named Executive Officer is eligible to receive a bonus under the Quarterly Incentive Bonus Plan. The Quarterly Incentive Bonus Plan is designed as a team bonus and is triggered if the Company meets or exceeds its budgeted net income and earnings per share for each quarter during the Company’s fiscal year (calculated after giving effect to any bonuses accrued under the Quarterly Incentive Bonus Plan and the Annual Incentive Compensation Plan). Individuals of the bonus team are eligible to receive a cash bonus of $5,000 for each quarter the bonus is triggered under the Quarterly Incentive Bonus Plan. The total annual amount each individual of the bonus team may receive under the Quarterly Incentive Bonus Plan is $20,000.

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PART III

Item 10.     Directors and Executive Officers of the Registrant

Our executive officers and directors and their respective ages and positions as of the date of this report are as follows:

Name	Age	Position(s)
Fletcher Jay McCusker	56	Chairman of the Board (Class 3 Director); Chief Executive Officer
William Boyd Dover	66	President
Michael N. Deitch	49	Chief Financial Officer; Vice President; Secretary; Treasurer
Mary J. Shea	50	Executive Vice President of Program Services
Craig A. Norris	38	Chief Operating Officer
Martin James Favis	46	Chief Development Officer
Fred D. Furman	57	Executive Vice President; General Counsel
Steven I. Geringer	59	Class 1 Director
Hunter Hurst, III	67	Class 1 Director
Kristi L. Meints	51	Class 3 Director
Warren S. Rustand	62	Class 2 Director
Richard Singleton	70	Class 2 Director

Our Board of Directors is comprised of six directors and is divided into three classes, serving staggered three year terms. The following is a brief description of the business experience of executive officers and directors for at least the past five years.

Fletcher Jay McCusker has served as our chairman of the board of directors and chief executive officer since our company was founded in December 1996. Prior to founding our company, Mr. McCusker served as executive vice president of Youth Services International, Inc. (YSII), a Nasdaq listed company that provided private institutional care for at-risk youth, from July 1995 until December 1996. From September 1992 until July 1995, he served as chief executive officer of Introspect Healthcare Corporation, a large multi-state behavioral health provider. In 1983, Mr. McCusker co-founded a mental health care company, Century Healthcare, which was sold to New York Stock Exchange listed Columbia Healthcare in 1992. Mr. McCusker received a bachelor’s degree in rehabilitation from the University of Arizona in 1974 and completed the public programs graduate program without a terminal degree at Arizona State University in 1982.

William Boyd Dover has served as our president since April 1997. Effective July 1, 2006, Mr. Dover will relinquish his position as president but continue to be employed by us in a non-executive capacity. Prior to joining our company, Mr. Dover had worked for over 30 years in the human service field in both the private and public sectors. Just before joining our company, he served as executive director of Desert Hills, a large inpatient facility serving children and adolescents in Tucson, Arizona from January 1995 through March 1997. The first nine years of his professional life were spent working in residential treatment centers with emotionally disturbed children in both Austin, Texas and Tucson, Arizona. He then spent the next four years as the director of the Pima County Juvenile Court in Tucson. From February 1979 through the end of 1991, Mr. Dover continued working in the public sector in both Phoenix and Tucson, Arizona. At various times he served as the assistant director of the department of economic security and was responsible for the state-wide administration of all welfare programs including child welfare, was later the assistant director of the Division of Behavioral Health within the State Health Department and was responsible for the state-wide administration of all drug, alcohol and mental health programs. Mr. Dover has also spent four years as the deputy director of the State Health Department, two years as an assistant county manager for Health Services in Tucson and was appointed by the Governor to serve as the “acting director” of the Health Department on two separate occasions. Mr. Dover received both a BS degree (1963) and a master’s degree in social work (1965) from the University of Utah.

Michael N. Deitch, a certified public accountant, has served as our chief financial officer since June 1997. He was named secretary and treasurer in October 1998. Prior to joining our company, Mr. Deitch served as

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director of financial controls for Crawford & Company (CRD), a New York Stock Exchange listed company specializing in health care and business claims adjusting from March 1995 to April 1997. Mr. Deitch founded and served as chief financial officer for Showtime Event Rentals, Inc., an event and party rental company from August 1994 until March 1995. Mr. Deitch served as litigation manager for Raburn and Decosimo, CPAs, a specialized litigation and business valuation firm, from January 1991 until August 1994. Mr. Deitch served as southeast region senior financial analyst and as a senior member of the tax department for Glasrock Home Health Care, Inc., a wholly-owned subsidiary of the New York Stock Exchange listed company British Oxygen Company, now known as the BOC Group, from November 1984 until January 1991. Mr. Deitch received a bachelor’s degree in accounting from the University of Tennessee in 1979 and a master’s degree in business administration from the University of Tennessee in 1981.

Mary J. Shea has served as our executive vice president of program services since February 2003 and as president of our Arizona operations from February 1997 until February 2003. Ms. Shea served as a member of our board of directors from September 1999 to August 2003. Prior to joining our company, she was the director of case management for Introspect Healthcare Corporation, a large, multi-state behavioral health provider, from October 1995 until February 1997. Ms. Shea worked as a supervisor for the State of Arizona and the Arizona Center for Clinical Management, a managed care entity providing behavioral health services in southern Arizona, from March 1990 until September 1995. She received a bachelor’s degree in natural resources from the University of Wisconsin in 1978.

Craig A. Norris has served as our chief operating officer since April 2004 and as president, eastern division from May 1998 to March 2004. Prior to joining our company, Mr. Norris served as the chief operating officer of Parents and Children Together, Inc., a home based counseling provider from June 1994 until April 1998, which we acquired in February 1997. Mr. Norris was employed as a psychotherapist for the Arizona Department of Health from December 1992 until June 1994. Mr. Norris was a treatment coordinator for the Arizona Center for Clinical Management, a managed care behavioral health care provider for southern Arizona, from May 1992 until December 1992. Mr. Norris received a bachelor’s degree in psychology from the University of Arizona in 1989 and dual master’s degrees in counseling and organizational management from the University of Phoenix in 1993 and 1996, respectively.

Martin James Favis has served as our chief development officer since February 2003 and serves as a board member of the National Board of the Foster Family Treatment Association. Effective April 1, 2006, Mr. Favis will step down as our chief development officer and become a consultant to us on potential mergers and acquisitions. Prior to joining our company, Mr. Favis served as president of our subsidiary, Camelot Care Corporation, Inc., from March 2002 until February 2003. Prior to our merger with Camelot, Mr. Favis served as Camelot’s chief operating officer from January 2000 until January 2002, where he was responsible for Camelot’s day-to-day management, and as Camelot’s Florida director from October 1998 until January 2000. Mr. Favis served as the chief executive officer of First Rehab, Plus, Inc., a Florida based provider of outpatient rehabilitation facilities, from August 1996 until October 1998. Mr. Favis received a bachelor’s degree in business from Villanova University in 1981.

Fred D. Furman, Esq. has served as our executive vice president since March 2006 and our general counsel since September 2003. From August 2002 until September 2003, Mr. Furman was self-employed as a consultant. Mr. Furman was previously with PMR Corporation, a publicly traded mental health company, from March 1995 until August 2002 (when PMR merged with Psychiatric Solutions, Inc.), where he held a number of positions, including most recently, from September 1997 through August 2002, as its president and general counsel. Mr. Furman is a former partner and head of the litigation department for the Philadelphia law firm of Kleinbard, Bell & Brecker LLP. Mr. Furman received his bachelor’s degree in history from Temple University in 1969 and a juris doctorate degree from Temple University, School of Law in 1973.

Steven I. Geringer has served as our director since March 2002 and chairperson of the compensation committee of our board of directors since May 2005 and has been a private investor since 1996. Mr. Geringer has

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thirty years of experience in the health care industry including senior management positions and directorships at publicly-traded and privately-held companies involved in hospital management, managed care, pharmaceutical benefits management and distribution, medical devices, and children’s social services programs. He served as president and chief executive officer of PCS Health Systems, Inc., one of the nation’s largest providers of managed pharmaceutical services to managed care organizations and health insurers, from June 1995 until June 1996, during which time PCS was acquired by Eli Lilly & Company. He also served as PCS’ president and chief operating officer from May 1993 until PCS’ then-parent, McKesson Corporation, acquired Clinical Pharmaceuticals, Inc., a company of which Mr. Geringer was a founder, chairman and chief executive officer. Mr. Geringer also serves as a director of Amsurg Corp., (AMSG) a Nasdaq listed ambulatory surgery center company, and chairman of its compensation committee and a member of its nominating and corporate governance committee. Mr. Geringer is also chairman of the board and director of Qualifacts Systems, Inc., a specialized health care information technology provider. Mr. Geringer received a bachelor’s degree in economics from The Wharton School of the University of Pennsylvania in 1968.

Hunter Hurst, III has served as our director since in December 1996 and chairperson of the nominating and corporate governance committee of our board of directors since May 2005. Since 1973, Mr. Hurst has served as Director of the National Center for Juvenile Justice, a national juvenile justice research and resource center. He has directed over thirty applied research studies and has authored numerous publications relating to juvenile issues. He received his bachelor’s degree in psychology and master’s degree in social work from Louisiana State University in 1960 and 1965, respectively.

Kristi L. Meints has served as our director and chairperson of the audit committee of our board of directors since August 2003. Since January 2005 and from August 1999 until September 2003, she has served as the chief financial officer of Chicago Systems Group, Inc., a technology consulting firm based in Chicago, Illinois. From October 2003 through December 2004, she served as chief financial officer of Peter Rabbit Farms, a carrot and vegetable farming business in Southern California. From January 1998 until August 1999, she was interim chief financial officer for Cordon Corporation, a start-up services company. Ms. Meints was group finance director for Avery Dennison Corporation (AVY), a New York Stock Exchange listed company that is a multi-national manufacturer of consumer and industrial products, from March 1996 until December 1997. From February 1977 until June 1995, she held a variety of financial positions at SmithKline Beecham Corporation, including as director of finance, worldwide manufacturing animal health products; and as manager of accounting and budgets for Norden Laboratories, Inc., one of its wholly owned subsidiaries. She received a bachelor’s degree in accounting from Wayne State College in 1975 and a master’s degree in business administration from the University of Nebraska in 1984.

Warren S. Rustand has served as our director since May 2005. Since September 2001, Mr. Rustand has served as the chief executive officer of Summit Capital Consulting, Inc., which specializes in the development of small to mid-size companies by structuring financial and human capital resources for them. He has also been a strategic partner in Harlingwood Partners, LP, a $200 million private fund focused on leveraged build-ups and consolidations in a variety of industries ranging from business services outsourcing to healthcare and manufacturing, since December 1998. Additionally, Mr. Rustand has had a long term interest in public policy, and in 1973, was selected as a White House Fellow. During his fellowship, he served in various positions such as special assistant to the Secretary of Commerce and special assistant to the Vice President. In addition, from 1974 to 1976, he served as the appointments secretary to the President. Mr. Rustand serves as a director of TLC Vision Corporation (TLCV), a Nasdaq listed eye-care services company, and the chairman of its audit committee. He received his bachelor’s and master’s degrees in political science from the University of Arizona in 1965 and 1972, respectively.

Richard Singleton has served as our director since March 1998. Colonel Singleton is a retired United States Army colonel. Colonel Singleton was one of the founders of Youth Services International, Inc. (YSII), a Nasdaq listed company that provides private institutional care for at-risk youth, in July 1993. He served as a superintendent of Boys School for the Department of Juvenile Justice State of Florida from June 1999 to July

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2004. From January 1999 until June 1999, Colonel Singleton was a regional director of operations for Three Springs, Inc., located in Huntsville, Alabama, where he was responsible for the overall operations and management of juvenile justice facilities in the State of Georgia. Colonel Singleton received a bachelor’s degree in education from the South Carolina State University in 1958 and a master’s degree in public administration from the University of Missouri in 1972.

Code of Ethics

We have adopted a code of ethics that applies to our senior management, including our chief executive officer, chief financial officer, controller and persons performing similar functions. Copies of our code of ethics are available without charge upon written request directed to Kate Blute, Director of Investor and Public Relations, at The Providence Service Corporation, 5524 East Fourth Street, Tucson, AZ, 85711.

Audit Committee

The Company’s board of directors (the “Board”) has a standing Audit Committee. The Audit Committee is currently composed of Ms. Meints (Chairperson) and Messrs. Hurst, Rustand and Singleton.

The Board has determined that each member of the Audit Committee is independent as defined in applicable Nasdaq National Market listing standards and Rule 10A-3 of the Securities Exchange Act of 1934, as amended. The Board has also determined that Ms. Meints is an “audit committee financial expert” as defined under Item 401 of Regulation S-K.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the Company’s executive officers, directors and persons who beneficially own more than ten percent of a registered class of the Common Stock to file with the SEC initial reports of ownership and reports of changes in ownership of Common Stock and other equity securities of the Company. Executive officers, directors and greater than ten percent stockholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file.

To the Company’s knowledge, based solely on a review of the copies of such reports furnished to the Company and written representations that no other reports were required, the Company believes that all Section 16(a) executive officers, directors and greater than ten percent beneficial stockholders complied with applicable Section 16(a) requirements during the year ended December 31, 2005.

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Item 11.     Executive Compensation

The following table sets forth certain information with respect to compensation paid by the Company for services rendered in all capacities to the Company and its subsidiaries during the fiscal years ended December 31, 2005, 2004 and 2003 to (1) the Chief Executive Officer of the Company and (2) each of the four most highly compensated executive officers of the Company whose salary and bonus exceeded $100,000 during the fiscal year ended December 31, 2005 (the “Named Executive Officers”).

			Annual Compensation						Long Term Compensation
Name and Principal Position	Year		Salary ($)(1)		Bonus ($)		Other Annual Compensation ($)(2)		Securities Underlying Options (#)	All Other Compensation ($)(3)
Fletcher Jay McCusker	2005		$	232,500	$	15,000		—	70,000	$	27,336
Chairman and Chief	2004			190,000		20,000		—	—		27,448
Executive Officer	2003			174,600		15,000		—	—		26,399
William Boyd Dover	2005		$	182,708	$	15,000	$	43,700	30,000	$	9,032
President	2004			165,000		20,000		24,800	—		8,981
	2003			152,500		15,000		—	—		7,642
Michael N. Deitch	2005		$	187,708	$	15,000		—	45,000	$	12,862
Chief Financial Officer,	2004			159,167		20,000		—	20,000		12,813
Vice President, Secretary	2003			134,498		15,000		—	10,000		19,801
and Treasurer
Fred D. Furman	2005		$	189,167	$	15,000	$	25,534	45,000	$	8,506
Executive Vice President and	2004			175,000		20,000		22,675	—		8,477
General Counsel	2003	(4)		46,442		—		18,501	110,000		1,201
Craig A. Norris	2005		$	194,167	$	15,000		—	45,000	$	12,671
Chief Operating Officer	2004			175,833		20,000		—	20,000		10,904
	2003			147,667		25,000		—	—		8,286

(1) Includes amounts deferred under the 401(k) plan.

(2) Messrs. Dover and Furman work in states other than their primary state of residency. Included in other annual compensation for Messrs. Dover and Furman for the fiscal years ended December 31, 2005, 2004 and 2003 are payments for expenses of an aggregate of $68,500 and $35,414, respectively, related to the cost to maintain a secondary residency in the state of their employment. In addition, for Mr. Furman for the fiscal years ended December 31, 2005, 2004 and 2003, $29,053 related to transportation and $2,243 for other miscellaneous expenses.

(3) The Company provides the Named Executive Officers with certain group life, health, medical and other non-cash benefits generally available to all salaried employees and not included in this column pursuant to SEC rules. For Messrs. McCusker, Dover, Deitch, Furman and Norris, the Company also paid for the premiums of certain health and dental benefits for their family, which are not available to all salaried employees and are included in this column. The amounts in this column include the following:

• Health and dental insurance premiums that the Company paid on behalf of Messrs. McCusker, Dover, Deitch, Furman and Norris in the following amounts for the fiscal year ended December 31, 2005, respectively: $12,463, $8,632, $12,462, $8,106 and $12,271.

• Matching contributions by the Company under its retirement savings plan were made on behalf of Messrs. Dover, Deitch, Furman and Norris in the amount of $400 each for the fiscal year ended December 31, 2005.

• Insurance premiums under an insurance plan that the Company provides for Mr. McCusker with coverage of up to $500,000. The Company paid $14,873 in premiums on this policy on behalf of Mr. McCusker in the fiscal year ended December 31, 2005.

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(4) Mr. Furman began his employment with the Company in September 2003. His compensation for 2003 reflects amounts he received from September 2003 through December 31, 2003.

Option Grants in 2005

The following table sets forth information concerning the number of stock options granted during 2005 to each of the Named Executive Officers.

Name	Individual Grants						Potential Realizable Value at Assumed Annual Rates of Stock Price Appreciation for Option Term (2)
	Number of Securities Underlying Options Granted (1)	% of Total Options Granted to Employees in 2005		Exercise Price Per Share		Expiration Date
							5%		10%
Fletcher Jay McCusker	50,000	6.4	%	$	20.62	2/16/15	$	648,390	$	1,643,149
	20,000	2.6	%	$	28.47	12/6/15	$	358,093	$	907,477
William Boyd Dover	10,000	1.3	%	$	20.62	2/16/15	$	129,678	$	328,630
	20,000	2.6	%	$	28.47	12/6/15	$	358,093	$	907,477
Michael N. Deitch	25,000	3.2	%	$	20.62	2/16/15	$	324,195	$	821,574
	20,000	2.6	%	$	28.47	12/6/15	$	358,093	$	907,477
Fred D. Furman	25,000	3.2	%	$	20.62	2/16/15	$	324,195	$	821,574
	20,000	2.6	%	$	28.47	12/6/15	$	358,093	$	907,477
Craig A. Norris	25,000	3.2	%	$	20.62	2/16/15	$	324,195	$	821,574
	20,000	2.6	%	$	28.47	12/6/15	$	358,093	$	907,477

(1) On December 6, 2005, the Board of the Company, upon recommendation of the Compensation Committee of the Board, approved the acceleration of the vesting dates of all unvested stock options previously awarded to eligible employees, directors and consultants, including stock options granted to the Named Executive Officers, under the Company’s 2003 Stock Option Plan, effective December 29, 2005. The options are 10 year options that would have vested one third on the grant date and one third on each of the first and second anniversary of the grant date prior to the acceleration of vesting of all unvested stock options outstanding at December 29, 2005. All other terms of the stock options remained the same.

(2) Potential realizable value represents the difference between the market value of the common stock for which the option may be exercised, assuming that the market of the common stock on the date of grant appreciates in value to the end of the ten-year option term at annualized rates of 5% and 10%, respectively, and the exercise price of the option. The rates of appreciation used in this table are prescribed by regulation of the SEC and are not intended to forecast future appreciation of the market value of the common stock.

Aggregated Option Exercises in 2005 and 2005 Year-End Option Values

The following table sets forth certain information concerning the number of unexercised options and the value of unexercised options at December 31, 2005 held by the Named Executive Officers.

	Shares Acquired on Exercise	Value Realized		Number of Securities Underlying Unexercised Options at December 31, 2005		Value of Unexercised In-the-Money Options at December 31, 2005 (1)
Name				Exercisable	Unexercisable	Exercisable		Unexercisable
Fletcher Jay McCusker	—		—	70,000	—	$	414,900	—
William Boyd Dover	—		—	38,572	—	$	304,886	—
Michael N. Deitch	20,000	$	264,466	55,000	—	$	302,950	—
Fred D. Furman	32,000	$	373,768	123,000	—	$	1,407,950	—
Craig A. Norris	—		—	65,000	—	$	395,250	—

(1) Values for “in-the-money” options/SARs represent the positive spread between the respective exercise prices of outstanding options/SARs and the fiscal year-end value of the common stock at December 31, 2005, which was $28.79.

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Equity Employee Benefit Plans

2003 Stock Option Plan.    The purpose of the Company’s 2003 Stock Option Plan is to provide additional incentives to officers, other key employees, and directors of, and important consultants to the Company and each present or future parent or subsidiary corporation, by encouraging them to invest in shares of the Company’s common stock, and thereby acquire a proprietary interest in us and an increased personal interest in the Company’s continued success and progress.

The aggregate number of shares of common stock that may be issued under the 2003 Stock Option Plan is 1,400,000. Notwithstanding the foregoing, in the event of any change in the outstanding shares of common stock by reason of a stock dividend, stock split, combination of shares, recapitalization, merger, consolidation, transfer of assets, reorganization, conversion or similar circumstances as determined by the Compensation Committee of the Board in its sole discretion, the aggregate number and kind of shares which may be issued under the 2003 Stock Option Plan shall be appropriately adjusted in a manner determined in the sole discretion of the Compensation Committee. Reacquired shares of common stock, as well as unissued shares, may be used for the purpose of the 2003 Stock Option Plan. The shares of common stock subject to options, which have terminated unexercised, either in whole or in part, shall be available for future option grants under the 2003 Stock Option Plan.

All of the Company’s officers, key employees, and officers and key employees of any present or future parent or subsidiary corporation are eligible to receive an option or options under the 2003 Stock Option Plan. All directors of, and important consultants to the Company and of any of the Company’s present or future parent or subsidiary corporations are also eligible to receive an option or options under the 2003 Stock Option Plan. No individual may receive options under the 2003 Stock Option Plan for more than 80% of the total number of shares of the common stock authorized for issuance under the 2003 Stock Option Plan. The individuals who receive an option or options shall be selected by the Board or the Compensation Committee of the Board. Currently, the Compensation Committee administers the 2003 Stock Option Plan and has delegated authority to Mr. McCusker, the Company’s Chief Executive Officer, to grant options to key employees and consultants, subject to limitations.

As of December 31, 2005, 1,397,754 stock options had been awarded under the 2003 Stock Option Plan. As of March 10, 2005, stock options for an aggregate of 1,397,754 shares were awarded under the 2003 Stock Option Plan of which options to purchase an aggregate of 425,000 shares were awarded to executive officers at exercise prices ranging from $13.38 to $28.47 per share and an aggregate of 163,333 shares were awarded to directors at exercise prices ranging from $17.13 to $28.47 per share. On December 6, 2005, the Board of the Company, upon recommendation of the Compensation Committee of the Board, approved the acceleration of the vesting dates of all unvested stock options previously awarded to eligible employees, directors and consultants, including stock options granted to the Named Executive Officers and non-employee directors, under the Company’s 2003 Stock Option Plan, effective December 29, 2005; provided the option holder was actively an employee, director or consultant of the Company on December 29, 2005. The options are 10 year options that would have vested one third on the grant date and one third on each of the first and second anniversary of the grant date prior to the acceleration of vesting of all unvested stock options outstanding at December 29, 2005. All other terms of the stock options previously awarded remained the same as set forth in the stock option agreement, a form of which is on file with the Securities and Exchange Commission as Exhibit 10.1 to the Company’s Form 10-Q for the quarterly period ended June 30, 2005.

1997 Stock Option and Incentive Plan.    The Company’s 1997 Stock Option and Incentive Plan adopted in 1997 authorized the issuance of 428,572 shares of common stock. As of December 31, 2005, 79,971 stock options had been awarded and outstanding under the 1997 Stock Option and Incentive Plan. No further awards may be granted under the 1997 Stock Option and Incentive Plan.

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Compensation of Directors

As compensation for their service as directors of the Company, each non-employee member of the Board receives a $10,000 annual stipend, except for the Audit Committee Chair who receives a $28,800 annual stipend. Payment of the annual stipends is made on a quarterly basis following each quarter of service. Additionally, each non-employee member of the Board receives $3,500 for each Board meeting attended in person, $1,000 for each telephonic meeting of the Board participated in, and $1,000 for each committee meeting attended or participated in by telephone of which such non-employee member of the Board is a member that is not held the same day as a Board meeting, except that the Audit Committee Chair receives $2,500 for each Audit Committee meeting attended or participated in by telephone that is not held the same day as a Board meeting.

In addition, each non-employee member then serving on the first business day of each January receives a ten year option to purchase 10,000 shares of the Company’s common stock under the Company’s 2003 Stock Option Plan with an exercise price equal to the closing market price of the Company’s common stock on the date of grant. For services to be rendered in 2006, each non-employee director was awarded an option to purchase 10,000 shares of the Company’s common stock on December 6, 2005 under the Company’s 2003 Stock Option Plan in lieu of receiving the award in January 2006. On December 29, 2005 the vesting of all unvested options then outstanding, including those options awarded to non-employee directors, were accelerated.

The following table sets forth the number of options to purchase shares of common stock each non-employee director had as of March 9, 2006 and the associated exercise price.

	Number of stock option shares
Exercise Price	Steve Geringer	Hunter Hurst III	Kristi Meints	Warren Rustand	Richard Singleton
$  3.50	—	—	—	—	2,858
$  4.73	—	—	—	—	4,287
$  7.00	—	—	1,429	—	1,429
$17.13	10,000	6,667	10,000	—	10,000
$20.30	10,000	10,000	30,000	—	10,000
$24.08	—	—	—	10,000	—
$28.47	10,000	10,000	10,000	10,000	10,000
Total	30,000	26,667	51,429	20,000	38,574

Employment Agreements

The Company entered into employment agreements, effective as of August 22, 2003, with the following named executive officers: Fletcher Jay McCusker, Chief Executive Officer; William Boyd Dover, President; Michael N. Deitch, Chief Financial Officer; and Craig A. Norris, Chief Operating Officer. Each of Messrs. McCusker, Dover, Norris and Deitch have employment agreements for a term of three years. Each employment agreement establishes, among other things, base salary levels at amounts designed to be competitive with executive positions at similarly situated companies. Under their employment agreements, Messrs. McCusker, Dover, Norris and Deitch were entitled to receive initial annual base salaries of $190,000, $165,000, $160,000 and $150,000, respectively. In fiscal 2004, the Compensation Committee increased the base salary of each of Messrs. Norris and Deitch to $180,000 and $170,000, respectively. The Compensation Committee approved an increase in the base salaries effective April 1, 2005, of Messrs. McCusker, Dover, Norris and Deitch to $250,000, $190,000, $200,000 and $195,000, respectively. Further, the Compensation Committee approved an increase in the base salaries effective April 1, 2006, of Messrs McCusker, Norris and Deitch to $300,000, $240,000 and $220,000, respectively. Generally, the annual base salaries are reviewed annually and may be modified by the Board or Compensation Committee. In addition to their base salaries, each executive is eligible to participate in any bonus plans or incentive compensation programs that the Company may establish from time to time. For fiscal 2005, Messrs. McCusker, Dover, Norris and Deitch each were awarded a bonus of $15,000 under the quarterly incentive bonus plan. No bonuses were granted under the annual incentive compensation plan.

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Under the employment agreements with each of the executive officers, the Company may be obligated to make severance payments to the executive officers. Pursuant to the employment agreements, the Company may terminate the employment agreements for cause at any time and without cause upon 30 days written notice. Mr. McCusker may terminate his employment agreement for good reason, upon 60 days written notice, if his duties are substantially altered or reduced, his salary is reduced, he is relocated more than 150 miles from Tucson, Arizona, the Company materially breaches his agreement or there is a change in the majority of the Company’s incumbent directors. “Incumbent directors” means the Company’s directors as of August 22, 2003 and any subsequent director nominated or elected by two-thirds of the then existing incumbent directors. In addition, the other executive officers may terminate these employment agreements for good reason upon 30 days prior written notice if the Company materially breaches such employment agreements. If an executive officer’s employment is terminated by the Company without cause or if an executive officer terminates the agreement for good reason, the Company must pay the executive his or her base salary for a stated severance term; provided, however, that in order to receive the severance payment, the executive officer must sign a general release. Pursuant to the employment agreements, each of Messrs. McCusker, Dover, Norris and Deitch has a stated severance term of one year.

Each of the employment agreements contains restrictive covenants providing for the employee’s non-competition, non-solicitation/non-piracy and non-disclosure. The term of Mr. McCusker’s non-competition and non-solicitation covenants is two years. Messrs. Dover, Norris and Deitch have 18 month non-competition covenants and two year non-solicitation covenants.

Bonuses

Annual Incentive Compensation Plan

Each Named Executive Officer was eligible to receive a bonus under the 2005 Annual Incentive Compensation Plan. The 2005 Annual Incentive Compensation Plan was designed as a team bonus and would have been triggered if the Company had met or exceeded its budgeted net income and earnings per share for fiscal 2005 (calculated after giving effect to any bonuses accrued under the 2005 Annual Incentive Compensation Plan and the Quarterly Incentive Bonus Plan). Individuals of the bonus team were eligible to receive a cash bonus as follows: (1) if net income and earnings per share would have exceeded budgeted target amounts by 1% to 5%, the cash bonus payable to each individual would have been 25% of the individual’s 2005 base salary; and (2) if net income and earnings per share would have exceeded budgeted target amounts by more than 5%, the cash bonus payable to each individual would have been 50% of the individual’s 2005 base salary. No bonuses were awarded to any Named Executive Officer in 2005 under this plan.

Quarterly Incentive Bonus Plan

Each Named Executive Officer is eligible to receive a bonus under the Quarterly Incentive Bonus Plan. The Quarterly Incentive Bonus Plan is designed as a team bonus and is triggered if the Company meets or exceeds its budgeted net income and earnings per share for each quarter during the Company’s fiscal year (calculated after giving effect to any bonuses accrued under the Quarterly Incentive Bonus Plan and the 2005 Annual Incentive Compensation Plan). Individuals of the bonus team are eligible to receive a cash bonus of $5,000 for each quarter the bonus is triggered under the Quarterly Incentive Bonus Plan. The total annual amount each individual of the bonus team may receive under the Quarterly Incentive Bonus Plan is $20,000. For 2005, each Named Executive Officer received $15,000 under this plan.

For a description of the 2006 bonus plans, see Item 9B of Part II of this report.

Compensation Committee Interlocks and Insider Participation

The Compensation Committee consists of Messrs. Geringer, Hurst and Singleton. No person who served as a member of the Compensation Committee during the fiscal year ended December 31, 2005 was a current or

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former officer or employee or engaged in certain transactions with us, required to be disclosed by regulations of the SEC. There were no compensation committee “interlocks” during the fiscal year ended December 31, 2005, which generally means that none of the Company’s executive officers served as a director or member of the compensation committee of another entity, one of whose executive officers served as the Company’s director or member of the Company’s Compensation Committee.

Item 12.     Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Equity Compensation Plans

The following table details information regarding the Company’s existing equity compensation plans as of December 31, 2005:

Plan Category	(a) Number of securities to be issued upon exercise of outstanding options, warrants and rights	(b) Weighted-average exercise price of outstanding options, warrants and rights		(c) Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
Equity compensation plans approved by security holders (1)	1,332,619	$	21.56	2,246
Equity compensation plans not approved by security holders	—		—	—
Total	1,332,619	$	21.56	2,246

(1) At December 31, 2005, under the 2003 Stock Option Plan there were options currently exercisable to purchase 1,252,648 shares of common stock and 2,246 shares of common stock eligible for future option grant and under the 1997 Stock Option and Incentive Plan there were options currently exercisable to purchase 79,971 shares of common stock. All outstanding options under the 2003 Stock Option Plan are exercisable. All outstanding options under the 1997 Stock Option and Incentive Plan are exercisable and no additional stock options may be granted under such plan.

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Security Ownership of Certain Beneficial Owners and Management

The following table sets forth certain information, as of March 9, 2006, with respect to the beneficial ownership of the Company’s common stock by (i) each stockholder known by the Company to own beneficially more than five percent of the Company’s outstanding common stock, (ii) all directors of the Company, (iii) all executive officers of the Company named in the “Summary Compensation Table” included in Item 11 of Part III of this report and (iv) all directors and executive officers of the Company as a group. Except as otherwise specified, the named beneficial owner has sole voting and investment power with respect to his shares.

Name	No. of shares of Common Stock Beneficially Owned (1)	Percent of Voting Power of Common Stock (1)
Arbor Capital Management, LLC(2) One Financial Plaza 120 South Sixth Street Suite 1000 Minneapolis, MN 55402	609,100	6.3%
Century Capital Management, LLC(3) 100 Federal Street, Boston, MA 02110	646,269	6.7%
FMR Corp.(4) 82 Devonshire Street, Boston, MA 02109	717,400	7.4%
Michael N. Deitch(5)	55,000	*
William Boyd Dover(6)	38,572	*
Fred Furman (7)	123,000	1.3%
Fletcher Jay McCusker(8)	180,000	1.9%
Craig A. Norris(9)	65,000	*
Steven I. Geringer(10)	62,143	*
Hunter Hurst, III(11)	26,667	*
Kristi L. Meints(12)	51,429	*
Richard Singleton(13)	38,574	*
Warren S. Rustand(14)	20,000	*
All directors and executive officers as a group (12 persons)(15)	731,527	7.6%

 * Less than 1%.

(1) The securities “beneficially owned” by an individual are determined as of March 9, 2006 in accordance with the definition of “beneficial ownership” set forth in the regulations of the Securities and Exchange Commission. Accordingly, they may include securities owned by or for, among others, the spouse and/or minor children of the individual and any other relative who has the same home as such individual, as well as other securities as to which the individual has or shares voting or investment power or has the right to acquire under outstanding stock options within 60 days after March 9, 2006. Beneficial ownership may be disclaimed as to certain of the securities.

(2) Includes 609,100 shares of common stock indirectly beneficially owned by Arbor Capital Management, LLC, an investment advisor. As a result of his position with and ownership in Arbor Capital Management, LLC, Rick D. Leggott may be deemed to indirectly beneficially own the 609,100 shares of common stock indirectly beneficially owned by Arbor Capital Management, LLC. This is based on the Schedule 13G filed with the SEC on February 3, 2006.

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(3) Includes 646,269 shares of common stock indirectly beneficially owned by Century Capital Management, LLC, a registered investment advisor. The shares are owned by various accounts managed by Century Capital Management, LLC. Those accounts have the right to receive, or the power to direct the receipt of, dividends from, and the proceeds from the sale of, such shares. This is based on the Schedule 13G filed with the SEC on February 9, 2006.

(4) Includes 717,400 shares of common stock indirectly beneficially owned by FMR Corp., a registered investment advisor. The shares are owned by various accounts managed by FMR Corp. Those accounts have the right to receive, or the power to direct the receipt of, dividends from, and the proceeds from the sale of, such shares. This is based on the Schedule 13G filed with the SEC on February 14, 2006.

(5) Represents shares of common stock issuable upon the exercise of options that are exercisable within 60 days of March 9, 2006.

(6) Represents shares of common stock issuable upon the exercise of options that are exercisable within 60 days of March 9, 2006.

(7) Represents shares of common stock issuable upon the exercise of options that are exercisable within 60 days of March 9, 2006.

(8) Includes 100,000 shares of common stock, which have been pledged to Compass Bank as collateral on a loan. Includes 70,000 shares of common stock issuable upon the exercise of options that are exercisable within 60 days of March 9, 2006. Includes 10,000 shares of common stock held by the McCusker Family Trust U/A as to which Mr. McCusker serves as a trustee. Does not include 17,450 shares of common stock held by The Fletcher J. McCusker GRAT for the benefit of Mr. McCusker’s son, as to which Mr. McCusker disclaims beneficial ownership.

(9) Represents shares of common stock issuable upon the exercise of options that are exercisable within 60 days of March 9, 2006.

(10) Includes 32,143 shares of common stock held by the Geringer Family Trust. Mr. Geringer shares voting and investment power over the securities held by the Geringer Family Trust. Includes 30,000 shares of common stock issuable upon the exercise of options that are exercisable within 60 days of March 9, 2006.

(11) Represents shares of common stock issuable upon the exercise of options that are exercisable within 60 days of March 9, 2006.

(12) Represents shares of common stock issuable upon the exercise of options that are exercisable within 60 days of March 9, 2006.

(13) Represents shares of common stock issuable upon the exercise of options that are exercisable within 60 days of March 9, 2006.

(14) Represents shares of common stock issuable upon the exercise of options that are exercisable within 60 days of March 9, 2006.

(15) Includes 568,719 shares of common stock issuable upon the exercise of options that are exercisable within 60 days of March 9, 2006, 100,000 shares of common stock that have been pledged to Compass Bank as collateral on a loan, 10,000 shares of common stock held by the McCusker Family Trust U/A as to which Mr. McCusker serves as a trustee and 32,143 shares of common stock held by the Geringer Family Trust.

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Item 13.     Certain Relationships and Related Transactions

Transaction with Mr. McCusker the Company’s Chief Executive Officer

Beginning in 2004, the Company began using a twin propeller KingAir airplane operated by Las Montanas Aviation, LLC for business travel purposes on an as needed basis. Las Montanas Aviation, LLC is owned by Mr. McCusker. The Company reimburses Las Montanas Aviation, LLC for the actual cost of use currently equal to $1,095 per flight hour. For the years ended December 31, 2004 and 2005, the Company reimbursed Las Montanas Aviation, LLC approximately $12,800 and $52,000, respectively, for use of the airplane for business travel purposes.

Item 14.     Principal Accounting Fees and Services

Fees for professional services provided by McGladrey & Pullen, LLP (“M&P”), the Company’s independent auditors, for the fiscal year ended December 31, 2005 and 2004 in each of the following categories were:

	Fiscal Year Ended December 31,
	2005		2004
Audit fees	$	541,000	$	565,000
Audit related fees	$	220,000	$	6,000
Tax fees	$	—	$	—
All other fees	$	—	$	—
Total	$	761,000	$	571,000

Audit Fees.    Audit fees consisted of amounts incurred for services performed in association with the annual financial statement audit (including required quarterly reviews), the audit of the Company’s internal control over financial reporting, and other procedures normally required by the independent auditor in order to be able to form an opinion on the Company’s consolidated financial statements. Other procedures included consultations relating to the audit or quarterly reviews, and services performed by M&P in connection with SEC registration statements, periodic reports and other documents filed with the SEC or other documents issued in connection with securities offerings, such as comfort letters provided to the Company’s underwriters.

Audit Related Fees.    Audit related fees consisted of amounts incurred for assurance and related services that are reasonably related to the performance of the audit or review of the Company’s financial statements or that are traditionally performed by the independent auditor. Audit related services included due diligence related to mergers and acquisitions, and accounting consultations and audits in connection with acquisitions.

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Tax Fees.    No tax fees were incurred during the periods presented.

All Other Fees.    No other fees were incurred during the periods presented.

The Audit Committee has considered and determined that the services provided by M&P are compatible with M&P maintaining its independence.

The Audit Committee has adopted a policy that requires advance approval of all audit, audit-related, tax services and other services performed by the independent auditor. The policy provides for pre-approval by the Audit Committee of specifically defined audit and non-audit services. Unless the specific service has been previously pre-approved with respect to that year, the Audit Committee must approve the permitted service before the independent auditor is engaged to perform it. The Audit Committee pre-approved all audit services provided to the Company by M&P in fiscal year 2005. No non-audit services were provided by M&P in fiscal year 2005.

PART IV

Item 15.     Exhibits, Financial Statement Schedules

(a)(1) Financial Statements

The following consolidated financial statements are included in Item 8.

• Consolidated Balance Sheets at December 31, 2005 and 2004;

• Consolidated Statements of Operations for the years ended December 31, 2005, 2004 and 2003;

• Consolidated Statements of Stockholders’ Equity (Deficit) at December 31, 2005, 2004 and 2003; and

• Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004 and 2003.

(2) Financial Statement Schedules

Schedule II Valuation and Qualifying Accounts

			Additions
	Balance at beginning of period		Charged to costs and expenses		Charged to other accounts		Deductions			Balance at end of period
Year Ended December 31, 2005:
Allowance for doubtful accounts	$	220,561	$	399,871	$	—	$	97,670	(1)	$	522,762
Valuation allowance		302,145		—		—		—			302,145
Total	$	522,706	$	399,871	$	—	$	97,670		$	824,907
Year Ended December 31, 2004:
Allowance for doubtful accounts	$	68,658	$	318,589	$	—	$	166,686	(1)	$	220,561
Valuation allowance		282,831		19,314		—		—			302,145
Total	$	351,489	$	337,903	$	—	$	166,686		$	522,706
Year Ended December 31, 2003:
Allowance for doubtful accounts	$	79,978	$	48,116	$	—	$	59,436	(1)	$	68,658
Valuation allowance		3,071,000		—		—		2,788,169			282,831
Total	$	3,150,978	$	48,116	$	—	$	2,847,605		$	351,489

Notes:

(1) Write-offs, net of recoveries.

All other schedules are omitted because they are not applicable or the required information is shown in our financial statements or the related notes thereto.

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(3) Exhibits

Exhibit Number		Description
2.1	(1)	Stock Purchase Agreement by and among The Providence Service Corporation, Ira Ehrlich and Cypress Management Services, Inc., dated as of January 3, 2003. (Schedules and exhibits are omitted pursuant to Regulation S-K, Item 601(b)(2); The Providence Service Corporation agrees to furnish supplementally a copy of such Schedules and/or exhibits to the Securities and Exchange Commission upon request.)
2.2	(4)	Purchase Agreement dated as of July 21, 2004 by and between The Providence Service Corporation and Aspen Education Group, Inc., Aspen Youth, Inc., Choices Group, Inc., Aspen MSO, LLC (d/b/a Aspen Community Services) and College Community Services. (Schedules and exhibits are omitted pursuant to Regulation S-K, Item 601(b)(2); The Providences Service Corporation agrees to furnish supplementally a copy of such schedules and/or exhibits to the Securities and Exchange Commission upon request.)
2.3	(5)	Purchase Agreement dated as of June 13, 2005 by and between The Providence Service Corporation and Children’s Behavioral Health, Inc., Nulton Diagnostic & Treatment Center, P.C. and Larry J. Nulton. (Schedules and exhibits are omitted pursuant to Regulation S-K, Item 601(b)(2); The Providences Service Corporation agrees to furnish supplementally a copy of such schedules and/or exhibits to the Securities and Exchange Commission upon request.)
2.4	(7)	Purchase Agreement dated as of August 22, 2005 by and between The Providence Service Corporation and Maple Services, LLC, Maple Star Nevada, 763667 Alberta Ltd., 1239658 Ontario Inc., Hamilton C. Hudson, Hudson Family Trust, Leonard Rutman, The Rutman Family Trust and Kay Hudson. (Schedules and exhibits are omitted pursuant to Regulation S-K, Item 601(b)(2); The Providences Service Corporation agrees to furnish supplementally a copy of such schedules and/or exhibits to the Securities and Exchange Commission upon request.)
2.5	(8)	Purchase Agreement dated as of September 20, 2005 by and between The Providence Service Corporation and Transitional Family Services, Inc., AlphaCare Resources, Inc., Ron L. Braund and Ron L. and Virginia M. Braund Charitable Remainder Unitrust. (Schedules and exhibits are omitted pursuant to Regulation S-K, Item 601(b)(2); The Providences Service Corporation agrees to furnish supplementally a copy of such schedules and/or exhibits to the Securities and Exchange Commission upon request.)
2.6		Purchase Agreement dated as of February 1, 2006 by and between The Providence Service Corporation and A to Z In-Home Tutoring, LLC, Scott Hines and Ann-Riley Caldwell, as amended. (Schedules and exhibits are omitted pursuant to Regulation S-K, Item 601(b)(2); The Providences Service Corporation agrees to furnish supplementally a copy of such schedules and/or exhibits to the Securities and Exchange Commission upon request.)
3.1	(1)	Second Amended and Restated Certificate of Incorporation of The Providence Service Corporation.
3.2	(1)	Amended and Restated Bylaws of The Providence Service Corporation.
+10.1	(1)	The Providence Service Corporation Stock Option and Incentive Plan, as amended.
+10.2	(3)	2003 Stock Option Plan, as amended.
+10.3	(1)	Employment Agreement by and between The Providence Service Corporation and Fletcher McCusker dated as of March 31, 2003.
+10.4	(1)	Employment Agreement by and between The Providence Service Corporation and William Boyd Dover, dated as of March 31, 2003.

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Exhibit Number		Description
+10.5	(1)	Employment Agreement by and between The Providence Service Corporation and Michael N. Deitch, dated as of March 31, 2003.
+10.6	(1)	Employment Agreement by and between The Providence Service Corporation and Craig A. Norris, dated as of March 31, 2003.
10.7	(2)	Second Amended and Restated Registration Rights Agreement by and among The Providence Service Corporation, Eos Partners SBIC, L.P., Eos Partners SBIC II, L.P., Petra Mezzanine Fund, L.P., Harbinger Mezzanine Partners, L.P., Geringer Family Trust u/a June 26, 1996, Lynn C. Chalache, Jane B. Terrell and Jill MacAlister, dated as of July 30, 2003.
10.8		Fee for service and Risk-Based Subcontract Agreement Children Services Contract A0508 by and between Community Partnership of Southern Arizona and The Providence Service Corporation, effective as of July 1, 2005, as amended.
10.9	(6)	Second Amended and Restated Loan and Security Agreement by and among The Providence Service Corporation and Healthcare Business Credit Corporation dated as of June 28, 2005. (Schedules and exhibits are omitted pursuant to Regulation S-K, Item 601(b)(2); The Providences Service Corporation agrees to furnish supplementally a copy of such schedules and/or exhibits to the Securities and Exchange Commission upon request.)
10.10	(5)	Second Amended and Restated Revolving Credit Note by The Providence Service Corporation and others listed therein for the benefit of Healthcare Business Credit Corporation (now known as CIT Healthcare LLC) dated June 28, 2005.
10.11	(5)	Second Amended and Restated Term Note by The Providence Service Corporation and others listed therein for the benefit of Healthcare Business Credit Corporation (now known as CIT Healthcare LLC) dated June 28, 2005.
+10.12		Annual Incentive Compensation Plan and Quarterly Incentive Bonus Plan
+10.13		Summary Sheet of Director Fees and Executive Officer Compensation
21.1		Subsidiaries of the Registrant.
23.1		Consent of Ernst & Young LLP.
23.2		Consent of McGladrey & Pullen, LLP.
31.1		Certification pursuant to Securities Exchange Act Rules 13a-14 and 15d-14 of the Chief Executive Officer.
31.2		Certification pursuant to Securities Exchange Act Rules 13a-14 and 15d-14 of the Chief Financial Officer.
32.1		Certification pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of the Chief Executive Officer.
32.2		Certification pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of the Chief Financial Officer.

 + Management contract or compensatory plan or arrangement.

(1) Incorporated by reference from an exhibit to the registrant’s registration statement on Form S-1 (Registration No. 333-106286) filed with the Securities Exchange Commission on June 19, 2003.

(2) Incorporated by reference from an exhibit to the registrant’s registration statement on Form S-1, as amended (Registration No. 333-106286) filed with the Securities and Exchange Commission on July 31, 2003.

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(3) Incorporated by reference from an exhibit to the registrant’s quarterly report on Form 10-Q for the quarter ended June 30, 2005 filed with the Securities and Exchange Commission on August 9, 2005.

(4) Incorporated by reference from an exhibit to the registrant’s current report on Form 8-K filed with the Securities and Exchange Commission on August 5, 2004.

(5) Incorporated by reference from an exhibit to the registrant’s current report on Form 8-K filed with the Securities and Exchange Commission on June 17, 2005.

(6) Incorporated by reference from an exhibit to the registrant’s current report on Form 8-K filed with the Securities and Exchange Commission on July 5, 2005.

(7) Incorporated by reference from an exhibit to the registrant’s current report on Form 8-K filed with the Securities and Exchange Commission on August 26, 2005.

(8) Incorporated by reference from an exhibit to the registrant’s current report on Form 8-K filed with the Securities and Exchange Commission on September 23, 2005.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

THE PROVIDENCE SERVICE CORPORATION
By:	/s/ FLETCHER JAY McCUSKER
	Fletcher Jay McCusker
	Chairman of the Board, Chief Executive Officer

Dated: March 16, 2006

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Signature	Title	Date
/s/ FLETCHER JAY McCUSKER Fletcher Jay McCusker	Chairman of the Board; Chief Executive Officer (Principal Executive Officer)	March 16, 2006
/s/ MICHAEL N. DEITCH Michael N. Deitch	Chief Financial Officer (Principal Financial and Accounting Officer)	March 16, 2006
/s/ WARREN RUSTAND Warrent Rustand	Director	March 16, 2006
/s/ STEVEN I. GERINGER Steven I. Geringer	Director	March 16, 2006
/s/ HUNTER HURST, III Hunter Hurst, III	Director	March 16, 2006
/s/ KRISTI L. MEINTS Kristi L. Meints	Director	March 16, 2006
/s/ RICHARD SINGLETON Richard Singleton	Director	March 16, 2006

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EX-2.6

EXHIBIT 2.6

	PURCHASE AGREEMENT
Parties:	The Providence Service Corporation
	a Delaware corporation (“Buyer”)
	c/o 5524 East Fourth Street
	Tucson, Arizona 85711
	A to Z In-Home Tutoring, LLC
	a Nevada limited liability company (“Company”)
	1300 Division Street
	Suite 306
	Nashville, TN. 37203
	Scott Hines (“Hines”)
	332 Harpath Ridge Drive
	Nashville, TN 37221
	Ann-Riley Caldwell (“Caldwell”)
	523 Elysian Fields Road
	Nashville, TN 37211

Dated as of: February 1, 2006

Background: Hines and Caldwell own all the issued and outstanding equity interests in the Company. The equity interests owned by Hines and Caldwell in the Company, respectively, are collectively referred to herein as the “Equity Interests.” Hines and Caldwell are jointly and severally referred to herein as the “Seller.” Buyer desires to purchase and Seller desires to sell, all of its Equity Interests in the Company free and clear of any Encumbrances, upon the terms and conditions set forth in this Agreement (the “Transaction”). The Company is engaged in the Business.

Intending to be legally bound, in consideration of the mutual agreements contained herein and subject to the satisfaction of the terms and conditions set forth herein, the parties hereto agree as follows:

SECTION 1. DEFINED TERMS

Certain defined terms used in this Agreement and not specifically defined in context are defined in this Section 1 as follows:

1.1     “Accounting Firm” shall mean Grant Thornton.

1.2     “Accounts Receivable” means: (a) any right to payment for goods sold, leased or licensed or for services rendered, whether or not it has been earned by performance, whether billed or unbilled, and whether or not it is evidenced by any Contract; (b) any note receivable; or (c) any other receivable or right to payment of any nature generally considered an accounts receivable under GAAP.

1.3     “Actual Capital Expenditures” shall have the meaning set forth in Section 6.5 herein.

1.4     “Ancillary Documents” shall have the meaning given to such term in Section 12.4 herein.

1.5     “Asset” means any real, personal, mixed, tangible or intangible property of any nature, including Cash Assets, prepayments, deposits, escrows, Accounts Receivable, Tangible Property, Real Property, Software, Contract Rights, Intangibles and goodwill, and claims, causes of action and other legal rights and remedies.

1.6     “Assumed Obligations” shall have the meaning set forth in Section 2.2.2.2

1.7     “Business” shall mean the business of the provision of any of the following services or combination thereof: tutoring services (including in-home tutoring) sponsored or funded by any Government Body or Governmental Program (including “no child left behind” services)

1.8     “Buyer” shall have the meaning set forth in the preamble.

1.9     “Cash Assets” means any cash on hand, cash in bank or other accounts, readily marketable securities, and other cash-equivalent liquid assets of the Company.

1.10     “CERCLA” shall have the meaning set forth in Section 3.2.1 herein.

1.11     “Closing” shall have the meaning given to such term in Section 5.1 herein.

1.12     “Closing Date” shall have the meaning given to such term in Section 5.1 herein.

1.13     “Closing Date Payment” shall have the meaning given to such term in Section 2.2.2.1 herein.

1.14     “Code” shall mean the Internal Revenue Code of 1986, as amended.

1.15     “Company Intangibles” means any Intangible that is used, held for use, marketed, maintained, supported, operated, under development or design, licensed, or with respect to which rights are granted in connection with, related to, pursuant to, in the conduct of, or as part of the Business, or any Intangible that is owned, in whole or in part, solely or jointly with one or more other Persons, by the Company.

1.16     “Company Web Sites” shall have meaning given to such term in Section 3.13.8 herein.

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1.17     “Consent” means any consent, approval, order or authorization of, or any declaration, filing or registration with, or any applicable, notice or report to, or any waiver by, or any other action (whether similar or dissimilar to any of the foregoing), of, by or with, any Person, which is necessary in order to take a specified action or actions in a specified manner and/or to achieve a specified result.

1.18     “Contract” means any written or oral contract, agreement, instrument, order, arrangement, commitment or understanding of any nature, including without limitation sales orders, purchase orders, leases, subleases, data processing agreements, service agreements, maintenance agreements, license agreements, sublicense agreements, loan agreements, promissory notes, security agreements, pledge agreements, deeds, mortgages, guaranties, indemnities, warranties, employment agreements, consulting agreements, sales representative agreements, joint venture agreements, buy-sell agreements, options or warrants.

1.19     “Contract Right” means any right, power or remedy of any nature under any Contract, including rights to receive property or services or otherwise derive benefits from the payment, satisfaction or performance of another party’s Obligations, rights to demand that another party accept property or services or take any other actions, and rights to pursue or exercise remedies or options.

1.20     “Current Assets” shall mean the aggregate dollar value of the Accounts Receivable, prepaid expenses, petty cash and deposits as determined in accordance with GAAP. For the purposes of calculating Net Assumed Assets, Accounts Receivable of the Company shall only include those Accounts Receivable that arose in the ordinary course of business, that are proper and valid Accounts Receivable, and that can and will be collected by the Company in full (without any counterclaim or setoff) prior to the 6 month anniversary of the Closing Date.

1.21     “Defense” shall have the meaning given to such term in Section 10.3.2 herein.

1.22     “Dispute Notice” shall have the meaning given to such term in Section 2.2.2.3 herein.

1.23     “Domain Names” shall have the meaning given to such term in Section 3.13.6 herein.

1.24     “Earn-Out Calculations” shall have the meaning given to such term in Section 2.2.2.3 herein.

1.25     “EBITDA” shall mean earnings before income tax, depreciation and amortization as such items are calculated in accordance with GAAP; the expenses included in such calculation shall include direct operating expenses only, consistent with past practice.

1.26     “Employee Benefit Plan” means any employee benefit plan as defined in Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), any “voluntary employees’ beneficiary association” within the meaning of Section 501(c)(9) of the Code, “welfare benefit fund” within the meaning of Section 419 of the Code, or “qualified asset account” within the meaning of Section 419A of the Code, and any other plan, program, policy or arrangement for or regarding bonuses, commissions, incentive compensation,

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severance, vacation, deferred compensation, pensions, profit sharing, retirement, payroll savings, stock options, stock purchases, stock awards, stock ownership, phantom stock, stock appreciation rights, medical/dental expense payment or reimbursement, disability income or protection, sick pay, group insurance, self insurance, death benefits, employee welfare or fringe benefits of any nature; but not including employment Contracts with individual employees.

1.27     “Encumbrance” means any liens, superlien, security interest, pledge, right of first refusal, mortgage, easement, covenant, restriction, reservation, conditional sale, prior assignment, or other encumbrance, claim, burden or charge of any nature.

1.28     “Entity” means any corporation (including any non-profit corporation), general partnership, limited partnership, limited liability partnership, joint venture, estate, trust, company (including any company limited by shares, limited liability company or joint stock company), firm, society or other enterprise, association, organization or entity.

1.29     “Environmental Laws” means all applicable Laws (including consent decrees and administrative orders) relating to the public health and safety and protection of the environment, including those governing the use, handling, storage, transportation and disposal or remediation of Hazardous Substances and governing the regulation of medical infections or biohazardous waste or substances as such terms are defined under applicable Laws, all as amended.

1.30     “Equity Interests” shall have the meaning set forth in the preamble.

1.31     “ERISA Affiliate” means any entity, trade or business (whether or not incorporated) that is part of the same controlled group under, common control with, part of an affiliated service group with, or part of another arrangement that includes, the Company or any ERISA Affiliate within the meaning of Code Section 414(b), (c), (m) or (o).

1.32     “Final Net Assumed Obligations” shall have the meaning given to such term in Section 2.2.3.6 herein.

1.33     “Financial Statements” shall have the meaning given to such term in Section 3.6.2 herein.

1.34     “First Earn-Out” shall have the meaning given to such term in Section 2.2.2.3 herein.

1.35     “First Earn-Out Term” shall have the meaning given to such term in Section 2.2.2.3 herein.

1.36     “Formation Date” means the earliest date upon which an Entity in the Company was formed, as applicable.

1.37     “Full Year Tax Return” shall have the meaning given to such term in Section 9.2.2 herein.

1.38     “Full Year Period” shall have the meaning given to such term in Section 9.2.2.

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1.39     “GAAP” means generally accepted accounting principles under current United States accounting rules and regulations, consistently applied.

1.40     “Government Body” means any federal, state, county, local, municipal governmental authority of any nature (including any governmental division, subdivision, department, agency, bureau, branch, office, commission, council, board (including any federal, state or local board(s) of medicine), instrumentality, organization, unit, body, school, school district or Entity or any court or other tribunal), entitled to exercise any administrative, executive, judicial, legislative, policy regulatory or taxing authority or power, including any accreditation body.

1.41     “Governmental Program” shall mean (i) any plan program which, whether directly, through insurance, or otherwise is funded, in whole or in part, by the United States Government, (ii) any plan or program funded by any state, country, school or school district or local governmental authority, or (iii) any other applicable third party payers which are a Government Body and which provide payment or reimbursement for any services provided as part of the Business.

1.42     “Hazardous Substances” means any substance, waste (including Medical Waste), contaminant, pollutant or material that has been determined by any Government Body to be capable of posing a risk of injury or damage to health, safety, property or the environment, including (a) all substances, wastes, contaminants, pollutants and materials defined, designated or regulated as hazardous, dangerous toxic pursuant to any Law, and (b) asbestos, polychlorinated biphenyls (“PCB’s”), petroleum, petroleum products and urea formaldehyde.

1.43     “Identified Employee” or “Identified Employees” means individually or collectively, Hines, Caldwell, Jenny Carpenter and Sinneshia Byrdsong.

1.44     “including” means including but not limited to.

1.45     “Indemnification Matter” shall have the meaning given to such term in Section 10.3 herein.

1.46     “Indemnification Notice” shall have the meaning given to such term in Section 10.3.1 herein.

1.47     “Indemnitee” and “Indemnitor” shall have the meanings given to such terms in Section 10.3 herein.

1.48     “Insurance Policy” means any public liability, product liability, general liability, comprehensive, property damage, vehicle, life, hospital, medical, dental, disability, worker’s compensation, key man, fidelity bond, theft, forgery, errors and omissions, directors’ and officers’ liability, or other insurance policy of any nature.

1.49     “Intangible” means any name, corporate name, domain name, fictitious name, Domain Name, trademark, trademark application, service mark, service mark application, trade name, brand name, product name, symbol, slogan, trade secret, know-how, patent, patent application, copyright, copyright application, Web site, design, logo, formula, invention, product

5

right, technology, Software, or other intangible asset of any nature, whether in use, operational, active, under development or design, non-operative, or inactive, owned, marketed, maintained, supported, used, licensed or otherwise held for use by, or licensed to or with respect to which rights are granted to, a Person, whether arising under statutory or common law in any jurisdiction or otherwise, and includes, without limitation, any and all Intellectual Property Rights in and to the foregoing.

1.50     “Intellectual Property Right” means any and all intellectual property rights (throughout the universe, in all media, now existing or created in the future, and for the entire duration of such rights) arising under statutory or common law, contract, or otherwise, and whether or not perfected, including without limitation, all (a) patents, reissues and reexamined patents, and patent applications, whenever filed and wherever issued, and all priority rights resulting from such applications; (b) rights associated with works of authorship including, but not limited to, copyrights, moral rights, copyright applications, copyright registrations, and rights to prepare derivative works; (c) rights relating to the protection of trade secrets and confidential information; (d) rights in trademarks, service marks, trade names, logos, symbols, and the like; (e) rights analogous to those set forth in this definition and any and all other proprietary rights relating to intangible property; and (f) divisions, continuations, continuations-in-part, substitutes, renewals, reissues and extensions of the foregoing (as and to the extent applicable) now existing, hereafter filed, issued, or acquired.

1.51     “Judgment” means any order, writ, injunction, citation, award, decree, administrative order or agreement or other judgment of any nature of any Government Body.

1.52     “Law” means any provision of any foreign, federal, state or local law, common law, statute, ordinance, charter, constitution, treaty, code, rule, regulation or guideline.

1.53     “Leased Real Property” shall have the meaning given to such term in Section 3.12.2 herein.

1.54     “Loss” or “Losses” shall have the meanings given to such terms in Section 10.1 herein.

1.55     “Material Adverse Effect” means any state of facts, change, event, effect or occurrence (which when taken together with all other states of fact, changes, events, effects or occurrences) (i) that is, or may be reasonably likely to be, adverse to (a) the operations, financial condition, financial performance or prospects of the Company or (b) any of the Assets or Obligations of any of the Company, and (ii) which adverse effect is or will be material, under either GAAP or applicable legal principles, to the Company.

1.56     “Medical Waste” means (i) pathological waste, (ii) blood, (iii) sharps, (iv) wastes from surgery or autopsy, (v) dialysis waste, including contaminated disposable equipment and supplies, (vi) cultures and stocks of infectious agents and associated biological agents, (vii) contaminated animals, (viii) isolation wastes, (ix) contaminated equipment, (x) laboratory waste, (xi) any substance, pollutant, material or contaminant listed or regulated under any Law and (xii) other biological waste and discarded materials contaminated with or exposed to blood, excretion, or secretions from human beings or animals.

6

1.57     “Medical Waste Laws” means the following, including regulations promulgated and orders issued thereunder, as in effect on the date hereof and the Closing Date: (i) The Medical Waste Tracking Act of 1988, 42 USC § 6992 et seq., (ii) the U.S. Public Vessel Medical Waste Anti-Dumping Act of 1988, 33 USC § 2501 et seq., (iii) the Marine Protection, Research, and Sanctuaries Act of 1972, 33 USC § 1401 et seq., (iv) the Occupational Safety and Health Act, 29 USC § 651 et seq., (v) the United States Department of Health and Human Services, National Institute for Occupational Safety and Health, Infectious Waste Disposal Guidelines, Publication No. 88-119, and (vi) any Laws insofar as they are applicable to assets or operations of the Company, its facilities and the Business which purports to regulate Medical Waste or impose requirements relating to Medical Waste.

1.58     “Monthly Balance Sheet” shall have the meaning set forth in Section 6.5 herein.

1.59     “Monthly Financial Statements” shall have the meaning set forth in Section 6.5 herein.

1.60     “NAO Dispute Notice” shall have the meaning set forth in Section 2.2.3.3.

1.61     “Net Assumed Obligations” shall mean the Assumed Obligations less Current Assets based on an accrual basis of accounting in accordance with GAAP for the Company; Assumed Obligations shall not include liabilities owed by the Company to Buyer pursuant to the Promissory Note or the proceeds of any advances made by Buyer to Company under the Promissory Note.

1.62     “Net Assumed Obligations Statement” shall have the meaning set forth in Section 2.2.3.2.

1.63     “Obligation” means any debt, liability or obligation of any nature (including, with respect to the Company, any Obligations owed to any Related Party), whether secured, unsecured, recourse, non-recourse, liquidated, unliquidated, accrued, absolute, fixed, contingent, ascertained, unascertained, known, unknown or otherwise.

1.64     “Permit” means any license, certification, permit, approval, waiver, order, authorization, right or privilege of any nature, granted, issued, approved, required or allowed by any Government Body.

1.65     “Person” means any individual, Entity or Government Body.

1.66     “Preamble” shall mean the Parties and Background sections herein.

1.67     “Proceeding” means any demand, claim, suit, action, litigation, investigation, audit, arbitration, administrative hearing or other proceeding of any nature.

1.68     “Promissory Note” shall have the meaning given to such term in Section 2.2.3.1.

1.69     “Pro Forma Return” shall have the meaning given to such term in Section 9.2.2 herein.

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1.70     “Purchase Price” shall have the meaning set forth in Section 2.2.1.

1.71     “Real Property” means any real estate, land, building, condominium, town house, structure or other real property of any nature, all shares of stock or other ownership interests in cooperative or condominium associations or other forms of ownership interest through which interests in real estate may be held, and all appurtenant and ancillary rights thereto, including easements, covenants, water rights, sewer rights and utility rights.

1.72     “Referral Source” means any referral source(s) of the Company including but not limited to any referring residential facilities, Government Bodies, schools and school districts.

1.73     “Related Party” means, with respect to any Person, any current or former partner, owner, equity owner, member, director, officer, manager or controlling Person of such Person (or any of their respective predecessors), any other Person affiliated with such Person (or any of their respective predecessors) or any lobbyist, agent (including any government relations agent), representative or consultant acting on behalf of such Person.

1.74     “Reportable Transaction” shall mean any transaction listed in Treasury Regulation Section 1.6011-4(b).

1.75     “SEC” shall mean the Securities and Exchange Commission.

1.76     “Second Earn-Out” shall have the meaning given to such term in Section 2.2.2.3 herein.

1.77    “Second Earn-Out Term” shall have the meaning given to such term in Section 2.2.2.3 herein.

1.78     “Seller” shall have the meaning in the preamble.

1.79     “Seller Group” shall have the meaning given to such term in Section 10.1 herein.

1.80     “Seller Indemnified Party” or “Seller Indemnified Parties” shall have the meanings given to such terms in Section 10.2 herein.

1.81     “Short-Period Tax Returns” shall have the meaning given to such term in Section 9.2.1 herein.

1.82     “Software” means any computer program, operating or other system, application, firmware or software of any nature, whether operational, active, under development or design, non-operational, or inactive (including, without limitation, all object code, source code, comment code, algorithms, processes, formulae, interfaces, navigational devices, menu structures or arrangements, icons, operational instructions, scripts, commands, syntax, screen designs, reports, designs, concepts, and visual expressions), technical manuals, test scripts, user manuals and other documentation therefore, whether in machine-readable form, programming language or any other language or symbols, and whether stored, encoded, recorded or written on disk, tape, film, memory device, paper or other media of any nature and any and all databases necessary or appropriate to operate or in the use of any such computer program, operating or other system, application, firmware or software.

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1.83     “Specified Contract” shall have the meaning ascribed to such term in Section 3.14.1 herein.

1.84     “Tangible Property” means any furniture, fixtures, leasehold improvements, vehicles, office equipment, computer equipment, other equipment, machinery, tools, forms, supplies or other tangible personal property of any nature.

1.85     “Tax” means: (a) any foreign, federal, state or local income, earnings, profits, gross receipts, franchise, capital stock, net worth, sales, use, value added, occupancy, general property, real property, personal property, intangible property, transfer, fuel, excise, payroll, withholding, unemployment compensation, social security, retirement or other tax of any nature; (b) any foreign, federal, state or local organization fee, qualification fee, annual report fee, filing fee, occupation fee, assessment, sewer rent or other fee or charge of any nature; or (c) any deficiency, interest or penalty imposed with respect to any of the foregoing.

1.86     “Tax Return” shall mean all returns and reports, amended returns, information returns, statements, declarations, estimates, schedules, notices, notifications, forms, elections, certificates or other documents required to be filed or submitted to any Government Body with respect to the determination, assessment, collection or payment of any Tax or in connection with the administration, implementation or enforcement of, or compliance with, any Tax.

1.87     “Taxing Authority” shall mean any Government Body exercising tax regulatory authority.

1.88     “Third Earn Out” shall have the meaning given to such term in Section 2.2.2.3.

1.89     “Third Earn-Out Term” shall have the meaning given to such term in Section 2.2.2.3.

1.90     “To the knowledge of” or “knowledge” and similar phrases means (i) in the case of an individual, knowledge of a particular fact or matter, actually known or that which could reasonably be expected to be known, and (ii) in the case of an entity, if any individual who is serving, or at any time has served, as a director, officer or executive manager (or in any similar capacity) has, or at any time had, knowledge (as contemplated by clause (i) above) of such fact or other matter.

1.91     “Transaction” shall have the meaning in the preamble.

1.92     “Unaudited Balance Sheet” shall have the meaning set forth in Section 3.6.2.

1.93     “Unaudited Balance Sheet Date” shall have the meaning given to such term in Section 3.6.2 herein.

1.89     “Unaudited Financial Statements” shall have the meaning given to such term in Section 3.6.2 herein.

1.90     “Web” shall have the meaning given to such term in Section 3.13.8 herein.

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SECTION 2. THE TRANSACTION

2.1     Sale and Purchase of Equity Interests. On the Closing Date, subject to the other terms and conditions of this Agreement, Seller shall sell, transfer, assign and convey to the Buyer, and the Buyer shall purchase, all right, title and interest in and to all of the Equity Interests, owned beneficially and of record by Seller, as more specifically set forth on Schedule 3.3, free and clear of any Encumbrances.

2.2     Purchase Price and Adjustments.

          2.2.1     Subject to the other terms and conditions of this Agreement, the total purchase price for the Equity Interests (the “Purchase Price”) shall consist of the items set forth in Section 2.2.2 of which $10,000 shall be allocated to the Restrictive Covenants in Section 9.7 hereof and the balance to the purchase of the Equity Interests.

          2.2.2     The Purchase Price shall be paid as follows:

              2.2.2.1     The Buyer shall pay (the “Closing Date Payment”) to Seller, by wire transfer on the Closing Date, an amount equal to Five Hundred Thousand Dollars ($500,000).

              2.2.2.2     By operation of law, Company shall continue to be the obligor on the Obligations specifically described in (i), (ii), (iii) and (iv) of Section 3.8.1 and the Buyer shall assume by operation of law and/or satisfy at Closing all such Obligations (“Assumed Obligations”).

              2.2.2.3     (a) An earn-out (payable 50% to Hines and 50% to Caldwell), if earned, equal to six (6) times the EBITDA of the Company for the period beginning February 1, 2006 and ending December 31, 2006 (the “First Earn-Out Term”) divided by 11 and multiplied by 12, less the sum of the Closing Date Payment and Final Net Assumed Obligations (such payment, the “First Earn-Out”) (b) an earn-out, if earned, equal to product of four (4) times the difference between the Company’s EBITDA for calendar year 2007 (the “Second Earn-Out Term”) less the Company’s EBITDA (whether positive or negative) for calendar year 2006 (annualized as set forth above) less any remaining portion of the Closing Date Payment and Final Net Assumed Obligations not taken into account and credited against the First Earn-Out, if any (the “Second Earn-Out”); and (c) an earn-out, if earned, equal the product of four (4) times the difference between the Company’s EBITDA for calendar year 2008 (the “Third Earn-Out Term”) less the greater of Company’s EBITDA (whether positive or negative) for calendar year 2006 (annualized as set forth above) or 2007 less any remaining portion of the Closing Date Payment, Final Net Assumed Obligations and negative calendar year 2007 EBITDA not taken into account and credited against the First Earn-Out or Second Earn-Out, if any and as applicable (the “Third Earn-Out”). For clarity, none of the First Earn-Out, the Second Earn-Out or the Third Earn-Out shall be less than Zero Dollars ($0), or otherwise result in an amount payable by Seller pursuant to this Section 2.2.2.3; however, for further clarity, this provision shall not effect the obligations of the Seller under Section 10 herein. Buyer shall determine the amount of the

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First Earn-Out, Second Earn-Out and Third Earn-Out within ten (10) days of the completion of the audit of its financial statements for calendar years 2006, 2007 and 2008 and Buyer shall use commercially reasonable efforts to complete each audit no later than 120 days following the end of the First Earn-Out Term, Second Earn-Out Term or Third Earn-Out Term, as applicable. Upon such determination, the Buyer shall deliver to the Seller a statement reflecting the relevant EBITDA calculation and the applicable calculation of the earn-out based on Buyer’s audited financials for each of the calendar years 2006, 2007 and 2008 (each such calculation, an “Earn-Out Calculation”). If Seller does not provide written notice to the Buyer (the “Dispute Notice”) disputing the Earn-Out Calculation for each year within thirty days after delivery thereof, then the applicable Earn-Out Calculation shall be final and binding upon the parties. If, on the other hand, the Seller does provide the Dispute Notice within the time period set forth in the preceding sentence, the Buyer and Seller shall submit the dispute to the Accounting Firm to resolve. The costs and expenses of the Accounting Firm in connection with resolving the dispute shall be borne equally by Buyer, on the one hand, and the Seller, on the other hand. The determination of the Accounting Firm shall be final and binding upon the parties. The earn-outs, if earned and determined as set forth above, shall be paid as follows: The First Earn-Out shall be in cash within twenty (20) days of the determination of such earn-out and the Second Earn-Out and Third Earn-Out shall be paid seventy-five per cent (75%) in cash within twenty (20) days of the determination of such earn-out and twenty five per cent (25%) shall be payable in shares of unregistered common stock of the Buyer to the Seller (the total number of shares to be determined by using the arithmetic average of the closing sales price per share of Buyer’s common stock as reported on the Nasdaq stock market or other applicable stock market for the five trading days immediately preceding the date Buyer’s auditors have completed their audit of Buyer’s financial statements for calendar year 2007 or 2008, as applicable). Buyer may set-off against any portion of the First Earn-Out, Second Earn-Out or Third Earn-Out to satisfy indemnity obligations of Seller in Section 10. Seller’s right to receive the First Earn-Out, Second Earn-Out, and Third Earn-Out shall be subordinated to the rights of Buyer’s primary lender.

              2.2.2.4     Notwithstanding anything herein to the contrary, the total Purchase Price (including Closing Date Payment, Assumed Obligations, First Earn-Out, Second Earn-Out and Third Earn Out, as applicable) shall not exceed $8,000,000. Buyer shall have no obligation for payment in excess of such amount. For clarity, Assumed Obligations shall only be counted once in the foregoing calculation, notwithstanding the inclusion of Assumed Obligations in the definition and methodology of calculation of the First Earn-Out, Second Earn-Out and Third Earn-Out.

2.2.3     No later than four (4) business days prior to Closing, the Seller shall deliver to Buyer a December 31, 2005 balance sheet of the Company which shall include a calculation of Net Assumed Obligations; such deliverable shall be prepared in accordance with GAAP and shall be attached hereto as Schedule 2.2.3.

              2.2.3.1     The Net Assumed Obligations shall be exclusive of any liabilities owed by Company to Buyer pursuant to the Promissory Note executed by Company in favor of Buyer dated October 31, 2005 (“Promissory Note”) and the proceeds of any advances made by Buyer to Company under the Promissory Note.

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2.2.3.2     Within sixty (60) days of the six (6) month anniversary of the Closing Date, the Buyer shall (i) review the components of the Net Assumed Obligations and prepare a detailed statement of the components of the Net Assumed Obligations (the “Net Assumed Obligations Statement”) and (ii) deliver the Net Assumed Obligations Statement to the Seller. The Seller shall have a thirty (30) day period to review the Net Assumed Obligations Statement and during such period, upon reasonable request, the Buyer shall share its work papers with the Seller or its professional advisers and to make itself reasonably available to the Seller and its professional advisers for the Seller’s review of the Net Assumed Obligations.

2.2.3.3     If Seller disputes the Net Assumed Obligations Statement, Seller shall deliver a notice to the Buyer no later than thirty days after their receipt of the Net Assumed Obligations Statement (the “NAO Dispute Notice”). Seller shall set forth in detail in the Dispute Notice the basis for their disagreement with the calculations of the Net Assumed Obligations. If Seller fails to deliver the NAO Dispute Notice within the allotted time period, Seller shall have been deemed to have agreed to the calculations of the Net Assumed Obligations prepared by the Buyer, which calculations shall be final, conclusive and binding upon the parties.

2.2.3.4     If Seller disputes the Net Assumed Obligations within the allotted time period, the parties in good faith will attempt to jointly resolve any dispute during the thirty day period following the delivery of the NAO Dispute Notice. If the Buyer and Seller can resolve their dispute and agree upon the Net Assumed Obligations of the Company, they shall memorialize their agreement in writing and such mutually agreed upon figure(s) shall be final, conclusive and binding upon all of the parties.

2.2.3.5     If the Buyer and Seller cannot resolve the dispute to their mutual satisfaction, the Buyer and Seller shall engage the Accounting Firm, or another mutually agreeable independent, qualified, nationally recognized and respected accounting firm, to determine the Net Assumed Obligations of the Company. The costs and expenses of the Accounting Firm shall be borne equally, but severally, by the Buyer, on the one hand, and Seller, on the other hand. To the extent that the Accounting Firm desires the parties to this Agreement to meet in person, the parties shall choose a mutually acceptable location for such meeting. Each of the Buyer and Seller shall cause their accounting professional advisers to provide the Accounting Firm such of their respective work papers as may be requested by the Accounting Firm. The Accounting Firm shall be requested to complete their engagement within forty-five days of being retained by the Buyer and Seller. The determination of the Accounting Firm shall be final, binding and conclusive upon the parties.

2.2.3.6     The final determination of the Net Assumed Obligations of the Company pursuant to this Section shall be referred to herein as the “Final Net Assumed Obligations”.

SECTION 3. REPRESENTATIONS AND WARRANTIES OF THE COMPANY AND SELLER.

Knowing that Buyer is relying thereon, and as an inducement to the Buyer to consummate the transactions contemplated by this Agreement, the Company (pre-Closing) and Seller, jointly and severally, represent and warrant to Buyer and covenant with Buyer, as set forth below in this Section 3.

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3.1     Organization. The Company is duly organized and validly existing corporation under the Laws of the jurisdiction of its formation and is in good standing under the Laws of the jurisdiction of its formation. The Company possesses the full limited liability company power and authority to enter into and perform its obligations under this Agreement and/or to consummate the transactions contemplated hereby. The Company possesses the full power and authority: (i) to own and use its Assets in the manner in which such Assets are currently owned and used, and (ii) to conduct its Business as such Business is currently being conducted. Except as set forth on Schedule 3.1, the Company is duly qualified or registered to do business in each jurisdiction where such qualification or registration is required by applicable Law.

          3.1.1     Except as set forth on Schedule 3.1, The Company does not own any equity of any corporation or any other interest in any Person. Except as set forth on Schedule 3.1, the Company has never acquired or succeeded to all or any portion of the Assets or businesses of any other Person, and, except as set forth on Schedule 3.1, there is no other Person that may be deemed to be a predecessor of the Company.

          3.1.2     Schedule 3.1 sets forth for the Company: (i) its exact legal name; (ii) its business form and jurisdiction and date of formation; (iii) its federal employer identification number; (iv) its headquarters address, telephone number and facsimile number; (v) its directors/managers and officers, indicating all current title(s) of each individual; (vi) its registered agent and/or office in its jurisdiction of formation (if applicable); (vii) all foreign jurisdictions in which it is qualified or registered to do business, the date it so qualified or registered, and its registered agent and/or office in each such jurisdiction (if applicable); (viii) all fictitious, assumed or other names of any type that are registered or used by it or under which it has done business at any time since such company’s date of formation; (ix) any name changes, recapitalizations, mergers, reorganizations or similar events since its date of formation and (x) its identification and/or registration numbers issued by any Governmental Program.

          3.1.3     Accurate and complete copies of the articles or certificates of organization or formation and other organization documents, each as amended to date and each of which are valid and effective, and all Contracts relating to the acquisition or formation of the Company, have been delivered to Buyer.

3.2     Authority; Non-Contravention.

          3.2.1     Seller and the Company has the corporate right, power and authority to enter into and to perform its, his, her or their obligations under this Agreement, and the execution, delivery and performance of this Agreement and the consummation of the transactions contemplated hereby by Seller and the Company have been duly authorized by its respective board of directors, managers, and equity owners, as applicable. This Agreement constitutes the legal, valid and binding agreement of Seller and the Company and is enforceable against Seller and the Company in accordance with its terms.

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3.2.2     Except as set forth on Schedule 3.2, neither the execution, delivery and performance of this Agreement nor the consummation or performance of any of the transactions contemplated hereby by the Seller or of the Company will directly or indirectly (with or without notice or lapse of time):

              3.2.2.1     contravene, conflict with or result in a violation of (a) any of the provisions of the articles or certificates of incorporation or organization, bylaws, Operating Agreement, or other organizational documents of the Seller or the Company or (b) any resolution adopted by the Seller or the Company’s board of directors, members, managers or any committee of the board of directors of the Seller or the Company;

              3.2.2.2     contravene, conflict with or result in a violation of, or give any Government Body or other Person the right to challenge any of the transactions contemplated hereby or to exercise any remedy or obtain any relief under, any Law or any Judgment to which the Company or any of the Assets owned or used by the Company, is subject;

              3.2.2.3     contravene, conflict with or result in a violation of any of the terms or requirements of, or give any Government Body the right to revoke, withdraw, suspend, cancel, terminate or modify, any material Permit that is held by the Company or that otherwise relates to any of the businesses of the Company or to any of the Assets owned or used by the Company;

              3.2.2.4     contravene, conflict with or result in a violation, termination, or breach of, or result in a default under, any provision of, or any Specified Contract (as defined in Section 3.14), collective bargaining agreement or Contract to which any of the Seller or the Company are a party to or by which each is bound; or

              3.2.2.5     result in the imposition or creation of any Encumbrance upon or with respect to any Asset owned or used by the Company.

3.2.3     Except as set forth on Schedule 3.2, the Company was not, is not or will not be required to make any filing with or give any notice to, or to obtain any Consent from, any Person in connection with the execution and delivery of this Agreement or the consummation or performance of any of the transactions contemplated hereby.

3.3     Capital Stock and Ownership.

          3.3.1     Schedule 3.3 sets forth the authorized capital structure of the Company, including the numbers and type of equity interests authorized and the number of each type of equity interests that are issued and outstanding. Hines and Caldwell own 100% of Company’s equity and have good and marketable title to the Equity Interests in the Company, free and clear of any Encumbrance except as set forth on Schedule 3.3. Seller has the right to vote all of their respective Equity Interests in the Company and has not appointed or granted any proxy to any other Person with respect to, or granted any other right to any other Person to vote any of, the Equity Interests of the Company. All of the issued and outstanding Equity Interests owned by Seller have been duly authorized and validly issued by appropriate actions of its directors, managers, equity owners or members, as applicable, and all applicable Law. There exists no right of first refusal or other preemptive right with respect to any of the membership interests or any other equity of the Company.

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3.3.2     All offerings, sales and issuances by the Company of any interests of equity, and all repurchases and redemptions of any of its equity interests by the Company, if any, were conducted in compliance with all applicable federal and state securities Laws and all other applicable Laws.

3.3.3     Except as set forth on Schedule 3.3, there is no:

              3.3.3.1     outstanding subscription, option, call, warrant or right (whether or not currently exercisable) to acquire any equity interests or other securities of the Company;

              3.3.3.2     outstanding security, instrument or obligation that is or may become convertible into or exchangeable for any equity interests or other securities of the Company;

              3.3.3.3     Contract (including any letter(s) of intent which may have been entered into by the Company) under which the Company is or may become obligated to sell assets and/or sell or otherwise issue any equity interests or any other securities;

              3.3.3.4     pending, or to the Seller’s and the Company’s knowledge, threatened or previously asserted claim by any Person to the effect that such Person is or was entitled to acquire or receive any equity interests or any other securities of the Company; or

              3.3.3.5     condition or circumstance that may directly or indirectly give rise to or provide a basis for the assertion of a claim by any Person to the effect that such Person is or may be validly entitled to acquire or receive any equity interests or other securities of the Company.

3.3.4     Except as set forth on Schedule 3.3, the Company has repurchased, redeemed or otherwise reacquired any of its equity interests or other securities. All securities so reacquired by the Company were reacquired in full compliance with the applicable provisions of all applicable Contracts and all applicable Laws.

3.4     Financial, Corporate and Other Records.

          3.4.1     Except as described on Schedule 3.4, the financial books and records of the Company have been properly prepared and maintained in form and substance adequate for preparing audited financial statements in accordance with GAAP, and such books and records fairly and accurately reflect (i) all of the Assets and Obligations of the Company and (ii) all of the Contracts and other transactions to which the Company is or was a party or by which the Company or the Business or Assets of the Company is or was affected.

          3.4.2     Accurate and complete copies of the contents of the minute books and stock books of the Company has been delivered to Buyer. Such minute books and stock books include (i) minutes of all meetings of all equity owners, board of directors and any committees of

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the board of directors at which any material action was taken, which minutes accurately record all material actions taken at such meetings, (ii) accurate and complete written statements of all actions taken by equity owners, board of directors and any committees of the board of directors without a meeting and (iii) accurate and complete records of the subscription, issuance, transfer and cancellation of all equity interests and all other securities since the date of incorporation or formation.

          3.4.3     Schedule 3.4 contains an accurate and complete list of all bank accounts, other accounts, certificates of deposit, marketable securities, other investments, safe deposit boxes, lock boxes and safes of the Company, and the names of all officers, employees or other individuals who have access thereto or are authorized to make withdrawals therefrom or dispositions thereof.

          3.4.4     Without in any way limiting the foregoing, except as described on Schedule 3.4, all books and records of the Company (including billing records and tutor’s notes of any nature, recruiting records and client files of any nature) are true, accurate and complete in all material respects and have been prepared and maintained in accordance with all applicable Laws (including any record-keeping and other requirements and regulations of schools, school districts, any federal, state or local agency and any other Government Body including a Government Body regulating Medicaid and/or education (state or federal)).

3.5     Compliance with Laws; Permits.

          3.5.1     Except as set forth on Schedule 3.5: (i) the Company is and has been in compliance in all material respects with each Judgment and with each Law that are applicable to it or to the conduct of any of its businesses or the ownership or use of any of its Assets, including (a) any Permit, any Laws pertaining to the Social Security Act including the Civil Monetary Penalty Law of the Social Security Act, and/or (b) any promulgations, interpretive advice or guidelines of any court or Government Body, including the Occupational Safety and Health Administration, the Centers for Medicare and Medicaid Services, any state or federal Medicaid and/or education laws; (ii) the Company has at all times been in compliance in all material respects with each Judgment or Law that is or was applicable to it or to the conduct of any of its businesses or the ownership or use of any of its Assets; (iii) no event has occurred which remains unresolved, and no condition or circumstance exists, that will (with or without notice or lapse of time) constitute or result in a violation by the Company of, or a failure on the part any of the Company to comply with, any Judgment or Law; and (iv) except for notices or communications related to matters which have been both resolved prior to the date hereof and which involve either fines, costs, losses or obligations of any nature which are less than $5,000 in any single case, the Company has not received, at any time, any notice or other communication (in writing or otherwise) from any Government Body or any other Person regarding (A) any actual, alleged, possible or potential violation of, or failure to comply with, any Judgment or Law, or (B) any actual, alleged, possible or potential obligation on the part of the Company to undertake, or to bear all or any portion of the cost of, any cleanup or any remedial, corrective or response action of any nature. The Company has provided to Buyer copies of all survey and/or audit reports (for the three-year period ended on the Unaudited Balance Sheet Date (as defined below in Section 3.6)) prepared by any Government Body in connection with reviewing compliance by the Company with state and/or federal licensing and

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certification requirements or Laws. Set forth on Schedule 3.5 is a list of all such survey and/or audit reports listing deficiencies, which previously have been made available to Buyer. At no time has the Company been suspended from providing services, from participation in the Medicare or Medicaid programs or any other Government Programs (as defined herein) or had its state or federal licensure or any other Permit suspended or revoked.

          3.5.2     Except as set forth on Schedule 3.5, the Company has obtained and holds all Permits (i) required for the lawful operation of its business as and where such business is presently conducted and (ii) necessary to enable it to obtain reimbursement under all applicable Government Programs and/or any Contracts and other arrangements with third-party payers, insurers or fiscal intermediaries. All Permits held by the Company are listed on Schedule 3.5, and accurate and complete copies of such Permits have been delivered to Buyer. Employees and independent contractors (including therapists, psychologists, social workers and tutors) and the Company have obtained and maintained in compliance with all applicable Laws any and all necessary licenses, certifications or other Permits necessary to perform their duties.

          3.5.3     Schedule 3.5 sets forth each consent or approval of, or registration, notification, filing and/or declaration with any court, government or governmental agency or instrumentality, creditor, lessor or other Person required to be given or made by the Company in connection with the execution, delivery and performance of this Agreement and the other agreements and instruments contemplated herein.

          3.5.4     Without in any way limiting the foregoing provisions of this Section 3.5, the Company is and has been in compliance in all material respects with (i) any applicable record keeping, inventory and other requirements and regulations of any Government Body and (ii) any and all fraud and abuse Laws including Laws relating to the filing of false or fraudulent claims with Medicare, Medicaid any other Governmental Program or any school, school district, state or local governmental agency. The Company is and has been in compliance in all material respects with all false claims Laws including The Federal False Claims Act and any equivalent law. The Company is and has been in compliance in all material respects with all Laws protecting a patient’s individual healthcare information, including the Health Insurance Portability and Accountability Act of 1996, to the extent applicable.

          3.5.5     The Company has not generated, transported, treated, stored and disposed, or otherwise handled Medical Waste under any Medical Waste Laws.

3.6     Financial Statements.

          3.6.1     The fiscal year end for the Company is December 31.

          3.6.2     The Company has delivered to Buyer and the attached as Schedule 3.6.2 the following financial statements and related notes (collectively, the “Financial Statements”): the unaudited, management-prepared balance sheets, statements of earnings and statements of cash flows for the 12 months ending as of December 31, 2005. (December 31, 2005 is referred to hereinafter as the “Unaudited Balance Sheet Date.”)

          3.6.3     The Financial Statements: (a) are based upon the books and records of the Company; (b) present fairly the financial position of the Company as of the respective dates

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thereof and the results of operations, changes of the Company’s equity and cash flows of the Company for the periods covered thereby; and (c) were prepared on an accrual basis in conformity with GAAP (other than for the absence of notes and subject to customary period end adjustments) and, in a manner consistent with the Company historic accounting practices applied on a consistent basis, except as otherwise indicated.

3.7     Assets.

          3.7.1     Schedule 3.7 contains an accurate and complete list of all Assets of the Company as reflected on the balance sheets of the Company as of the Unaudited Balance Sheet Date, including: (i) Cash Assets, itemized by bank or other account, showing cost and market value if different from cost; (ii) Accounts Receivable, showing client names, individual invoice dates, individual invoice amounts and allowances for doubtful accounts, or, in the case of earned but not billed receivables, client names and individual dates on which the receivables are billable; (iii) other current Assets, itemized by category and with appropriate explanation; (iv) Tangible Property, grouped as to type, showing cost, accumulated depreciation and net book value; and (v) Software and Intangibles, showing cost or amount capitalized, accumulated amortization and net book value.

          3.7.2     Schedule 3.7 accurately identifies all Assets that are being leased by or licensed to the Company.

          3.7.3     Except as set forth on Schedule 3.7, the Company owns and has good, valid and marketable title to, all of its respective Assets that are purported to be owned by it and has the right to transfer all rights, title and interest in such Assets, free and clear of any Encumbrance.

          3.7.4     Except for the Assets listed on Schedule 3.7, no other Assets are necessary to operate, or have been material to the operation of, the Business of the Company.

3.8     Obligations.

          3.8.1     Schedule 3.8 contains an accurate and complete list of all Obligations of the Company reflected on its balance sheet as of the Unaudited Balance Sheet Date, itemized by balance sheet account and specifically listed, according to obligor, including (i) accounts payable, (ii) accrued expenses and reserves, itemized by category and with appropriate explanation, (iii) deferred revenues, itemized by client and time periods, and (iv) other current and long-term liabilities.

          3.8.2     The Company has no Obligations other than (i) Obligations identified as such in the column on the balance sheets of the Company as of the Unaudited Balance Sheet Date, (ii) Obligations set forth on Schedule 3.8 and (iii) Obligations that were incurred since the Unaudited Balance Sheet Date in the ordinary course consistent with past practice (none of which arose out of any Proceeding or which relate to any breach of contract, breach of warranty, infringement, violation of law or breach of any of the representations and warranties made in Section 3.9 of this Agreement). Except as described on Schedule 3.8, none of the Obligations of the Company are guaranteed by any Person.

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3.9     Operations Since the Unaudited Balance Sheet Date. Except as set forth on Schedule 3.9, since the Unaudited Balance Sheet Date:

          3.9.1     Except in the ordinary course of its Business consistent with its past practices, the Company has not: (i) pledged or hypothecated any of its Assets or otherwise permitted any of its Assets to become subject to any Encumbrance; (ii) incurred any Obligation; (iii) made any loan or advance to any Person; (iv) assumed, guaranteed or otherwise become liable for any Obligation of any Person; (v) committed for any capital expenditure; (vi) purchased, leased, sold, abandoned or otherwise acquired or disposed of any business or Assets; (vii) waived or released any right or canceled or forgiven any debt or claim; (viii) discharged any Encumbrance or discharged or paid any indebtedness or other Obligation; (ix) assumed or entered into any Contract or collective bargaining agreement other than this Agreement; (x) amended or terminated any Specified Contract; (xi) increased, or authorized an increase in, the compensation (or any grade level for purposes of compensation) or benefits paid or provided to any of their directors, managers, officers, employees, salesmen, agents or representatives; (xii) established, adopted or amended (including any amendment with a future effective date) any Employee Benefit Plan; (xiii) declared, accrued, set aside, or paid any dividend or made any other distribution in respect of securities, Cash Assets or other Assets; (xiv) repurchased, redeemed or otherwise reacquired any securities; (xv) sold or otherwise issued any securities; (xvi) amended its articles or certificate of incorporation or formation, bylaws or other organizational documents; (xvii) been a party to any merger, consolidation, recapitalization, reclassification of shares, membership interests, membership interests split or stock split, reverse stock or reverse membership interests split or similar transaction; (xviii) accrued any deferred bonuses or compensation due to any equity owner, member, employee or agent of the Company, or paid any such deferred bonuses or compensation except to the extent such deferred bonuses or compensation was accrued on the Unaudited Balance Sheet; (xix) changed any of its methods of accounting or accounting practices in any respect; (xx) made any Tax Election, or (xxi) adopted and/or implemented any new accounting policy and/or procedures.

          3.9.2     Except as set forth on Schedule 3.9.2, even in the ordinary course of its business consistent with past practice, other than with respect to hiring employees in the ordinary course, purchasing equipment which equipment purchases are reflected in the Unaudited Financial Statements and office leases and leasehold improvements which have either been set forth in the schedules attached hereto or the Unaudited Balance Sheets, the Company has not since the Unaudited Balance Sheet Date incurred any Obligation, made any loan to any Person, acquired or disposed of any business or Assets, entered into any Contract or other transaction, or done any of the other things described in Section 3.9.1, involving an amount exceeding $10,000 in any single case.

          3.9.3     There has been no material adverse change or material casualty loss affecting the Company or the Business, Assets or financial condition of the Company; and there has been no material adverse change in the financial performance of the Company; and there has been no loss, damage or destruction to, or any interruption in the use of, any of the Software or other Assets (whether or not covered by insurance) of the Company.

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3.10     Accounts Receivable. All Accounts Receivable shown on Schedule 3.7 of the Company arose in the ordinary course of business and are proper and valid Accounts Receivable, can and will be collected by the Company in full (without any counterclaim or setoff) prior to the 6 month anniversary of the Closing Date, net of the allowance for doubtful accounts and contractual allowances in amounts consistent with the past practice the Company and which are taken into consideration in the preparation of the Financial Statements. There are no refunds, discounts, rights of setoff, reasons for denial or assignments affecting any such Accounts Receivable other than as set forth in the preceding sentence. Proper amounts of deferred revenues appear on the books and records of the Company, in accordance with GAAP, with respect to the Company’s (a) billed but unearned Accounts Receivable; (b) previously billed and collected Accounts Receivable still unearned; and (c) unearned client deposits. All applicable Accounts Receivable of each of the Company have been coded and billed materially in accordance with the requirements of applicable Contracts or any regulations of the Medicaid programs or any other Government Program or federal program.

3.11     Tangible Property. The Company has good and marketable title to all of its Tangible Property, free and clear of any Encumbrances, except as set forth in the Unaudited Balance Sheets or on Schedule 3.11. Except as set forth on Schedule 3.11, all of the Tangible Property of the Company is located at the offices or facilities of the Company, and the Company has the full and unqualified right to require the immediate return of any of its Tangible Property which is not located at its offices or facilities. All Tangible Property of the Company, to Company’s knowledge, wherever located, (a) is in good condition, ordinary wear and tear excepted, (b) is structurally sound and free of any defect and deficiency, (c) complies in all material respects with, and is being operated and otherwise used in material compliance with, all applicable Laws, and (d) is sufficient for the operations and Business of the Company as presently conducted.

3.12     Real Property.

            3.12.1     Owned Real Property. Schedule 3.12.1 contains an accurate and complete list of all real estate owned by the Company (“Owned Real Property”), showing location, value and debt (including mortgage debt) secured by such Owned Real Property.

            3.12.2     Leased Real Property. Schedule 3.12.2 contains an accurate and complete list of all real estate leased or utilized by the Company including but not limited to the Company’s home office and facility locations (“Leased Real Property”), showing location, rental cost and landlord. All Leased Real Property under lease to or otherwise used by the Company is in good condition, is sufficient for the current operations of the Company, has written leases executed by the appropriate lessor and the Company as the lessee and such leases are in full force and effect.

            3.12.3     To Company’s knowledge, no such Leased Real Property, nor the occupancy, maintenance or use thereof, is in violation of, or breach or default under, any Contract or Law (including Environmental Laws) and no other party is in breach or default under such Contract or Law, and no notice or threat from any lessor, Government Body or other Person has been received by the Company or served upon any such Owned Real Property or Leased Real Property claiming any violation of, or breach, default or liability under, any Contract or Law (including Environmental Laws), or requiring or calling attention to the need for any work, repairs, construction, alteration, installations or environmental remediation.

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            3.12.4     To Company’s knowledge, no Proceedings are pending which would affect or pertain to the zoning, use or environmental condition of any of the Owned Real Property or Leased Real Property. Except as set forth in Schedule 3.12.2, no portion of any Owned Real Property or Leased Real Property is within an identified flood plain or other designated flood hazard area as established under any Law or otherwise by any governmental authority.

            3.12.5     All of the Owned Real Property or Leased Real Property has direct legal access to, abuts, and is served by a publicly dedicated and maintained road, which road does and shall provide a valid means of ingress and egress thereto and therefrom, without additional expense. All utilities, including water, gas, telephone, electricity, sanitary and storm sewers, are currently available to all of the Owned Real Property or Leased Real Property at normal and customary rates, and are adequate to serve the Owned Real Property or Leased Real Property for the Company’s current use thereof.

3.13     Software and Other Intangibles.

            3.13.1     Schedule 3.13 contains an accurate and complete list and description of all names, corporate names, fictitious names, trademarks, service marks, trade names, brand names, product names, symbols, slogans, copyrights, Web sites, designs, logos, formulae, inventions, product rights, technology, and Software owned, marketed, licensed (in or out), supported, maintained, used, under development, or held for use by the Company that are material to the Business, and, in the case of Software, a product description, the language in which it is written and the type of hardware platform(s) on which it runs.

            3.13.2     The Company owns solely and exclusively and has good and marketable title to, or otherwise has the full right to use pursuant to an off-the-shelf license agreement commercially available to the general public, all Intangibles of the Company, free and clear of all Encumbrances. No rights or permission of the Company, any equity owner, or any other Person are necessary to use, make, manufacture, reproduce, distribute, display, perform, market, license, sell, offer to sell, modify, adapt, translate, enhance, improve, update, or create derivative works based upon any Intangible, to the extent the Intangible is used, made, manufactured, reproduced, distributed, displayed, performed, marketed, licensed, sold, offered for sale, modified, adapted, translated, enhanced, improved, updated, and/or with respect to which derivative works are created in connection with, related to, pursuant to, in the conduct of, or as part of the Business. None of the Intangibles of the Company, except as listed on Schedule 3.13.2, are registered in the name of any one or more Persons other than the Company, including any one or more current or former owners, equity owners, partners, directors, executives, officers, employees, salesmen, agents, patients, representatives, clients or contractors or any equity owners of the Company, nor does any such Person have any interest therein or right thereto, including, but not limited to, the right to royalty payments.

            3.13.3     To Company’s knowledge, none of the Intangibles or their respective past or current uses of the Company, including the preparation, distribution, marketing or

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licensing thereof, has violated or infringed upon, or is violating or infringing upon, any Intellectual Property Right or other proprietary right of any Person. None of the Intangibles of the Company is subject to any Encumbrance or Judgment. No Proceeding is pending or, to the knowledge of any of Seller or the Company is threatened, nor has any claim or demand been made, which challenges or challenged the legality, validity, enforceability, use or exclusive ownership by the Company of any or all of Intangibles of the Company. To Company’s knowledge, no Person is violating or infringing upon, or has violated or infringed upon at any time, any Intellectual Property Right or other right of the Company or with regard to Intangibles of the Company.

3.13.4     The Company has maintained all Intellectual Property Rights with respect to Intangibles of any of the Company, as applicable. To Company’s knowledge, no portion of any Intangible of the Company contains any “back door,” “time bomb,” “Trojan horse,” “worm,” “drop dead device,” “virus” or other software routine, code, or program or hardware component that permits unauthorized access to or use of or disables or erases software, hardware, or data without the consent of the user, or that is intended or designed to do so.

3.13.5     Any and all licenses, sublicenses and other Contracts covering or relating to any Intangible of any of the Company or to which the Company is a party under which the Company use any Intangible of any of the Company is legal, valid, binding, enforceable and in full force and effect, and upon consummation of the transactions contemplated hereby, will continue to be legal, valid, binding, enforceable and in full force and effect on terms identical to those in effect immediately prior to the consummation of the transactions contemplated hereby. The Company is not in breach of or default under any license, sublicense or other Contract covering or relating to any Intangible of the Company nor has the Company performed any act or omitted to perform any act which, with notice or lapse of time or both, will become or result in a material violation, breach or default thereunder. No Proceeding is pending or, to the knowledge of Seller or the Company is being or has been threatened, nor has any claim or demand been made, which challenges the legality, validity, enforceability or ownership of any license, sublicense or other Contract covering or relating to any Intangible of any of the Company.

3.13.6     Set forth on Schedule 3.13.6 are all Internet domain names related to or used or held for use in connection with, related to, pursuant to, in the conduct of, or as part of the Business, or licensed to or used, owned, or registered by the Company (“Domain Names”). The Company is the registrant of all Domain Names, and all registrations of Domain Names are current and in good standing until such dates as set forth on Schedule 3.13.6. No action or activity has been taken or is pending to challenge rights to, suspend, cancel or disable any Domain Name, the registration therefore, or any right of the Company thereto (including the right to use a Domain Name). To Company’s knowledge, the Company has all right, title and interest in and to, and rights to use on the Internet and otherwise as a trademark and trade name, the Domain Names. Also set forth on Schedule 3.13.6 are all Intangibles with respect to which one or more registrations have been awarded by or one or more applications have been filed with one or more Government Bodies, the date of such registrations and applications, all identification numbers given by all Government Bodies with regard to the registrations and applications, and the jurisdictions with regard to which such registrations were awarded and such applications were filed.

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            3.13.7     The Company is the sole owner of, and has good and marketable title to, any and all right, title and interest in and to any and all proprietary databases created by the Company and related to or held for use or used in the Business. No Person other than the Company has any right or interest of any kind or nature in or to such databases. To Company’s knowledge, no Person (i) is violating or infringing upon, or has violated or infringed upon at any time, any right of the Company in or to such databases, or (ii) is breaching or has breached at any time any duty or obligation owed to the Company in respect of such databases. To Company’s knowledge, neither the past nor current use of any such database or the information contained therein in the Business (iii) has violated or infringed upon, or is violating or infringing upon, the rights of any Person, (iv) breaches any duty or obligation owed to any Person, or (v) violates the privacy or any Law relating to the privacy of any Person.

            3.13.8     The Company has maintained in connection with its operations, activity, conduct, and business on the World Wide Web (“Web”) and any and all other applicable Internet operations, activity, conduct, and business, at all times during such operations, activity, conduct, and business, a written privacy statement or policy governing the collection, maintenance, and use of data and information collected from users of Web sites owned, operated, or maintained by, on behalf of, or for the benefit of any of the Company in connection with, related to, pursuant to, in the conduct of, or as part of the Business (the “Company Web Sites”). At all times during the Company Web or Internet operations, activity, conduct, or business, the Company privacy statements and policies have been conspicuously made available to users of the Company Web Sites.

3.14     Contracts.

            3.14.1     Schedule 3.14 contains an accurate and complete list of all of the following types of Contracts to which the Company is a party or by which the Company is bound which provide for an obligation in excess of $10,000 (collectively, the “Specified Contracts”), grouped into the following categories and, where applicable, subdivided by product line or division: (i) Contracts for the provision of goods and services (including Contracts with suppliers, service providers, clients and government payers); (ii) Software license and Software maintenance Contracts under which the Company is the licensor or provider of services, and other client Contracts; (iii) Contracts for the purchase or lease of Real Property or otherwise concerning Real Property owned or used by the Company; (iv) loan agreements, mortgages, notes, guarantees, bonds and other financing Contracts; (v) Contracts for the purchase, lease and/or maintenance of computer equipment and other equipment, Contracts for the purchase, license, lease and/or maintenance of Software under which the Company is the purchaser, licensee, lessee or user; and other supplier Contracts; (vi) employment, consulting and sales representative Contracts (excluding Contracts which constitute Employee Benefit Plans listed on Schedule 3.16, and excluding oral Contracts with employees for “at will” employment); (vii) Contracts under which any rights in and/or ownership of any Software product, technology or other Intangible of the Company, or any prior version thereof, or any part of the client base, business or Assets of the Company, or any shares or other ownership interests in the Company (or any of their predecessors) was acquired; (viii) Contracts containing clauses that prohibit or restrict the Company from soliciting any employee, client or Referral Source of any other Person or otherwise prohibiting or restricting the Company from engaging in any business or from disclosing information with respect to the Company or the Business; (ix) Contracts for

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management services; and (x) other Contracts material to the business of the Company (excluding Contracts which constitute Insurance Policies listed on Schedule 3.20). A description of each oral Specified Contract is included on Schedule 3.14, and true and correct copies of each written Specified Contract have been made available to Buyer.

            3.14.2     Each Specified Contract is valid and in full force and effect, and is enforceable by the Company in accordance with their terms.

            3.14.3     Except as set forth on Schedule 3.14: (i) neither the Company nor any other Person has violated, breached, or declared or committed any default under, any Specified Contract; (ii) no event has occurred, and no circumstance or condition exists that will (with or without notice or lapse of time) (A) result in a violation or breach of any of the provisions of any Specified Contract by the Company or a violation or failure to comply with any Judgment or Law (including, without limitation, any non-profit Law) by the Company or any other Person, (B) give the Company or any other Person the right to declare a default or exercise any remedy under any Specified Contract, (C) give the Company, or any other Person the right to accelerate the maturity or performance of any Specified Contract, or (D) give the Company or any other Person the right to cancel, terminate or modify any Specified Contract; (iii) the Company has not received any notice or other communication (in writing or otherwise) regarding any actual, alleged, possible or potential violation or breach of, or default under, any Specified Contract; and (iv) the Company has not waived any of their rights under any Specified Contract. The consummation of the transactions contemplated by this Agreement will not give rise to a right of another party to terminate or modify any Specified Contract. The event, circumstance or conditions set forth above in (ii) (A)-(D) shall specifically include any event, circumstance or conditions relating to or affecting any Person’s non-profit status.

            3.14.4     The performance of the Specified Contracts in accordance with their respective terms will not result in any violation of or failure to comply with any Judgment or Law (including, without limitation, any non-profit Laws) applicable to the Company or any other Party on or prior to the Closing Date.

            3.14.5     Except as set forth on Schedule 3.14, no Person is renegotiating, or has the right to renegotiate, any amount paid or payable to the Company under any Specified Contract or any other term or provision of any Specified Contract.

            3.14.6     The Specified Contracts are all the Contracts necessary and sufficient to operate the Business of the Company as currently operated. Except as set forth on Schedule 3.14 (which such Schedule 3.14 shall include proposals or offers that are included in the Budget), there are no currently outstanding proposals or offers submitted by the Company to any Referral Source, prospect, supplier or other Person which, if accepted, would result in a legally binding Contract of the Company involving an amount or commitment exceeding $10,000 in any single case or an aggregate amount or commitment exceeding $25,000 in the aggregate.

3.15     Employees and Independent Contractors.

            3.15.1     Schedule 3.15 contains an accurate and complete list of all of the employees of the Company (including any employee of the Company who is on a leave of

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absence or on layoff status) and (i) their titles or responsibilities; (ii) their social security numbers and principal residence address; (iii) their dates of hire; (iv) their current salaries or wages and all bonuses, commissions and incentives paid at any time during the past twelve months; (v) their last compensation changes and the dates on which such changes were made; and (vi) any specific bonus, commission or incentive plans or agreements for or with them.

3.15.2     Schedule 3.15 also contains an accurate and complete list of all sales representatives, independent contractors and tutors actively engaged by the Company and (i) their tax identification numbers and state or country of residence; (ii) their payment arrangements; and (iii) a brief description of their jobs or projects currently in progress.

3.15.3     Except as limited by the specific and express terms of any employment Contracts listed on Schedule 3.15 and except for any limitations of general application which may be imposed under applicable employment Laws, the Company has the right to terminate the employment of each of its employees at will and to terminate the engagement of any of its independent contractors without payment to such employee or independent contractor other than for services rendered through termination and without incurring any penalty or liability other than liability for severance pay in accordance with the Company’s disclosed severance pay policy.

3.15.4     The Company is in compliance in all material respects with all Laws relating to employment practices. The Company has delivered to Buyer accurate and complete copies of all employee manuals and handbooks, disclosure materials, policy statements and other materials relating to the employment of the current and former employees of the Company.

3.15.5     The Company has not been a party to or bound by any union or collective bargaining Contract, nor is any such Contract currently in effect or being negotiated by or on behalf of the Company, nor has the Company been the target of a union organization drive.

3.15.6     Except as set forth on Schedule 3.15, since the respective Formation Date of the Company, the Company has not experienced any labor problem that was or is material to it. The Company’s relations with its employees is currently on a good and normal basis.

3.15.7     To the knowledge of Seller and the Company, after due inquiry: (i) no currently employed Identified Employee has received an offer to join a business that may be competitive with any of the businesses of the Company; and (ii) no currently employed Identified Employee is a party to or is bound by any confidentiality agreement, non-competition agreement or other Contract (with any Person) that will have an adverse effect on (A) the performance by such Identified Employee of any of his duties or responsibilities as an employee of the Company, or (B) any of the businesses or operations of the Company.

3.15.8     Except as set forth on Schedule 3.15, each of the Company’s current employees (including Identified Employees) has signed agreements with the Company containing restrictions that adequately protect the proprietary and confidential information of the Company and vest in the Company the full ownership of items developed by such current employees (including Identified Employees).

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            3.15.9     Except as set forth on Schedule 3.15, since January 1, 2005, no currently employed Identified Employee has indicated an intention to terminate or has terminated his or her employment. Except as set forth on Schedule 3.15, since January 1, 2005, no tutor with whom the Company has a relationship or arrangement has indicated an intention to terminate such relationship or arrangement. The transactions contemplated by this Agreement will not to the Company’s knowledge adversely affect relations with any employees (including Identified Employees) or independent contractors (including tutors) of the Company.

3.16     Employee Benefit Plans.

            3.16.1     Schedule 3.16.1 contains an accurate and complete list and description of (i) all of the Employee Benefit Plans which the Company, or any ERISA Affiliate, sponsors, maintains or contributes to, is required to contribute to, or has or could reasonably be expected to have any liability of any nature with respect to, whether known or unknown, direct or indirect, fixed or contingent, for the benefit of present or former employees of the Company and/or its ERISA Affiliates (referred to collectively as the “ Company’s Employee Benefit Plans” and individually as a “ Company’s Employee Benefit Plan”), (ii) all employees employed by the Company affected or covered by an Employee Benefit Plan, (iii) all Obligations thereunder as of the Closing Date, and (iv) all ERISA Affiliates. Accurate and complete copies of all of the Company’s Employee Benefit Plans have been provided to Buyer as well as the most recent determination letter issued, if any, or if none, Internal Revenue Service (“IRS”) opinion or advisory letter issued with respect to a Company’s Employee Benefit Plan that is intended to be a qualified plan within the meaning of Section 401(a) of the Code, all pending applications for rulings, determination letters, opinions, no action letters and similar documents filed with any governmental agency (including the Department of Labor and the IRS), summary plan descriptions, service agreements, stop loss insurance policies, and all related contracts and documents (including, but not limited to, employee summaries and material employee communications), all closing letters, audit finding letters, revenue agent findings and similar documents. None of Company’s Employee Benefit Plans is subject to Title IV of ERISA or Code Section 412. None of Company’s Employee Benefit Plans is a Multiple Employer Plan or Multiemployer Plan under Code Section 413(c) or 414(f). No employer, other than the Company or an ERISA Affiliate, is permitted to participate or participates in the Company’s Employee Benefit Plans and no leased employees (as defined in Section 414(n) of the Code) or independent contractors are eligible for, or participate in, the Company’s Employee Benefit Plans. None of Company’s Employee Benefit Plans promises or provides health, life or other welfare benefits to retirees or former employees, or severance benefits, except as required by Code Section 4980B, Sections 601 through 609 of ERISA, or comparable state statutes which provide for continuing health care coverage.

            3.16.2     Except as set forth on Schedule 3.16.2, neither the Company nor any ERISA Affiliate has (i) established, sponsored, maintained or contributed to (or has or had the obligation to contribute to) any Employee Benefit Plan, (ii) proposed any Employee Benefit Plan which it plans to establish, sponsor, maintain or to which it will be required to contribute, or (iii) proposed any changes to any of Company’s Employee Benefit Plans now in effect. Except as set

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forth on Schedule 3.16.2, each of Company’s Employee Benefit Plans that provides a self-insured health benefit is subject to a stop-loss insurance policy in which the Company is an insured party and no facts exist which could form the basis for any denial of coverage under such policy.

3.16.3     With respect to the Company’s Employee Benefit Plans, the Company and each ERISA Affiliate will have made, on or before the Closing Date, all payments required to be made by them on or before the Closing Date and will have accrued (in accordance with GAAP) as of the Closing Date all payments due but not yet payable as of the Closing Date. There has not been, nor will there be, any Accumulated Funding Deficiencies (as defined in ERISA or the Code) or waivers of such deficiencies.

3.16.4     The Company has not been required and has not filed any Form 5500 or any other form or filing required to be submitted to any governmental agency with regard to the Company’s Employee Benefit Plans.

3.16.5     All of the Company’s Employee Benefit Plans are, and have been, operated in compliance with their provisions and with all applicable Laws including ERISA and the Code and the regulations and rulings thereunder. With respect to each of the Company’s Employee Benefit Plans that is intended to be qualified under Section 401(a), each such plan has been determined by the IRS to be so qualified as to form, and each trust forming a part thereof has been determined by the IRS to be exempt from tax pursuant to Section 501(a) of the Code, and with respect to the Company’s Employee Benefit Plans that is intended to be a “voluntary employees’ beneficiary association” within the meaning of Section 501(c)(9) of the Code, each such association has been determined by the IRS to have such status. No reason exists that would cause such qualified or Section 501(c)(9) status to be revoked for any period. The Company, its ERISA Affiliates, and all fiduciaries of the Company’s Employee Benefit Plans have complied with the provisions of the Company’s Employee Benefit Plans and with all applicable Laws including ERISA and the Code and the regulations and rulings thereunder. There have been no Reportable Events (as defined in ERISA), no events described in Sections 4062, 4063 or 4064 of ERISA, and no termination or partial termination (including any termination or partial termination attributable to this transaction) of any of the Company’s Employee Benefit Plans. There would be no Obligation of the Company or any ERISA Affiliate under Title IV of ERISA if any of the Company’ Employee Benefit Plans were terminated as of the Closing Date. Neither the Company nor any ERISA Affiliate has incurred, nor will incur, any withdrawal liability, nor does the Company nor any ERISA Affiliate have any contingent withdrawal liability, under ERISA, to any Multiemployer Plan (as defined in ERISA). Neither the Company nor any ERISA Affiliate has incurred, or will incur, any Obligation to the Pension Benefit Guaranty Corporation (or any successor thereto). None of the Company’s Employee Benefit Plans is a “MEWA” as defined in Section 3(40)(A) of ERISA. No non-exempt prohibited transaction under Section 406 or 407 of ERISA or Section 4975 of the Code has occurred with respect to any of the Company’ Employee Benefit Plans. Neither the Company nor any ERISA Affiliate has incurred, nor will incur, any tax liability or civil penalty, damages, or other liabilities arising under Section 502 of ERISA, resulting from any of the Company’s Employee Benefit Plans, with respect to any matter arising on or before the Closing Date.

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            3.16.6     Neither the execution and delivery of this Agreement nor the consummation of the transactions contemplated hereby will (i) result in any payment (including any severance, unemployment compensation or golden parachute payment) becoming due from the Company or any ERISA Affiliate under any of Company’ Employee Benefit Plans, (ii) increase any benefits otherwise payable under any of the Company’ Employee Benefit Plans, or (iii) result in the acceleration of the time of payment or vesting of any such benefits to any extent.

            3.16.7     There are no pending actions, claims or lawsuits that have been asserted or instituted against any of the Company’s Employee Benefit Plans, the assets of any of the trusts under such plans, the plan sponsor, the plan administrator or any fiduciary of any such plan (other than routine benefit claims), and, to the knowledge of the Company, there are no facts which could form the basis for any such action, claim or lawsuit. There are no investigations or audits by any government agency of any of the Company’s Employee Benefit Plans, any trusts under such plans, the plan sponsor, the plan administrator or any fiduciary of any such plan that have been instituted or threatened and, to the knowledge of the Seller and the Company, there are no facts which could form the basis for any such investigation or audit.

            3.16.8     The Company and/or its ERISA Affiliates can terminate each of the Company’s Employee Benefit Plans without further liability to the Company and/or its ERISA Affiliates. No action or omission of the Company, or any ERISA Affiliate, or any director, officer, or agent thereof in any way restricts, impairs or prohibits the Company or any ERISA Affiliate, or any successor, from amending, merging, or terminating any of the Company’s Employee Benefit Plans in accordance with the express terms of any such plan and applicable law.

            3.16.9     Except as set forth on Schedule 3.16.9, no event has occurred nor will occur which will result in the Company having an Obligation in connection with any of the Company’s Employee Benefit Plans of any ERISA Affiliate.

3.17     Clients, Payers and Suppliers. Except as set forth on Schedule 3.17, the present relationship of the Company with its clients, payers, suppliers and providers is on a good and normal basis, and the Company is not experiencing any material problems with its clients, payers, suppliers or providers. For the six (6) month period prior to the Closing Date, the Company has not experienced termination of its relationship with their clients, payers, suppliers, and providers outside of the ordinary course consistent with prior experience. Except to the extent of any adverse effect that is attributable to Buyer, the transactions contemplated hereby will not materially adversely affect the Company’s relations with any of the clients, payers, Referral Sources or suppliers of the Company. The Company has delivered to Buyer an accurate and complete copy of the most recent surveys, if any, of clients, families of clients and payers for each of the Company.

3.18     Taxes.

            (a)     The Company has filed all Tax Returns that were required to be filed. All such Tax Returns were correct and complete and have been prepared in compliance with all applicable laws and regulations. All Taxes owed by the Company (whether or not shown on any

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Tax Return) have been paid. The Company is not currently the beneficiary of any extension of time within which to file any Tax Return. No claim has ever been made by a Governmental Body in a jurisdiction where the Company does not file Tax Returns where the Company may be subject to taxation by that jurisdiction. There are no Liens on any of the Assets of any of the Company that arose in connection with any failure (or alleged failure) to pay any Tax.

(b)     The Company has withheld and paid all Taxes required to have been withheld and paid in connection with amounts paid or owing to any employee, independent contractor, creditor, equity owner or other Person for all periods for which the statutory period of limitations for the assessment of such Tax has not yet expired and all IRS Forms W-2 and 1099 required with respect thereto have been properly completed and timely filed.

(c)     Neither the Company nor any director, officer, manager or member (or employee responsible for Tax matters) of the Company expects any Governmental Body to assess any additional Taxes for any period for which Tax Returns have been filed. No foreign, federal, state or local Tax audits or administrative Tax proceedings are pending or being conducted with respect to the Company. Neither the Company nor any director, officer, manager or member (or employee responsible for Tax matters) of the Company has received from any foreign, federal, state or local Taxing Authority (including jurisdictions where the Company has not filed Tax Returns) any (i) notice indicating an intent to open an audit or other review; (ii) request for information related to Tax matters; or (iii) notice of deficiency or proposed adjustment for any amount of Tax proposed, asserted or assessed by any Taxing Authority against the Company.

(d)     Schedule 3.18 (i) lists all federal, state, local and foreign Tax Returns filed with respect to the Company for taxable periods ending on or after January 1, 2002; (ii) indicates those Tax Returns that have been audited; and (iii) indicates those Tax Returns that currently are the subject of an audit. Seller has delivered to Buyer correct and complete copies of all examination reports and statements of deficiencies assessed against or agreed to by the Company since January 1, 2002.

(e)     The Company has not waived any statute of limitations in respect of Taxes or agreed to any extension of time with respect to a Tax assessment or deficiency.

(f)     The unpaid Taxes of the Company (i) did not, as of December 31, 2005, exceed the reserve for Tax liability (rather than any reserve for deferred Taxes established to reflect timing differences between book and Tax income) set forth on the face of the Unaudited Balance Sheet and (ii) do not exceed the reserve as adjusted for the passage of time through the Closing Date in accordance with the past customs and practice of the Company in filing its Tax Returns. Since August 31, 2005, the Company has not incurred any liability for Taxes arising from extraordinary gains or losses, as the term is used in GAAP, outside the ordinary course of business consistent with past custom and practice.

(g)     The Company has disclosed on its Federal Income Tax Returns all positions taken therein that could give rise to a substantial understatement of federal income tax within the meaning of Section 6662 of the Code.

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            (h)     The Company (i) is not or has not been a party to any Tax allocation or sharing agreement or (ii) has not been a member of an Affiliated Group (as defined in Section 1504(a) of the Code) filing a consolidated federal income Tax Return or have a liability for Taxes of any person under Treasury Regulation Section 1.1502-6 (or any similar provision of state, local or foreign law), as a transferee or successor, by contract or otherwise.

            (i)     The Company has not been a United States real property holding corporation within the meaning of Section 897(c)(2) of the Code during the applicable period specified in Section 897(c)(1)(A)(ii) of the Code.

            (j)     There is no contract, agreement, plan or arrangement covering any persons that, individually or collectively, could give rise to the payment of any amount that would not be deductible by reason of Section 280G of the Code, or would constitute compensation in excess of the limitations set forth in Section 162(m) of the Code.

            (k)     The Company has not been the “distributing corporation” (within the meaning of Section 355(a)(1) of the Code) nor the “controlled corporation” (within the meaning of Section 355(a)(1) of the Code) within the two-year period ending as of the date of this Agreement.

            (l)     The Company has disclosed to the Internal Revenue Service on the appropriate Tax Returns any Reportable Transaction in which it has participated. The Company has retained all documents and other records pertaining to any Reportable Transaction in which it has participated, including documents and other records listed in Treasury Regulation Section 1.6011-4(g) and any other documents or other records which are related to any Reportable Transaction in which it has participated but not listed in Treasury Regulation Section 1.6011-4(g).

            (m)     Except as provided for on Schedule 3.18, the Company will not be required to include any item of income in, or exclude any item of deduction from, taxable income for any taxable period (or portion thereof) ending after the Closing Date as a result of any: (i) change in accounting method for a taxable period ending on or prior to the Closing Date under Section 481(a) of the Code (or any corresponding provision of state, local or foreign income Tax law); (ii) ”closing agreement” as described in Section 7121 of the Code (or any corresponding provision of state, local or foreign income Tax law); (iii) installment sale or open transaction disposition made on or prior to the Closing Date; or (iv) prepaid amount received on or prior to the Closing Date.

3.19     Proceedings and Judgments.

            3.19.1     Except as set forth on Schedule 3.19: (i) no Proceeding is currently pending or, to the knowledge of Seller or the Company, threatened, nor has any Proceeding occurred at any time since the Formation Date, to which the Company was a party, or by which the Company or any Assets or Business of the Company are or were affected; (ii) no Judgment is currently outstanding, nor has any Judgment been outstanding at any time against the Company since the Formation Date, or by which any of the Company or any Assets or Business of the Company are or were affected; and (iii) no breach of contract, breach of warranty, tort,

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negligence, infringement, product liability, discrimination, wrongful discharge, statutory or other claim or charge of any nature has been asserted or, to the knowledge of Seller and the Company, threatened by or against any of the Company at any time since the Formation Date, and, to the knowledge of Seller or the Company, there is no reasonable basis for any such claim. Except as set forth on Schedule 3.19, no event has occurred, and no claim, dispute or other condition or circumstance exists, that will, directly or indirectly, give rise to or serve as a basis for the commencement of any Proceeding described in this Section 3.19.1.

            3.19.2     As to each matter described on Schedule 3.19, accurate and complete copies of all pertinent and material pleadings, judgments, orders, correspondence and other legal documents have been delivered to Buyer.

            3.19.3     To the knowledge of Seller or the Company, no officer or employee of the Company is subject to any Judgment that prohibits such officer or employee from engaging in or continuing any conduct, activity or practice relating to any of the businesses of the Company.

            3.19.4     There is no proposed Judgment that, if issued or otherwise put into effect, (i) could reasonably be expected to have a Material Adverse Effect on business, condition, assets, technology, liabilities, operations, employees, financial performance, revenues, net income, political environment, economic environment or prospects of or with respect to the Company (or on any aspect or portion thereof) or on the ability of the Company to comply with or perform any covenant or obligation under this Agreement, or (ii) would have the effect of preventing, delaying, making illegal or otherwise interfering with any of the transactions contemplated by this Agreement or making it more difficult for Buyer to realize any anticipated benefit of any of the transactions contemplated by this Agreement.

3.20     Insurance. Schedule 3.20 contains an accurate and complete list and description of all Insurance Policies (excluding Insurance Policies that constitute the Employee Benefit Plans described on Schedule 3.16) currently owned or maintained by the Company. Except as set forth on Schedule 3.20, accurate and complete copies of all Insurance Policies described or required to be described on Schedule 3.20 have been delivered to Buyer. Each such Insurance Policy is in full force and effect; the Company has not received notice of cancellation with respect to any such Insurance Policy; and, to the knowledge of Seller or the Company, there is no basis for the insurer thereunder to terminate any such Insurance Policy. Except as set forth on Schedule 3.20, there are no claims that are pending under any of the Insurance Policies described on Schedule 3.20.

3.21     Environmental Matters.

            3.21.1     Except as set forth in Schedule 3.21 to this Agreement, all activities at or upon the Leased Real Property have been and are being conducted in compliance in all material respects with all Laws, concerning (a) handling of Hazardous Substances as defined below, (b) discharges to the air, soil, surface water, or groundwater, and (c) storage, treatment, disposal of any Hazardous Substances at or connected with any activity at the Leased Real Property. Except as listed on Schedule 3.21 and heretofore provided to Buyer, there have been no environmental inspections, investigations, studies, audits, tests, reviews or other analyses conducted in relation to any property or business now or previously owned, operated, or leased by the Company.

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3.21.2     Except as set forth in Schedule 3.21, no Hazardous Substance is present in any medium at the Leased Real Property in such a manner as may require remediation under any applicable Environmental Law. Except as set forth in Schedule 3.21, no employee has brought a claim, or threatened to bring a claim, against the Company that he or she was harmed by workplace exposure to a Hazardous Substance, nor, to the knowledge of each of Seller or the Company, is there any basis for such claim.

3.21.3     Except as enumerated in Schedule 3.21 to this Agreement: (a) no polychlorinated biphenyl or substances containing polychlorinated biphenyl are or have been present at the Leased Real Property; (b) no asbestos or materials containing asbestos are or have been present at the Leased Real Property; (c) no radioactive materials or wastes are or have been present at the Leased Real Property; and (d) no underground or above ground storage tanks, active or abandoned, are or have been present at the Leased Real Property.

3.21.4     Except as disclosed in Schedule 3.21, neither the Seller nor the Company, have been notified by any Government Body or third party of any violation by the Company or liability of the Company under any Environmental Law. There are no pending civil, criminal, or administrative proceedings against the Company under any Environmental Law arising out of or relating to the condition of the Leased Real Property or the Company’s activities thereon and none of Seller or the Company have knowledge of any threatened civil, criminal or administrative proceedings under any Environmental Law against the Company arising out of or relating to the condition of the Leased Real Property or the Company’s activities thereon. Schedule 3.21 includes a correct and complete list of the Company’s registrations with, licenses, authorizations or approvals from, or Permits issued by, Government Bodies necessary to conduct the Company’s activities at the Leased Real Property in compliance with the Environmental Laws, all of which are in full force and effect.

3.21.5     Schedule 3.21 includes a correct and complete listing of all facilities at which: (a) the Company has treated or disposed of Hazardous Substances; (b) any third party under contract with the Company disposes or has treated or disposed of Hazardous Substances received from the Company. The generation, treatment, storage, transportation and disposal of such Hazardous Substances was and is in compliance with all Environmental Laws applicable at the time of generation, treatment, storage, transportation and disposal. Except as disclosed on Schedule 3.21, no facility at which such Hazardous Substances were or are disposed, recycled, treated or stored on the Leased Real Property is the subject of a legal action under any Environmental Law brought by any Government Body, agency or third party, or is listed or proposed for listing under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (“CERCLA”) or under any similar state statute.

3.21.6     Neither the Seller or the Company, has knowledge of any facts or circumstances relating to the Business or the Leased Real Property that could lead to environmental claims, liabilities or responsibilities being ascribed against Buyer and none of Seller or the Company has retained or assumed by Contract, operation of law or otherwise, any liability or responsibility for any environmental claim or condition.

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3.21.7     Each of Seller and Company acknowledge that upon reasonable cause Buyer may commission an investigation of (i) the Company’s compliance with Environmental Laws, (ii) the presence of Hazardous Substances at the Leased Real Property, or (iii) the presence at the Leased Real Property of materials which are the subject of Section 3.21.3 of this Agreement.

                3.21.7.1     At Buyer’s expense, each of the Seller and the Company will comply with any reasonable request for information made by Buyer or its agents in connection with any such investigation. Each of the Seller and the Company represent and warrant that any response to any such request for information will be full and complete.

                3.21.7.2     Each of the Seller and the Company will upon request assist Buyer or its agents at Buyer’s expense to obtain any records pertaining to the Leased Real Property or to the Company in connection with such an investigation.

                3.21.7.3     Each of Seller and the Company will accord Buyer and its agents access to all areas of the Leased Real Property at reasonable times and in reasonable manners in connection with any such investigation, provided that such investigation does not unreasonably interfere with the Business.

3.22     Questionable Payments. None of the current or former shareholders, owners, members, directors, managers, executives, officers, representatives, agents or employees of any of the Company (when acting in such capacity or otherwise on behalf of the Company or any of its predecessors): (a) has used or is using any corporate funds for any illegal contributions, gifts, entertainment or other unlawful expenses relating to political activity; (b) has used or is using any corporate funds for any direct or indirect unlawful payments to any foreign or domestic government officials or employees; (c) has violated or is violating any provision of the Foreign Corrupt Practices Act of 1977; (d) has established or maintained, or is maintaining, any unlawful or unrecorded fund of corporate monies or other properties; (e) has made at any time since the Formation Date, any false or fictitious entries on the books and records of the Company; (f) has made any bribe, rebate, payoff, influence payment, kickback or other unlawful payment of any nature using corporate funds or otherwise on behalf of any of the Company; or (g) has made any material favor or gift that is not deductible for federal income tax purposes using corporate funds or otherwise on behalf of the Company.

3.23     Third Party Payers.

            3.23.1     Except as set forth on Schedule 3.23.1, the Company holds any and all Permits for participation in, and is a party to a valid provider agreement for payment by applicable social service payers, school districts, schools or applicable Government Programs for the provision of tutoring services, social services or other services provided as part of the Business. Without in any way limiting the prior sentence, each service location of the Company is eligible to receive payments pursuant to an applicable Government Program. The Company is in compliance in all material respects with all conditions of participation in and eligibility requirements for applicable Government Programs. The Company has timely filed with each governmental agency all cost reports or similar filings required to be filed by it under federal and state law in connection with its operations, and all such cost reports or similar filings comply in

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all material respects with applicable legal requirements. The Company has not received any notice of pending or possible investigations by, or loss of participation in, any of the Government Programs. All billing practices by the Company to all third party payers, including the Government Programs and private insurance Company, have been true, fair and correct and in material compliance with all applicable laws, regulations and policies of all such third party payers, and the Company has not billed for or received any payment or reimbursement in excess of amounts allowed by Laws. Except as set forth on Schedule 3.23.1, neither Seller nor the Company has knowledge of (i) any statutory or regulatory changes or any administrative rulings which would adversely affect the Business, (ii) any retroactive and/or prospective rate adjustments or pending, or threatened, recapture, offset, recoupment or withholding of payments which would affect the level of program payments received by the Company, and/or (iii) any freezes and/or funding reductions related to payments received by the Company (in connection with services rendered by the Company) from any Government Programs or other third party payors and/or (iv) any currently pending or threatened investigations of the Company by, or loss or suspension of participation in, any Government Programs. The Company has not exceeded any cap or ceiling applicable to payments which may be received from any Government Programs during any period. The Company has no obligation to return or refund to any Government Programs or Government Body any payments received in excess of any applicable payment cap or ceiling.

3.23.2     The Company has no liabilities to any third party fiscal intermediary, school, school district or carrier administering the Government Programs, directly to the Government Programs or any governmental agency or to any other third party payer for the recoupment of any amounts previously paid to the Company by any such third party fiscal intermediary, school district, school or carrier, Government Program or other third party payer. There are no pending and, to the knowledge of the Seller and the Company, threatened actions by any school, school district, third party fiscal intermediary or carrier, Government Program or other third party payer to suspend payments to the Company.

3.23.3     Without in any way limiting the foregoing, the Company has duly filed all required third-party cost reports or similar report required for all periods since the Formation Date and such reports have been filed either on a timely basis or prior to the time any penalty could be incurred for failure to file on a timely basis or has provided all information necessary or requested to the organizations through which it provides services. All of such cost reports accurately reflect the information to be included thereon and do not claim, and the Company has not received, reimbursement in excess of the amount provided by law. Schedule 3.23.3 indicates the cost reports which have been audited and finally settled, the status of the cost reports which have not been audited and finally settled, and a brief description of any and all notices of program reimbursement. The Company has disclosed to Buyer all information relating to facts and circumstances regarding proposed or pending audit adjustments, disallowances, appeals of disallowances, any reserves recorded with respect to filed costs reports and any and all other unresolved claims or disputes in respect of such cost reports. Except as disclosed to Buyer on Schedule 3.23.3, there are no facts or circumstances that may reasonably give rise to any disallowance under any such cost report.

3.23.4     Without in any way limiting the foregoing provisions contained in this Section 3.23, the Company has provided to and/or obtained from any applicable Government

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Body all needed Permits necessary to qualify for any tutoring, Medicaid or other Governmental Program payment or reimbursement and is continuing compliance with such Permits or cooperated with the certified organizations through which it provides services (whether a Government Body or otherwise) to the extent necessary for such organizations to so qualify and comply.

3.24     Referral Relationships. Neither Seller nor the Company nor any agent acting on behalf or for the benefit of the Company, (i) has offered or paid any remuneration, in cash or in kind, to, or made any financial arrangements with, any past or present clients, Referral Sources, suppliers, contractors or third party payers in order to obtain business or payments for such persons, (ii) has given or agreed to give, or has knowledge that there has been made or that there is any agreement to make, any gift to or gratuitous payment of any kind (whether in money, property or services) to any then-existing or potential client, supplier, contractor, third party payer or any other person, (iii) has made or agreed to make, or has knowledge that there has been made or that there is any agreement to make, any contribution, payment or gift of funds or property to, or for the private use of, any governmental official, employee or agent, (iv) has established or maintained any unrecorded fund or asset for any purpose or made any false or artificial entries on any of its books for any reason, or (v) has made or agreed to make or has knowledge that there has been made or that there is an agreement to make a payment to any Person with the intention or understanding that any part of such payment would be used for any purpose other than that described in the documents supporting such payment. As is set forth on Schedule 3.24 the Company has furnished to Buyer true and complete copies of any contract, lease agreement or other written arrangement and has advised Buyer of any oral arrangements, including any joint venture or consulting agreement, with any physician, hospital, nursing facility, home health agency, school district or school or other person or entity who is in a position to make or influence referrals to or otherwise generate business for the Company.

3.25     Service Facilities; Service Level Indicators. Schedule 3.25 sets forth with respect to the Company: (i) each service facility by location or region, (ii) the type of service conducted from such facility, (iii) an indication of whether such facility was developed or acquired including the year of development or acquisition, as the case may be, and (iv) the average daily client count for each such facility for the twelve months ending November 30, 2005.

3.26     Related Party Transactions. Except as set forth on Schedule 3.26 and except for any employment Contracts listed on Schedule 3.14, there are no real estate leases, personal property leases, loans, guarantees, Contracts, transactions, understandings or other arrangements of any nature between or among the Company and any Related Party of the Company.

3.27     Brokerage Fees. Except as set forth on Schedule 3.27, no Person acting on behalf of the Company or Seller is or shall be entitled to any brokerage or finder’s fee in connection with the transactions contemplated hereby.

3.28     Inapplicability of Antitakeover Laws. The Company is not subject to any state takeover law that might apply to the transactions contemplated hereby.

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3.29     Full Disclosure. No representation or warranty made by Seller or the Company in this Agreement or pursuant hereto (a) contains any untrue statement of any material fact; or (b) omits to state any fact that is necessary to make the statements made, in the context in which made, not false or misleading in any material respect. The copies of documents, if any, attached as Schedules to this Agreement or otherwise delivered to Buyer in connection with the transactions contemplated hereby, are accurate and complete in all material respects, and are not missing any amendments, modifications, correspondence or other related papers which would be pertinent to Buyer’s understanding thereof in any material respect.

SECTION 4. REPRESENTATIONS AND WARRANTIES OF BUYER

Knowing that Seller is relying thereon, Buyer represents and warrants to Seller as of the date of this Agreement, and covenants with Seller, as follows:

4.1     Organization. Buyer is a corporation that is duly organized, validly existing and in good standing under the Laws of its jurisdiction of incorporation. Buyer possesses the full corporate power and authority to own its Assets, conduct its business as and where such business is presently conducted, and enter into this Agreement.

4.2     Agreement. Buyer’s execution, delivery and performance of this Agreement and the agreements contemplated hereby, and its consummation and performance hereunder of the transactions contemplated by this Agreement and under related agreements: (a) have been duly authorized by all necessary corporate actions by its board of directors; (b) do not constitute a violation of or default under its charter or bylaws; (c) do not constitute a default or breach (immediately or after the giving of notice, passage of time or both) under any Contract to which Buyer is a party or by which Buyer is bound; (d) do not constitute a violation of any Law or Judgment that is applicable to it or to its businesses or Assets, or to the transactions contemplated by this Agreement; and (e) do not require the Consent of any Person other than Buyer’s lender(s). This Agreement constitutes the valid and legally binding agreement of Buyer, enforceable against it in accordance with its terms.

SECTION 5. CLOSING

5.1     Closing. The closing of the transactions contemplated by this Agreement (the “Closing”) shall take place at 10:00 a.m., Philadelphia, Pennsylvania time, on or before February 15, 2006, or at such other time and place mutually agreeable to the parties, provided the date of such Closing is no earlier than the day the last of the conditions in Section 7 and Section 8 is fulfilled or waived, subject in all cases to the provisions of Section 11. The date on which Closing occurs is referred to herein as the “Closing Date.” The transactions contemplated herein shall be effective as of February 1, 2006 (the “Effective Date”).

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SECTION 6. [INTENTIONALLY OMITTED]

SECTION 7. CONDITIONS PRECEDENT TO CLOSING

7.1     Conditions Precedent to Closing of Buyer. Each and every obligation of the Buyer to enter into and complete Closing is subject, at Buyer’s option, to the fulfillment and satisfaction of each of the following conditions:

          7.1.1     The representations and warranties of Seller and the Company, each of which contained in this Agreement, will be true and correct in all material respects on and as of the Closing Date with the same force and effect as though made on and as of the Closing Date. The Schedules to this Agreement will be complete, accurate and current on and as of the Closing Date. Seller and the Company will have performed and complied with all covenants and agreements required by this Agreement to be performed or complied with by them on or prior to the Closing Date. Seller and the Company will have delivered to Buyer a certificate, dated the Closing Date to the foregoing effect.

          7.1.2     There will not have occurred material damage to the Assets or the Business of the Company.

          7.1.3     No action, suit or proceeding will have been instituted before any court or governmental body or instituted or threatened by any Person which could materially affect the Assets, Obligations, financial condition or prospects of the Company or restrain or prevent the carrying out of the transactions contemplated hereby or seek damages in connection with such transactions.

          7.1.4     Buyer’s Board of Directors, managers and members shall have authorized the consummation of the transactions contemplated by this Agreement.

          7.1.5     Buyer shall have received the consolidated, unaudited, internally prepared balance sheet of the Company prepared on an accrual basis in accordance with GAAP as of December 31, 2005 together with the statement of earnings and statement of cash flows for the 12 month period then ended.

          7.1.6     All necessary approvals and/or filings (including Consents) for the transactions contemplated hereby to be obtained and/or made by the Company will have been obtained and/or made, as the case may be, and shall be in full force and effect.

          7.1.7     No Material Adverse Change shall have occurred to the Business, Assets, Obligations, operations, or financial condition (including working capital) of the Company from and as of the date of the Unaudited Balance Sheet Date to the Closing Date.

          7.1.8     The satisfactory completion, as determined by the Buyer’s sole and absolute discretion, of Buyer’s due diligence regarding the Company and any related transaction, including without limitation, Buyer’s review of the tax implications of the transactions contemplated hereby.

          7.1.9     Buyer shall have obtained binding commitments necessary to finance all of the transactions contemplated by this Agreement and the Company’s working capital needs, in the sole determination of the Buyer.

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7.1.10     The Company shall have authorized the consummation of the transactions contemplated by this Agreement by proper approval of its equity owners and directors.

7.1.11     Any and all Obligations of each of the Company:

                7.1.11.1     due to any employee or other Person under any employee retention or bonus plan or for severance, parachute or employee closing bonuses shall have been paid off by the Company in full satisfaction of such Obligation(s) on or prior to the Closing Date;

                7.1.11.2     due to Seller or their Related Parties or affiliates (collectively referred to as the “Seller Obligations”) shall have been paid off by the Company in full satisfaction of such Obligation(s) on or prior to the Closing Date excluding amounts due to Hines for Company purchases made on personal credit card accounts in the ordinary course of business as specifically reflected on the December 31, 2005 balance sheet and not to exceed $75,000 and Business Partners Network, LLC for accounts receivable financing and term note; and

          7.1.12     The Company’s fixed asset value shall be at least equivalent of its fixed asset value as of December 31, 2004 plus any fixed assets acquired thereafter less normal depreciation.

          7.1.13     Buyer’s senior lender, HBCC, shall have consented to the transactions contemplated herein.

          7.1.14     The Company’s pre-transaction professional and general liability insurance will continue to be in full force and effect to the satisfaction of the Buyer, or Buyer is able to procure new professional and liability insurance that is acceptable in all respects to the Company’s payers, as applicable.

          7.1.15     The deliveries set forth in Section 8.1 shall have occurred.

7.2     Conditions Precedent to Closing of Seller. Each and every obligation of Seller to enter into and complete Closing is subject, to the fulfillment and satisfaction of each of the following conditions:

          7.2.1     The representations and warranties of Buyer contained in this Agreement will be true and correct in all material respects on and as of the Closing Date with the same force and effect as though made on and as of the Closing Date. Buyer will have performed and complied with all covenants and agreements required by this Agreement to be performed or complied with by it on or prior to the Closing Date. Buyer will have delivered to Seller a certificate, dated the Closing Date, and signed by an authorized officer of Buyer to the foregoing effect.

          7.2.2     All necessary approvals and/or filings for the transactions contemplated hereby to be obtained and/or made by Buyer will have been obtained and/or made, as the case may be, and shall be in full force and effect.

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          7.2.3     No action, suit or proceeding will have been instituted before any court or government body or restricted or threatened by any person which could materially prevent the carrying out of the transactions contemplated hereby.

          7.2.4     The Buyer’s Board of Directors shall have authorized the consummation of the transactions contemplated by this Agreement.

          7.2.5     The deliveries set forth in Section 8.2 shall have been caused to be made by Buyer.

SECTION 8. DELIVERIES AT CLOSING

8.1     Seller’s and the Company’s Deliveries at Closing. Each of Seller and the Company, as applicable, shall deliver to Buyer at Closing:

          8.1.1     Assignments assigning all of the Equity Interests owned by Seller to Buyer and delivery of original certificates, if any, evidencing such Equity Interests.

          8.1.2     Good standing certificate or the equivalent for the Company, dated no earlier than twenty (20) days before the Closing Date, from the applicable jurisdiction of incorporation or formation and from each other jurisdiction in which the Company is qualified or registered to do business as a foreign corporation.

          8.1.3     (a) A certified copy of the Certificate of Formation and each amendment thereto, of the Company, from the secretary of state of the jurisdiction in which the Company is organized, and (b) a copy of the Company’s Operating Agreement and each amendment thereto, as certified by the Secretary of the Company.

          8.1.4     Copies of the resolutions duly adopted by the Company authorizing the Company to execute, deliver and perform this Agreement and to consummate the transactions contemplated by this Agreement, certified by an officer of the Company, as applicable, as in full force and effect, without modification or rescission, on and as of the Closing Date.

          8.1.5     Certificate of the Secretary of the Company as to the incumbency and signatures of the officers of the Company executing this Agreement;

          8.1.6     Duly executed resignations of each director, manager and officer of the Company, other than as specified by the Buyer.

          8.1.7     The minute books and other limited liability company records of the Company.

          8.1.8     Payoff statements or termination statements and any other termination documents terminating all Encumbrances and claims in and to the Assets, the Owned Real Estate and the Leased Real Property.

          8.1.9     Receipts acknowledging Buyer’s payment to Seller of the Purchase Price.

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8.1.10     Copies of all Consents listed on Schedule 3.2, to the satisfaction of Buyer.

8.1.11     All keys to safe deposit boxes of the Company and authorized forms to change (i) the permitted users of the safe deposit boxes and (ii) permitted users and authorized persons for banking relationships.

8.1.12     The legal opinion of Gladstone & Baker, PLLC, counsel to Seller and the Company, in form and substance acceptable to Buyer.

8.1.13     Releases duly in the form of Exhibit 8.1.13, duly executed by each of Seller and the Company (“Releases”).

8.1.14     Caldwell and Hines shall execute a Software Assignment Agreement in the form attached as Exhibit 8.1.14.

8.1.15     Hines and Caldwell shall have entered into employment arrangements (including restrictive covenant provisions) with Buyer or the Company, to the satisfaction of the Buyer.

8.1.16     All other agreements, certificates, instruments, financial statement certifications and documents reasonably requested by Buyer in order to fully consummate the transactions contemplated by this Agreement and carry out the purposes and intent of this Agreement.

8.1.17     Duly executed Subordination Agreement in the form attached as Exhibit 8.1.17.

8.1.18     Each Seller shall execute a Waiver and Consent Agreement in the form attached hereto as Exhibit 8.1.18 waiving any rights under Sections 32 and 33 of the Company’s Operating Agreement regarding the sale of membership interests in the Company and shall approve Buyer as the sole member of the Company.

8.1.19     The Company, Seller and Petra Capital Partners shall execute an agreement in the form attached hereto as Exhibit 8.1.19 releasing the Company from all obligations to Petra Capital Partners under a letter agreement dated July 27, 2005 and providing for Seller to assume such obligations to Petra Capital Partners.

8.1.20     Business Partners Network, LLC (“BPN”), William Campbell and Kathy Campbell shall have (a) properly documented its relationship with the Company, (b) terminated its consulting agreement (with a full release), (c) been paid off (with a full release), and (d) confirmed that each owns no equity in the Company.

8.1.21     The Company and Seller shall have attached their budget for 2006 as Schedule 8.1.21.

8.1.22     The Seller shall have delivered landlord waivers to the satisfaction of the Buyer.

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8.2     Buyer’s Deliveries at Closing. Buyer shall deliver to Seller at Closing:

          8.2.1     Wire transfers of immediately available United States federal currency in the amounts and to the recipients specified in Section 2.2.2.1 herein.

          8.2.2     A Good Standing Certificate of Buyer, dated within twenty (20) days of the Closing Date from the State of Delaware.

          8.2.3     Copies of the resolutions duly adopted by the Board of Directors of Buyer, authorizing Buyer to execute, deliver and perform this Agreement and to consummate the transactions contemplated hereby, certified by an officer of Buyer as in full force and effect, without modification or rescission, on and as of the Closing Date.

          8.2.4     A certificate of the Secretary of Buyer as to the incumbency and signatures of the officers of Buyer executing this Agreement.

SECTION 9. CERTAIN OBLIGATIONS AFTER CLOSING

9.1     Post-Closing Cooperation of the Parties.

          9.1.1     From and after the Closing Date: (a) Seller shall use best efforts to cooperate with Buyer to transfer to Buyer the full control and enjoyment of the Business and Assets of each of the Company; (b) Seller shall not take any action, directly or indirectly, alone or together with others, that obstructs or impairs the smooth assumption by Buyer of control of the Business and the Assets, (c) Seller shall promptly deliver to Buyer all correspondence, papers, documents and other items and materials received by them or found to be in their possession which pertain to the Business or the Assets of the Company, (d) Seller shall use commercially reasonable efforts to cooperate with Buyer in connection with the preparation and audit of any financial statements of the Company, including, without limitations, where appropriate, the signing of such reasonable accurate management representation letters as are required in connection with such audit; and (e) Buyer shall provide the Earn-Out calculations for the First Earn Out, Second Earn Out and Third Earn-Out as provided in Section 2.2.2.3. At any time and from time to time after the Closing Date, at Buyer’s request and without further consideration, Seller, as applicable, shall promptly execute and deliver all such further agreements, certificates, instruments and documents and perform such further actions as Buyer may reasonably request, in order to fully consummate the transactions contemplated by this Agreement and fully carry out the purposes and intent of this Agreement including without limitation such documents and actions as may be required in connection with the continuation or termination of the Company’s Employee Benefit Plans, the adoption of the Buyer’s Employee Benefit Plans and the filing of Tax Returns of the Company for all periods ending on, before or including the Closing Date.

9.2     Preparation of Tax Returns.

          9.2.1     Tax Periods Ending on or Before the Closing Date. Buyer shall prepare or cause to be prepared all Tax Returns with respect to the Company for taxable periods ending on or before the Closing Date (“Pre-Closing Tax Periods”). Buyer shall provide such

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Pre-Closing Tax Period Tax Returns to Seller at least fifteen (15) days before the due date therefor, as extended by any proper extension, and shall accept all comments of Seller that are reasonable. Buyer shall file all Pre-Closing Tax Period Tax Returns on or before the due date, as extended by any proper extension. Buyer shall include on the Tax Returns for the Pre-Closing Tax Periods the income of the Company for all applicable Pre-Closing Tax Periods. Seller pay all Taxes due as shown on the Tax Returns for the Pre-Closing Tax Periods to Buyer within five days of Buyer notifying Seller of the amount of such Taxes that are due. Seller shall pay all fees and expenses associated with preparing the Tax Returns for the Pre-Closing Tax Periods.

          9.2.2     Buyer shall prepare or cause to be prepared and file or cause to be filed any Tax Returns of the Company for Tax periods which begin before the Closing Date and end after the Closing Date (“Straddle Tax Periods”). Seller shall pay to Buyer an amount equal to the portion of such Taxes which relates to the portion of such Straddle Tax Period ending on the Closing Date. Any such payment for Taxes for any Straddle Tax Period shall be made by Seller to Buyer within five days of the date when Buyer notifies Seller of an amount of such Taxes that are payable to the relevant Taxing Authority. For purposes of this Section 9.2.2, in the case of any Taxes that are imposed on a periodic basis and are payable for a Straddle Tax Period, the portion of such Tax which relates to the portion of such Tax period ending on the Closing Date shall (a) in the case of any Tax other than Taxes based upon or related to income or receipts, be deemed to be the amount of such Tax for the entire Tax period multiplied by a fraction the numerator of which is the number of days in the Tax period ending on the Closing Date and the denominator of which is the number of days in the entire Tax period, and (b) in the case of any Tax based upon or related to income or receipts be deemed equal to the amount which would be payable if the relevant Tax period ended on the Closing Date. Any credits relating to a Straddle Tax Period shall be taken into account as though the relevant Tax period ended on the Closing Date. All determinations necessary to give effect to the foregoing allocations shall be made in a manner consistent with prior practice (to the extent permitted by law) of the Company.

          9.2.3     Tax Return Periods After the Closing Date. Buyer shall timely prepare and file or cause to be timely prepared and filed all Tax Returns for the Company required to be filed for taxable periods beginning after the Closing Date. Buyer shall timely pay or cause to be paid the amount of Taxes due shown on such Tax Returns.

9.3     Cooperation on Tax Matters.

          9.3.1     Buyer, the Company and Seller shall cooperate fully, as and to the extent reasonably requested by the other party, in connection with the filing of Tax Returns pursuant to this Section and any Tax proceeding. Such cooperation shall include the retention and (upon the other party’s request) the provision of records and information which are reasonably relevant to any such audit, litigation or other proceeding and making employees available on a mutually convenient basis to provide additional information and explanation of any material provided hereunder. The Company and Seller agree (A) to retain all books and records with respect to Tax matters pertinent to the Company relating to any taxable period beginning before the Closing Date until the expiration of the statute of limitations (and, to the extent notified by Buyer or Seller, any extensions thereof) of the respective taxable periods, and to abide by all record retention agreements entered into with any Taxing Authority, and (B) to give the other party reasonable written notice prior to transferring, destroying or discarding any such books and records and, if the other party so requests, the Company or Seller, as the case may be, shall allow the other party to take possession of such books and records.

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          9.3.2     Buyer shall provide Seller with notice of any written inquiries, audits, examinations or proposed adjustments by the Internal Revenue Service or any other Taxing Authority, which relate to any Pre-Closing Tax Periods within thirty (30) days of receipt of such notice. Seller shall have the sole right to represent the interests of the Company in any Tax audit or other Proceeding relating to any Pre-Closing Tax Periods, to employ counsel of its choice at its own expense, and to settle any issues and to take any other actions in connection with such Proceedings relating to such taxable periods; provided, however, that Seller shall use reasonable efforts to inform Buyer of the status of any such Proceedings, shall provide Buyer (at Buyer’s cost and expense) with copies of any pleadings, correspondence, and other documents as Buyer may reasonably request, shall consult with Buyer prior to the settlement of any such Proceedings and shall obtain the prior written consent of Buyer prior to the settlement of any such Proceedings that would affect Buyer in any taxable period ending after the Closing Date, which consent shall not be unreasonably withheld; provided further, however, that Buyer and counsel of its own choosing shall have the right to participate in, but not direct, the prosecution or defense of such Proceedings at Buyer’s sole expense. Buyer shall have the right to control all other Tax audits or Proceedings of the Company; provided, however, that Buyer shall not settle any such Proceedings without the consent of Seller, which consent shall not be unreasonably withheld, if Seller would incur any additional Taxes for (i) Pre-Closing Tax Periods or (ii) the portion of the Straddle Tax Period ending on the Closing Date. Buyer and the Company shall execute and deliver to Seller such powers of attorney and other documents as may be necessary or appropriate to give effect to the foregoing.

          9.3.3     Buyer, Seller and the Company agree, upon request, to use commercially reasonable efforts to obtain any ruling, certificate or other document from any Governmental Body or any other Person as may be necessary to mitigate, reduce or eliminate any Tax that could be imposed (including, but not limited to, with respect to the transactions contemplated hereby).

          9.3.4     Seller and the Company agree to retain all documents and other records for the appropriate period of time as set forth in Treasury Regulation Section 1.6011-4(g) which relate to any Reportable Transaction in which the Company has participated.

9.4     Amended Returns. Any amended Tax Return of the Company or claim for Tax refund on behalf of the Company for any period for which the Seller is responsible under Section 9.2 shall be filed, or caused to be filed, only by Seller; provided however that Seller shall not, without the prior written consent of Buyer (which consent shall not be unreasonably withheld or delayed) make or cause to be made, any such filing, to the extent such filing, if accepted, reasonably might change the Tax liability of the Company or Buyer for any period ending on or after the Closing Date. Any other amended Tax Return of the Company or claim for Tax refund on behalf of the Company shall be filed, or caused to be filed, only by Buyer.

9.5     Transfer Taxes. Notwithstanding any other provisions of this Agreement to the contrary, (i) Seller shall pay all sales, use, stock transfer, stamp, recording, real property transfer and similar Taxes, if any, required to be paid in connection with the sale of the Stock contemplated by this Agreement.

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9.6     Restrictive Covenants.

          9.6.1     Confidentiality Covenant. Buyer recognizes that the Seller has acquired valuable information concerning the Company, its business, its customers, its internal and external processes, and other proprietary information and/or may acquire valuable information concerning Buyer, its business, its customers, its internal and external processes, and other proprietary information. Seller agrees that all such information is confidential and shall not be disseminated, shared, given, revealed, sold, assigned, transferred or otherwise delivery in any way or in any manner to any Person not a party to this Agreement, except Seller’s respective attorneys or accountants, but only to the extent such information is reasonably necessary for the express purpose of that advisor. Such advisors shall be similarly bound to the confidentiality provision set forth herein.

          9.6.2     Noncompetition Covenant. For a period of five (5) years after the Closing Date (the “Restricted Period”) none of the Seller will, directly or indirectly (whether as an owner (other than as an owner of less than 5% of any company whose stock is publicly traded on a national stock exchange), manager, employee, lender, investor, guarantor, surety, consultant, independent contractor, advisor or other capacity), engage in the Business in the United States (including Alaska) except on behalf of the Company.

          9.6.3     Nonsolicitation Covenant. During the Restricted Period, Seller will not, directly or indirectly (whether as an owner, manager, consultant, independent contractor, advisor or other capacity), solicit, hire or assist any Person who is or during such period becomes a customer (including a Person to which Buyer or its subsidiaries or affiliates provide management services), supplier, payer, employee of, or a consultant to, the Buyer, its subsidiaries or affiliates, in any manner which interferes with such Person’s relationship with the Buyer, its subsidiaries or affiliates, or in an effort to obtain any such Person as a customer (including a Person to which Buyer or its subsidiaries or affiliates provide management services), supplier, payer, employee of, or a consultant to, any Person that conducts a business competitive with any part of the Buyer, its subsidiaries or affiliates.

          9.6.4     Enforcement of Covenants. The parties hereto declare that it is impossible to measure in money the damages that will accrue to Buyer in the event that Seller breaches any of the covenants set forth in Section 9.6.1, 9.6.2 and 9.6.3 (“Restrictive Covenants”). In the event that Seller breaches any such Restrictive Covenant, Buyer shall be entitled to an injunction, a restraining order or such other equitable relief, including, but not limited to, specific performance (without the requirement to post bond), restraining Seller from violating such Restrictive Covenant. Seller waives any claim or defense that Buyer has an adequate remedy at law and agrees not to assert in any such action or proceeding the claim or defense that Buyer has an adequate remedy at law. The parties hereby agree that the Restricted Period shall be extended, with respect to Seller by any period during which Seller is found to be in violation of, or to have violated, these covenants.

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          9.6.5     Acknowledgements.   Buyer is acquiring the Business (including its goodwill, staff, internal and external processes, customers, and other proprietary information) and paying the Purchase Price in anticipation of operating the Business in the states where it presently is being operated, expanding the Business in such states in accordance with Seller’s business plan and extending the Business throughout the entire United States. Seller is aware of Buyer’s intentions and acknowledges Buyer has stated that the Purchase Price Buyer is willing to pay would be substantially less without the Restrictive Covenants. Seller has agreed to in this Section 9. Seller acknowledges that the Restrictive Covenants are reasonable and necessary to protect the Buyer’s legitimate business interests.

          9.6.6     Scope.   If any portion of any Restrictive Covenant or its application is construed to be invalid, illegal or unenforceable, then the remaining portions and their application shall not be affected thereby, and shall be enforceable without regard thereto. If any of the Restrictive Covenants is ever disputed or determined to be unenforceable because of its scope, duration, geographical area or other similar factor, then the court or other trier of fact making such determination shall modify, reduce or limit such scope, duration, area or other factor, and enforce such Restrictive Covenant to the extent it believes is lawful and appropriate.

9.7     SEC Compliance. To the extent requested by Buyer, Seller shall use commercially reasonable efforts to assist Buyer with respect to Buyer’s completion of any audit procedures necessary for Buyer to comply with its Securities and Exchange Commission filings required to be made in connection with the signing of this Agreement and the Closing, including causing the Company’s current accountants and auditors to cooperate with Buyer. Buyer shall be responsible for the fees and costs of the auditors it selected.

9.8     Obligations.   Subject to the obligations of the Seller under this Agreement (including indemnifications, obligations and restrictive covenant obligations), as of the Closing Buyer shall indemnify Seller against any guarantee or other Obligation of any of Seller specifically described on Schedule 9.8. Buyer shall cooperate (in a commercially reasonable manner) with Seller’s efforts to be released from any such Obligations shown on Schedule 9.8.

SECTION 10. INDEMNIFICATION

10.1     Indemnification by Seller.   The Company (prior to the Closing only) and Seller (collectively be referred to as the “Seller Group”), jointly and severally, shall indemnify, defend and hold harmless Buyer, its officers, directors, employees, agents, representatives, subsidiaries, affiliates and Buyer’s successors and assigns (each a “Buyer Indemnified Party” or, collectively, “Buyer Indemnified Parties”) from and against any and all actions, suits, claims, demands, debts, liabilities, obligations, losses, damages, costs and expenses, including reasonable attorney’s fees and court costs (“Loss”, or “Losses”), arising out of or caused by, directly or indirectly, any of the following; provided, the determination of Losses shall be made without regard to any materiality qualification:

            10.1.1     Any misrepresentation, breach or failure of any warranty or representation made by the Seller Group in or pursuant to this Agreement. It is understood by the parties that the representations and warranties made by the Seller Group (except for the Company) in this Agreement survive until the Expiration Date (as set forth in Section 12.4 herein).

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            10.1.2     Any failure or refusal by any of the Seller Group to satisfy or perform any covenant, term or condition of this Agreement or any agreement to be executed and delivered pursuant to this Agreement that is required to be satisfied or performed by any or all of them.

            10.1.3     Other than for Taxes incurred in the ordinary course of business for taxable periods ending on the Closing Date to the extent set forth on the Unaudited Balance Sheet, any liabilities for Taxes of Seller and the Company and any Person other than the Company for which any of the Company has liability as a transferee or successor, by contract or otherwise for periods on or prior to the Closing Date.

            10.1.4     Obligations described in Section 7.1.11.

            10.1.5     Any Proceeding against the Buyer Indemnified Parties by any Person arising out of or caused by, directly or indirectly, any act or omission of the Company, or any of its equity holders, managers, officers, employees, agents or representatives, occurring at any time on or before the Closing Date.

            10.1.6     Any lack of customary insurance coverage for a similar company engaged in a similar business for the period prior to the Closing Date.

            10.1.7     Any Proceeding disclosed on Schedule 3.19.

10.2     Indemnification by Buyer. Buyer shall indemnify, defend and hold harmless Seller and the Company (but the indemnification obligation benefiting the Company shall expire upon the occurrence of the Closing) and their respective officers, employees, agents, representatives (including executors, administrators and personnel representatives) and successors and assigns (each a “Seller Indemnified Party” or, collectively, “Seller Indemnified Parties”), from and against any and all Losses, arising out of or caused by, directly or indirectly, any or all of the following:

            10.2.1     Any misrepresentation, breach or failure of any warranty or representation made by the Buyer in or pursuant to this Agreement, it being the agreed intention of the parties that for purposes of this Section.

            10.2.2     Any material failure or refusal by Buyer to satisfy or perform any covenant, term or condition of this Agreement or any agreement to be executed and delivered pursuant to this Agreement that is required to be satisfied or performed by it.

            10.2.3     Any Proceeding against Seller by any Person not arising out of or caused by, directly or indirectly, any act or omission of Seller, or any of his agents or representatives, occurring at any time after the Closing Date.

10.3     Indemnification Procedures. With respect to each event, occurrence or matter (an “Indemnification Matter”) as to which Buyer or any member of the Seller Group, as the case may be, (the “Indemnitee”) is entitled to indemnification from the Seller Group or Buyer, as the case may be, (the “Indemnitor”) under Section 10.1:

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            10.3.1     Within thirty (30) days after the Indemnitee receives written documents underlying the Indemnification Matter or, if the Indemnification Matter does not involve a third party action, suit, claim or demand, after the Indemnitee first has actual knowledge of the Indemnification Matter, the Indemnitee shall give notice to the Indemnitor of the nature of the Indemnification Matter and the amount demanded or claimed in connection therewith (“Indemnification Notice”), together with copies of any such written documents.

            10.3.2     If a third party action, suit, claim or demand is involved, then, upon receipt of the Indemnification Notice, the Indemnitor shall, at its expense and through counsel of its choice, promptly assume and have sole control over the litigation, defense or settlement (“Defense”) of the Indemnification Matter, except that (i) the Indemnitee may, at its option and expense and through counsel of its choice, participate in (but not control) the Defense; (ii) if the Indemnitee reasonably believes that the handling of the Defense by the Indemnitor may have a material adverse effect on the Indemnitee, its business or financial condition, or its relationship with any student, school, school district, Referral Source, prospect, supplier, payer, employee, salesman, consultant, agent or representative, then the Indemnitee may, at its option and expense and through counsel of its choice, assume control of the Defense, provided that the Indemnitor shall be entitled to participate in the Defense at its expense and through counsel of its choice; (iii) the Indemnitor shall not consent to any Judgment, or agree to any settlement, without the Indemnitee’s prior written consent; and (iv) if the Indemnitor does not promptly assume control over the Defense or, after doing so, does not continue to prosecute the Defense in good faith, the Indemnitee may, at its option and through counsel of its choice, but at the Indemnitor’s expense, assume control over the Defense. In any event, the Indemnitor and the Indemnitee shall fully cooperate with each other in connection with the Defense, including by furnishing all available documentary or other evidence as is reasonably requested by the other.

            10.3.3     All amounts owed by the Indemnitor to the Indemnitee (if any) shall be paid in full within ten (10) business days after a final Judgment (after allowing Indemnitor the option of exhausting all possible appeals) determining the amount owed is rendered, or after a final settlement or agreement as to the amount owed is executed. If the amounts owed by the Indemnitor to the Indemnitee are not paid when due, interest shall accrue on such amount at the rate of six percent (6%) per annum compounded until paid in full.

10.4     Limits on Indemnification. The maximum liability that Buyer or Seller Group, as applicable, may have with respect to claims for indemnification under Sections 10.2 and 10.1, respectively, will be an amount equal to the Purchase Price paid under Section 2.2.2.1. or earned under 2.2.2.3. (the “Indemnification Cap”), other than with respect to matters involving (i) fraud, intentional misconduct, willful misconduct or bad faith, (ii) breaches of any representation, warranty or covenant contained in (a) Section 3.2 (Authority; Non-Contravention), (b ) Section 3.3 (Capital Stock and Ownership), (c) Section 3.8 (Obligations), (d) Section 3.10 (Accounts Receivable), (e) Section 3.18 (Taxes), (f) Section 3.22 (Questionable Payments) and (g) Section 3.27 (Brokerage Fees), and (iii) claims made by any Buyer Indemnified Parties hereunder in connection with Losses resulting, arising from or related to any Proceeding disclosed on Schedule 3.19 (“Litigation”), (collectively, the “Carve-outs”). No claims for

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indemnification shall be payable until the aggregate amount of such claims exceeds $10,000 (“Deductible”) and then only the amount by which those Losses exceed the Deductible shall be payable. Indemnification claims relating to the Carve-outs are not subject to the Deductible.

10.5     Reduction for Insurance or Other Recoveries. The amount which an indemnifying party or parties, as the case may be, is required to pay to, for or on behalf of the applicable indemnitee pursuant to this Section 10 shall be reduced by any insurance proceeds actually recovered from each of the Company’ insurance policies in place prior to Closing by or on behalf of such indemnitee in reduction of the related Loss (provided that nothing contained herein shall obligate any indemnitee to maintain any such insurance coverage or to pursue any such recovery).

10.6     Set-Off of Claims for Losses Against Earn-Out. In addition to all other available remedies, Buyer may deduct the amount of Losses from the First Earn-Out, Second Earn-Out and Third Earn-Out (including the cash or stock to be issued as payment thereunder) to satisfy any Indemnification Matters or Losses under this Section 10 at Buyer’s sole discretion; provided, however, the Buyer shall not be obligated to exhaust all of its rights and remedies against the foregoing.

SECTION 11. TERMINATION

11.1     Right to Terminate. Notwithstanding anything to the contrary set forth in this Agreement, this Agreement may be terminated and the transactions contemplated herein abandoned at any time prior to the Closing:

            (i)     by mutual consent of the Buyer, on the one hand, and Seller, on the other;

            (ii)     by the Buyer, on the one hand, or Seller, on the other hand, if the Closing shall not have occurred by February 15, 2006, provided, however, that the right to terminate this Agreement under this Section 11.1 shall not be available to any party whose failure to fulfill any obligation under this Agreement has been the cause of, or resulted in, the failure of the Closing to occur on or before such date;

            (iii)     by the Buyer, on the one hand, or Seller, on the other hand, if a court of competent jurisdiction shall have issued an order, decree or ruling permanently restraining, enjoining or otherwise prohibiting the transactions contemplated by this Agreement, and such order, decree, ruling or other action shall have become final and nonappealable;

            (iv)     by Seller and the Company if the Buyer (x) breaches its representations and warranties in any material respect, or (y) fails to comply in any material respect with any of its covenants or agreements contained herein; or

            (v)     by the Buyer if Seller and/or the Company (x) breach their representations and warranties in any material respect, or (y) fail to comply in any material respect with any of its covenants or agreements contained herein.

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11.2     Obligations to Cease. In the event that this Agreement shall be terminated pursuant to Section 11.1 hereof, all obligations of the parties hereto under this Agreement shall terminate and there shall be no liability of any party hereto to any other party except for (i) the obligations of Section 9.6.1 with respect to confidentiality, (ii) the obligations with respect to publicity contained in Section 12.1 hereof and (iii) the obligations with respect to costs contained in Section 12.2 hereof, provided, however, that in the event of a termination of this Agreement by reason of either clause (iv) or (v) of Section 11.1 hereof, the non-terminating party(ies) shall reimburse the terminating party(ies) for its (their) reasonable out-of-pocket expenses (which shall include legal and accounting fees, etc.), incurred relative to this Agreement and the transactions contemplated herein.

SECTION 12. OTHER PROVISIONS

12.1     Publicity. At all times before the Closing Date, without the prior written consent (which consent shall not be unreasonably withheld) of the other parties hereto, none of the parties hereto shall issue any announcement, press release, public statement or other information to the press or any third party with respect to this Agreement or the transactions contemplated hereby; provided, however, that nothing contained herein shall prevent any party hereto, at any time, from furnishing any required information to any Government Body or from issuing any announcement, press release, public statement or other information to the press or any third party with respect to the Agreement or the transaction contemplated hereby (after consulting with the other parties hereto at least one day prior to furnishing such information or issuing such announcement, press release or public statement) if required by Law or any stock exchange or inter-dealer quotation system on which the securities of a party are traded.

12.2     Fees and Expenses. Except with respect to indemnification claims which shall be governed by Section 10, which fees shall be paid equally by the Buyer, on the one hand, and Seller on the other hand, Buyer shall pay all of the fees and expenses incurred by it, and Seller shall pay all of the fees and expenses incurred by Seller and the Company, in negotiating and preparing this Agreement (and all other Contracts and documents executed in connection herewith or therewith) and in consummating the transactions contemplated hereby.

12.3     Notices. All notices, consents or other communications required or permitted to be given under this Agreement shall be in writing and shall be deemed to have been duly given when delivered personally or one business day after being sent by a nationally recognized overnight delivery service, postage or delivery charges prepaid or five business days after being sent by registered or certified mail, return receipt requested, postage charges prepaid. Notices also may be given by facsimile and shall be effective on the date transmitted if confirmed within 48 hours thereafter by a signed original sent in one of the manners provided in the preceding sentence. Notices to Seller and the Company (prior to the Closing) shall be sent to their respective addresses stated on page one of this Agreement, with a copy sent simultaneously to Robert L. Baker, Esq., Gladstone & Baker, PLLC, 49 Music Square West, Suite 300, Nashville, TN 37203. Notices to Buyer shall be sent to Buyer’s address stated on page one of this Agreement to the attention of Fred Furman, Esquire, General Counsel, with a copy sent simultaneously to Blank Rome LLP, One Logan Square, Philadelphia, PA 19103, Attention: Thomas Dwyer, Esquire. Any party may change its address for notice and the address to which copies must be sent by giving notice of the new addresses to the other parties in accordance with this Section 12.3, provided that any such change of address notice shall not be effective unless and until received.

49

12.4     Survival. All representations and warranties made by any party hereto pursuant to the terms of this Agreement or any Ancillary Document (as defined herein) and any rights to indemnification for a breach of a representation or warranty shall survive until the twenty-one (21) month anniversary of the Closing Date (the “Expiration Date”); provided, however, that the representations and warranties made by Seller as to Section 3.2 (Authority; Non-Contravention), Section 3.3 (Capital Stock and Ownership), Section 3.8 (Obligations), Section 3.10 (Accounts Receivable), Section 3.18 (Taxes) and Section 3.22 (Questionable Payments), shall extend for their respective statutes of limitations plus ninety (90) days. All statements of fact contained in this Agreement (and the schedules and exhibits hereto) or in any certificate, document or statement (including without limitation the Financial Statements) delivered pursuant hereto or in connection with the consummation of the transactions contemplated hereby, including, without limitation, the Releases (collectively, the “Ancillary Documents”) shall be deemed representations and warranties.

12.5     Interpretation of Representations. Each representation and warranty made in this Agreement or pursuant hereto is independent of all other representations and warranties made by the same parties, whether or not covering related or similar matters, and must be independently and separately satisfied. Exceptions or qualifications to any such representation or warranty shall not be construed as exceptions or qualifications to any other representation or warranty.

12.6     Reliance by Buyer. Notwithstanding the right of Buyer to investigate the business, Assets and financial condition of Seller and the Company, and notwithstanding any knowledge obtained or obtainable by Buyer as a result of such investigation, Buyer has the unqualified right to rely upon, and has relied upon, each of the representations and warranties made by Seller and the Company in this Agreement or pursuant hereto. Seller has the unqualified right to rely upon, and has relied upon, each of the representations and warranties made by Buyer pursuant to this Agreement. The representations and warranties are bargained for assurances.

12.7     Entire Understanding. This Agreement, together with the Exhibits and Schedules hereto, state the entire understanding among the parties with respect to the subject matter hereof, and supersede all prior oral and written communications and agreements, and all contemporaneous oral communications and agreements, with respect to the subject matter hereof, including all confidentiality letter agreements and letters of intent previously entered into among some or all of the parties hereto. No amendment or modification of this Agreement shall be effective unless in writing and signed by the party against whom enforcement is sought. Nothing contained in this Agreement shall be deemed to limit (or adversely affect) in any manner any right or remedy of any Indemnitee under any of the agreements contemplated by this Agreement.

12.8     Assignment. This Agreement shall bind, benefit, and be enforceable by and against Buyer, Seller, the Company and their respective successors and assigns. No party shall in any manner assign any of its rights or obligations under this Agreement without the express

50

prior written consent of the other parties; provided, however, that, without the consent of any other party hereto, Buyer may assign or otherwise transfer this Agreement (and any other agreements delivered pursuant hereto) (x) to its lender in connection with Buyer’s financing of the transactions contemplated hereunder or (y) to a wholly owned subsidiary of the Buyer.

12.9     Waivers. Except as otherwise expressly provided herein, no waiver with respect to this Agreement shall be enforceable unless in writing and signed by the party against whom enforcement is sought. Except as otherwise expressly provided herein, no failure to exercise, delay in exercising, or single or partial exercise of any right, power or remedy by any party, and no course of dealing between or among any of the parties, shall constitute a waiver of, or shall preclude any other or further exercise of, any right, power or remedy.

12.10     Severability. If any provision of this Agreement is construed to be invalid, illegal or unenforceable, then the remaining provisions hereof shall not be affected thereby and shall be enforceable without regard thereto.

12.11     Counterparts. This Agreement may be executed in any number of counterparts, each of which when so executed and delivered shall be an original hereof, and it shall not be necessary in making proof of this Agreement to produce or account for more than one counterpart hereof.

12.12     Section Headings. Section and sub-Section headings in this Agreement are for convenience of reference only, do not constitute a part of this Agreement, and shall not affect its interpretation.

12.13     References. All words used in this Agreement shall be construed to be of such number and gender as the context requires or permits.

12.14     Controlling Law. THIS AGREEMENT IS MADE UNDER, AND SHALL BE CONSTRUED AND ENFORCED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF DELAWARE APPLICABLE TO AGREEMENTS MADE AND TO BE PERFORMED SOLELY THEREIN, WITHOUT GIVING EFFECT TO PRINCIPLES OF CONFLICTS OF LAW.

12.15     Jurisdiction and Process. In any action between or among any of the parties, whether arising out of this Agreement, any of the agreements contemplated hereby or otherwise, (a) each of the parties irrevocably waives the right to trial by jury, (b) each of the parties irrevocably consents to service of process by first class certified mail, return receipt requested, postage prepaid, to the address at which such party is to receive notice in accordance with Section 12.3, and (c) the prevailing parties shall be entitled to recover their reasonable attorneys’ fees, costs and disbursements from the other parties (in addition to any other relief to which the prevailing parties may be entitled).

12.16     No Third-Party Beneficiaries. No provision of this Agreement is intended to or shall be construed to grant or confer any right to enforce this Agreement, or any remedy for breach of this Agreement, to or upon any Person other than the parties hereto, including any client, payer, Referral Source, prospect, supplier, employee, contractor, salesman, agent or representative of any of the Company.

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12.17 Neutral Construction. In view of the fact that each of the parties hereto have been represented by their own counsel and this Agreement has been fully negotiated by all parties, the legal principle that ambiguities in a document are construed against the draftsperson of that document shall not apply to this Agreement.

[Signature Page follows]

52

IN WITNESS WHEREOF, the parties have executed or caused to be executed this Agreement effective as of the day and year first above written.

THE PROVIDENCE SERVICE CORPORATION
By:	/s/ Fletcher McCusker
Name:	Fletcher McCusker
Title:	CEO

A to Z IN-HOME TUTORING, LLC.
By:	/s/ Ann-Riley Caldwell
Name:	Ann-Riley Caldwell
Title:	President

/s/ Scott Hines

SCOTT HINES

/s/ Ann-Riley Caldwell

ANN-RILEY CALDWELL

[SIGNATURE PAGE TO PURCHASE AGREEMENT]

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The following sets forth a list of omitted exhibits and schedules. The Providence Service Corporation agrees to furnish supplementally a copy of such exhibits and/or schedules to the Securities and Exchange Commission upon request.

Exhibit 8.1.13	Form of Release
Exhibit 8.1.14	Software Assignment Agreement
Exhibit 8.1.17	Subordination Agreement
Exhibit 8.1.18	Waiver and Consent Agreement
Exhibit 8.1.19	Petra Agreement
Schedule 2.2.3	Estimated Balance Sheet
Schedule 3.1	Equity
Schedule 3.2	Non-Contravention
Schedule 3.3	Capital Stock and Ownership
Schedule 3.4	Financial, Corporate and Other Records
Schedule 3.4.1	Exceptions to GAAP
Schedule 3.4.3	Bank Accounts
Schedule 3.5	Compliance with Laws and Permits
Schedule 3.6.2	Financial Statements
Schedule 3.7	Assets
Schedule 3.7.1 (iii)	Assets
Schedule 3.7.1 (iv)	Tangible Property
Schedule 3.7.1 (v)	Software and Intangibles
Schedule 3.8	Obligations
Schedule 3.8.1 (i)	Unpaid Bills Detail
Schedule 3.8.1 (ii)	Accrued Expenses and Reserves
Schedule 3.8.1 (iv)	Other Current/Long Term Liabilities
Schedule 3.9	Operations Since the Unaudited Balance Sheet Date
Schedule 3.9.2	Transactions Exceeding $10,000 Post Unaudited Balance Sheet Date
Schedule 3.11	Tangible Property
Schedule 3.12.1	Owned Real Property
Schedule 3.12.2	Leased Real Property
Schedule 3.13	Software and Intangibles
Schedule 3.13.2	Intangibles Not Registered in Company’s Name
Schedule 3.13.6	Domain Names
Schedule 3.14	Specified Contracts
Schedule 3.15	Employees and Independent Contractors
Schedule 3.15.1	Employees
Schedule 3.15.2	Sales Reps. Independent Contractors/Tutors
Schedule 3.15.3	Employment Contracts
Schedule 3.15.6	Material Labor Problems
Schedule 3.15.8	Employees Without Confidentiality Restrictions
Schedule 3.15.9	Employees/Tutors Indicating Intent to Terminate
Schedule 3.16	Employee Benefit Plans
Schedule 3.16.1	Employee Benefit Plans – Supplement 1
Schedule 3.16.2	Employee Benefit Plans – Supplement 2
Schedule 3.16.9	Employee Benefit Plans Obligations – Supplement 3
Schedule 3.17	Clients, Payers and Suppliers
Schedule 3.18	Tax Returns
Schedule 3.19	Proceedings and Judgments
Schedule 3.20	Insurance
Schedule 3.21	Environmental Matters
Schedule 3.23.1	Third Party Payers
Schedule 3.23.3	Cost Reports
Schedule 3.24	Referral Relationships
Schedule 3.25	Service Facilities; Service Level Indicators
Schedule 3.26	Related Party Transactions
Schedule 3.27	Brokerage Fees
Schedule 8.1.13	Releases
Schedule 8.1.14	Software Assignment Agreement
Schedule 8.1.17	Subordination Agreement
Schedule 8.1.18	Waiver and Consent Agreement
Schedule 8.1.19	Petra Capital Partners Release
Schedule 8.1.21	2006 Budget
Schedule 9.8	Seller Guarantees

i

FIRST AMENDMENT TO PURCHASE AGREEMENT

This Amendment (the “First Amendment”) is made as of February 24, 2006 by and among The Providence Service Corporation (the “Buyer”), A to Z In-Home Tutoring, LLC (the “Company”), Scott Hines (“Hines”) and Ann-Riley Caldwell (“Caldwell and together with Hines, the “Seller”) with respect to the Purchase Agreement dated as of February 1, 2006 entered into by the Buyer, Company and the Seller (the “Purchase Agreement”). Capitalized terms not defined herein shall have the meanings ascribed to them in the Purchase Agreement.

INTENDING TO BE LEGALLY BOUND HEREBY, the undersigned parties agree to amend the Purchase Agreement as follows:

1. The parties agree that with respect to the portion of the Second Earn-Out and/or Third Earn-Out that becomes payable (if any) in shares of the Buyer to the Seller, if future events would result in the issuance of more than 9.9% of the issued and outstanding shares of the Buyer’s common stock (the “Share Limit”) pursuant to the Second Earn-Out or Third Earn-Out, as measured on the date of the Purchase Agreement, then the portion of the Second Earn-Out and/or Third Earn-Out payable in excess of the Share Limit shall not be payable in equity or shares of the Buyer but instead shall be payable in cash (notwithstanding the seventy-five percent (75%) limit on the cash portion of any Second Earn-Out and/or Third Earn-Out) as set forth in Section 2.2.2.3 of the Purchase Agreement.

2. Except as stated herein, no other terms and provisions of the Asset Purchase Agreement shall be amended. The remaining terms and provisions of the Asset Purchase Agreement shall remain in full force and effect. This First Amendment may be executed in counterparts.

[SIGNATURE PAGE FOLLOWS]

IN WITNESS WHEREOF, the Parties have executed or have caused this Amendment to be executed by their authorized officers as of the date first written above.

BUYER:
THE PROVIDENCE SERVICE CORPORATION
By:	/s/ Fletcher McCusker
Name:	Fletcher McCusker
Title :	CEO
COMPANY:
A to Z IN-HOME TUTORING, LLC
By:	/s/ Fletcher McCusker
Name:	Cairman / CEO
Title:	Fletcher McCusker
SELLER:
/s/ Scott Hines
SCOTT HINES
/s/ Ann-Riley Caldwell
ANN-RILEY CALDWELL

EX-10.8

EXHIBIT 10.8

SUBCONTRACT AGREEMENT   THE PROVIDENCE SERVICE CORPORATION

CONTRACT NUMBER: A0508 FY05/06

I.      “CPSA”:	Community Partnership of Southern Arizona
	4575 East Broadway Boulevard
	Tucson, Arizona 85711
	Neal Cash, Chief Executive Officer
2.      “Contractor”:	THE PROVIDENCE SERVICE CORPORATION
	620 N. Craycroft
	Tucson, AZ 85719
	Craig A. Norris, COO, The Providence Service Corporation
	Phone: (520) 747-6600

3. Term of Subcontract:

The term of this subcontract shall commence on July 1, 2005 and shall continue for a period of one year thereafter, unless terminated, canceled or extended. At the option of CPSA this subcontract may be extended by written amendment for two one year periods thereafter.

4. Binding Effect:

This Subcontract shall be binding upon and shall inure to the benefit of the parties hereto and their respective successors and permitted assigns.

CPSA:	Community Partnership of Southern Arizona
Signature:	/s/ Neal Cash
Print Name and Title:	Neal Cash, Chief Executive Officer
Date:	August 31, 2005
CONTRACTOR:	The Providence Service Corporation
Signature:	/s/ Craig A. Norris
Print Name and Title:	Craig A. Norris, Chief Operating Officer The Providence Service Corporation
Date:	August 24, 2005

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SUBCONTRACT AGREEMENT   COMPREHENSIVE SERVICE NETWORK   THE PROVIDENCE SERVICE CORPORATION

CONTRACT NUMBER: A0508 FY05/06

SUBCONTRACT TABLE OF CONTENTS

1. Subcontract Cover Page	1
2. Subcontract Table of Contents	2
3. Scope of Work	3
4. Standard Terms	16
5. Special Terms	36
6. Schedule I-A – Monthly One-Twelfth Payment Methodology	41
7. Schedule I-B – Cost Reimbursement Methodology	43
8. Schedule II – Program Funding Allocation	44
9. Schedule III – Subcontract Deliverables	46
10. Attachments	49
A. Definitions	49
B. Service Site Listing	58
C. Independent Practitioners	59
D. HB 2003 Contractor’s Expenditure Report (CER)	60

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SUBCONTRACT AGREEMENT   COMPREHENSIVE SERVICE NETWORK   THE PROVIDENCE SERVICE CORPORATION

CONTRACT NUMBER: A0508 FY05/06

SCOPE OF WORK

A. PURPOSE

To provide a complete and integrated continuum of behavioral health services to enrolled children, meeting DSM IV criteria for mental illness, including substance use or dependence related disorders. Included under the auspices of this Subcontract is the population of uniquely identified children enrolled in the Comprehensive Medical and Dental Plan (CMDP) who are wards of the State of Arizona.

B. ELIGIBILITY GROUPS COVERED UNDER THIS SUBCONTRACT

The following individuals and families are covered under this subcontract:

1. Title XIX and Title XXI Eligible Children and Adults

a. The ADHS/DBHS/CPSA Provider Manual lists the AHCCCS eligibility key codes for all Title XIX and Title XXI children and adults that are covered under this subcontract.

b. The Title XIX eligible children include but are not limited to:

i. Title XIX children who have been adjudicated by the court to be in the care and custody of:

a) Arizona Department of Economic Security/Division of Children, Youth and Families (Child Protective Services);

b) Arizona Department of Juvenile Corrections (except for those who are adjudicated delinquents and are in a correctional institution);

c) Administrative Office of the Courts/Juvenile Probation.

These Title XIX eligible children in the care and custody of the state are enrolled with the Comprehensive Medical and Dental Program (CMDP) health plan. CMDP is responsible for the acute care medical health benefit for these children.

ii. Title XIX children in the Arizona Department of Economic Security/Division of Children Youth and Families Adoption Subsidy Program.

iii. Title XIX children in the Arizona Department of Economic Security/Division of Children Youth and Families voluntary foster care arrangements.

c. Title XIX and Title XXI eligible Native Americans regardless if they live on or off reservation, except when enrolled with an ADHS Tribal Contractor.

2. Developmentally Disabled (DD) ALTCS Children and Adults

The ADHS/DBHS/CPSA Provider Manual lists the DD ALTCS eligibility key code groups that are covered under this subcontract.

3. Non-Title XIX/XXI Persons with a Serious Mental Illness (SMI)

These are persons who are determined to have a serious mental illness in accordance with the ADHS/DBHS/CPSA Provider Manual, Section 3.10, SMI Eligibility Determination.

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4. The following individuals and families are covered under this subcontract to the extent that funding is available and allocated to the Contractor. The Contractor may limit the scope of services provided to these populations consistent with ADHS/DBHS/CPSA Provider Manual, Section 3.2, Service Prioritization for Non-Title XIX/XXI Funding:

a. Non-Title XIX/XXI General Mental Health Adults (GMH)

Adult persons age eighteen and older who have general behavioral health issues and have not been determined to have a serious mental illness.

b. Non-Title XIX/XXI Substance Abuse Adults (SA)

Adult persons age eighteen and older who have a substance use disorder, or are referred for DUI screening, education and treatment, and have not been determined to have a serious mental illness.

c. Non-Title XIX/XXI Children

Children up through the age of seventeen who are in need of behavioral health services

C. SERVICES TO BE PROVIDED UNDER THIS SUBCONTRACT

1. Based on the funding source as specified in Schedule II, Program Funding Allocation, the Contractor shall develop, maintain and monitor a continuum of Covered Services for its enrolled members. The Contractor shall ensure that the complete continuum of behavioral health services contained in the ADHS/DBHS Covered Behavioral Health Services Guide is available to meet the needs of and provided when needed to eligible and enrolled persons. A comprehensive listing of service codes, including limitations, such as Title XIX or Tile XXI reimbursability, categories of service, and allowed provider types, can be found in the CPSA Service Authorization Matrix. All service codes, unless explicitly stated otherwise, refer to both substance abuse/dependence and mental health services and populations.

2. Service provision is based on the premise that all mandated and appropriate covered services will be of high quality and provided in a culturally competent manner, in the least restrictive environments, accessible to all populations and sensitive to consumer choice.

3. All services must be provided in compliance with the processes established in the ADHS/DBHS/CPSA Provider Manual and the CPSA Program Protocol Manual. Additionally:

a. Services to those determined to have serious mental illness must be provided in accordance with all provisions of Arizona Administrative Code Title 9, Chapter 21, Behavioral Health Services for Persons with Serious Mental Illness, and with the ADHS Principles for Persons with a Serious Mental Illness, available on the ADHS/DBHS web site and incorporated herein by reference.

b. Services provided to Title XIX/XXI children must be delivered in accordance with the Arizona Vision set forth in the JK Settlement Agreement and the Title XIX Children’s Behavioral Health Annual Action Plan available on the ADHS/DBHS web site and incorporated herein by reference.

4. All services will be provided in the context of the enrolled person’s Adult Recovery Team, Child and Family Team, or Young Adult Team.

a. The Contractor shall continue to deliver ongoing behavioral health services to a member 18 through the 21st year and his/her family, facilitated through a Young Adult Team, provided:

i. The Member and family choose to remain enrolled with the Children’s Network.

ii. The Member is Title XIX/XXI and/or CMDP enrolled

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iii. The Young Adult Team has commenced development of life skills and independence 6 months prior to 18th birthday

iv. The determination as a person with Serious Mental Illness is completed and Title XIX rights and requirements are implemented.

5. The Contractor shall encourage adult persons to include family members in the assessment and treatment for behavioral health recipients, unless it is contraindicated by family circumstances. The Contractor shall support the participation of parents/primary caregivers, adolescents and children in the assessment and treatment process. A unified process of assessment, planning, service delivery and support among multiple agencies represents the preferred practice.

6. Psychotropic medications must be provided according to the CPSA Formulary. Contractor employed and contracted physicians, registered nurse practitioners, and/or physician assistants shall prescribe and abide by the CPSA drug formulary and by the ADHS/DBHS/CPSA Provider Manual Sections 3.15, Psychotropic Medications: Prescribing and Monitoring, 3.16, Medication Formulary and 3.14, Securing Services and Prior Authorization.

7. The Contractor may not arbitrarily deny or reduce the amount, duration, or scope of a required service solely because of the behavioral health diagnosis, type of illness, or condition of the eligible or enrolled person. The Contractor may place appropriate limits on a service on the basis of criteria, such as medically necessary covered services, or for utilization control, provided the services furnished can reasonably be expected to achieve their purpose.

8. Contractor is encouraged to use consumers of behavioral health services and their families to provide supportive services to enrolled members including payment, as appropriate, for those services. Consumers and families shall receive appropriate training and must meet requirements for service provision under this Subcontract.

9. The Contractor shall ensure coordination and continuity of care for behavioral health recipients admitted to the Arizona State Hospital, including but not limited to the following:

a. diversion of potential admission from the Arizona State Hospital, as appropriate;

b. coordination of the admission process with the Arizona State Hospital Admissions Office;

c. participation in the Arizona State Hospital treatment and discharge planning;

d. forwarding of available clinical and medical record information upon or shortly after admission; and

e. any other requested communication and/or collaboration with the Arizona State Hospital

D. CRISIS SERVICES:

CPSA is responsible for ensuring that Crisis Services, including detoxification services, are available to eligible and enrolled persons who are at imminent risk of decompensation, relapse, hospitalization, risk of harm to self or others, or loss of residence due to a behavioral health condition. Contractor is responsible for coordinating its members’ access to the CPSA Community-wide Crisis Providers in Pima County. The Contractor shall ensure that each enrolled Member has clear written instructions on how to access crisis services. For enrolled members in crisis beyond regular business hours, the Contractor shall arrange for phone consultation, services to stabilize the crisis and appropriate referral to continue stabilization.

Although the Contractor is not expected to duplicate the range of services provided by the Community-wide Crisis Providers, as an Intake provider, the Contractor is expected to respond to eligible, but non-enrolled persons in urgent need or to arrange for services to a community-wide crisis provider according to the ADHS/DBHS appointment standards and to CPSA established protocol, Network/SAMHC Crisis Interface: Persons who Present Needing Medication or Network/SAMHC Crisis Interface: All Other Crisis Situations.

Page 5

CPSA funds contracted providers to deliver Crisis Stabilization services for adolescents in a 10 bed unit and for children, 2 beds in a group setting. The contractor shall participate with these contracted providers to ensure appropriate utilization of these resources in accordance with protocols and scopes of work specific to these resources.

CPSA funds detoxification services through a Detoxification Service Provider (DSP). The DSP provides services for Members assessed as requiring care at intensities of service comparable to ASAM Levels II-D, III.2-D, and III.7-D. The Contractor is responsible for coordinating members’ access to services provided by the DSP in accordance with the processes established by the CPSA Program Protocol Manual.

E. COORDINATION OF CARE

The Contractor shall collaborate with community and government agencies and individuals to coordinate the delivery of Covered Services with other services and supports needed by the enrolled person and their families. Specific requirements related to this provision are delineated in ADHS/DBHS/CPSA Provider Manual Section 4.4, Coordination of Care with Other Government Entities.

Contractor agrees to comply with the terms and conditions of the Arizona Department of Economic Security (ADES) Interagency Service Agreement (ISA) between Rehabilitation Services Administration (RSA) and ADHS/DBHS and to coordinate with RSA as required in ADHS/DBHS/CPSA Provider Manual Section 4.4, Coordination of Care with Other Government Entities.

The Contractor must communicate and coordinate with enrolled persons’ AHCCCS Health Plan primary care providers and other health care providers regarding the enrolled persons’ behavioral health and general medical care and treatment in compliance with the ADHS/DBHS/ CPSA Provider Manual Section 4.3, Coordination of Care with AHCCCS Health Plans and Primary Care Providers.

F. PROVIDER NETWORK REQUIREMENTS

1. Network Development, monitoring and maintenance

a. Contractor shall establish and maintain a community-based governing or advisory board for local decision-making and input into service delivery and network development.

b. The Contractor shall establish, maintain and monitor a provider network that is capable of delivering a full continuum of treatment, rehabilitative and supportive services for children and adults. The continuum of care may be provided directly or through contractual arrangements with qualified providers (Subcontracted Providers). The Contractor shall provide technical assistance to its providers regarding Covered Services, encounter submission and documentation requirements on an as needed basis.

c. The Contractor’s network must meet the Minimum Network Standards and Staff Inventory requirements established by CPSA. Contractor must submit quarterly reports documenting these minimum standards in the format prescribed by CPSA and on the time schedule enunciated in Schedule III, Subcontract Deliverables.

d. The Contractor’s network must be sufficient to ensure that:

i. Capacity to serve eligible and enrolled persons of non-dominant culture and ethnicity is demonstrated;

ii. Unnecessary use of emergency departments and urgent care centers is reduced;

iii. Use of jail and detention centers is reduced;

iv. Covered Services, including emergency care, are provided promptly and are reasonably accessible in terms of location and hours of operation and are delivered in compliance with

Page 6

ADHS/DBHS/CPSA Provider Manual, Section 3.2, Appointment Standards and Timeliness of Service.

v. Children with special health care needs have adequate access to behavioral health practitioners with experience in treating the child’s diagnosed condition.

e. The Contractor’s network must include intake sites and capacity adequate to ensure the following:

i. Scheduled hours for intake appointments must ensure accessibility and ease of entry into the behavioral health system.

ii. All service sites must be staffed adequately to complete SMI determinations within time frames established by ADHS/DBHS/CPSA Provider Manual Section 3.10, SMI Eligibility Determination.

iii. Financial assessments must be conducted at each intake site by a staff person trained in financial screening and dedicated to the completion of applications for public benefits according to ADHS/DBHS/CPSA Provider Manual, Section 3.1, Accessing and Interpreting Eligibility and Enrollment Information and Screening and applying for AHCCCS Health Insurance.

iv. At intake, written materials will be provided to the Member to include at a minimum: Member Handbook, Rights and Responsibilities of Members, name and phone number of their assigned Clinical Liaison and the procedure for reaching the Clinical Liaison in the event of an urgent or emergent need.

v. Intake services are available during non-business hours (evenings and weekends) to accommodate Member’s access into the system. Intake services are also available outside the Contractor’s office, i.e. schools, homes, wellness centers.

f. The Contractor’s network must be sufficient to ensure that a Clinical Liaison is assigned to each member. The Clinical Liaison is responsible for providing clinical oversight, working in collaboration with the enrolled person and his/her family or significant others to implement an effective treatment plan, and serves as the point of contact, coordination and communication with other systems where clinical knowledge of the case is important. Contractor must comply with the ADHS/DBHS/CPSA Provider Manual, Section 3.7, Clinical Liaisons. The Contractor shall maintain a roster in the CPSA Information System that identifies the Clinical Liaison and Clinical Liaison contact information for each behavioral health recipient. The Contractor shall update the roster as the Clinical Liaison changes.

g. The Contractor shall recruit, evaluate and monitor providers with an appropriate combination of skills, training and experience to provide Covered Services under this Subcontract.

h. The Contractor shall, and require its subcontractors to, credential and privilege providers as required in the ADHS/DBHS Provider Manual Section 3.20, Credentialing and Privileging, including processes to expedite temporary credentialing and privileging when needed to ensure the sufficiency of the network and add to specialized providers

i. The Contractor shall retain providers based upon performance and quality improvement data acquired while delivering services under this subcontract.

j. Contractor shall not restrict or inhibit providers in any way from communicating freely with or advocating for persons regarding:

i. Behavioral health care, medical needs and treatment options, even if needed services are not covered by the Contractor or if an alternate treatment is self-administered;

ii. Any information the behavioral health recipient needs in order to decide among all relevant treatment options;

iii. The risks, benefits, and consequences of treatment or non-treatment; and,

iv. The behavioral health recipient’s right to participate in decisions regarding his or her behavioral health care, including the right to refuse treatment, and to express preferences about future treatment decisions.

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k. Contractor shall provide enrolled persons choice within the provider network, subject to reasonable frequency limitations and contingent on the availability within the Contractor’s service network of an alternative that is suitable to meet the enrolled member’s needs.

l. The Contractor shall not discriminate, with respect to participation in its network, against any provider based solely on the provider’s type of licensure or certification. In addition, the Contractor shall not discriminate against providers that service high-risk populations or specialize in conditions that require costly treatment. This provision, however, does not prohibit the Contractor from limiting provider participation to the extent that the Contractor is meeting the needs of those persons covered under this contract. This provision also does not interfere with measures established by the Contractor to control costs consistent with its responsibilities under this subcontract nor does it preclude the Contractor from using different reimbursement amounts for different specialists or for different practitioners in the same specialty.

m. If the Contractor or its Subcontracted Provider network is unable to provide a covered service required under this Subcontract, the Contractor shall ensure timely and adequate coverage of these services through an out-of-network provider until a network provider is contracted. The Contractor shall coordinate with respect to authorization and payment under these circumstances.

n. If the Contractor declines to include individuals or groups of providers in its network, it shall give the affected providers written notice of the reason for its decision. The Contractor may not include providers excluded from participation in Federal health care programs, pursuant to Section 1128 or Section 1128 A of the Social Security Act.

2. Additional Network Requirements:

a. Juvenile Service Provisions: The Contractor and its Subcontracted Providers shall meet and ensure that all its paid and unpaid personnel who are required or are allowed to provide behavioral health services directly to Juveniles have met all fingerprint and certification requirements of A.R.S. §36 425.03 prior to providing such services. Additionally, the Contractor and any subcontractors providing Level II and III behavioral residential services to juveniles will comply with all relevant provisions in A.R.S.36-1201.

b. Level I, II and III Provisions: A Level I, II and III provider shall accept all referrals of behavioral health recipients made by the Contractor and that the subcontractor shall not arbitrarily or prematurely deny, suspend, or terminate services to a behavioral health recipient without prior notification to the Contractor.

c. Level I Provisions: Level I providers shall comply with the Contractor’s quality management programs and the utilization control and review procedures specified in 42 CFR, Parts 441 and 456, as implemented by AHCCCS and DHS.

d. IMD Facility Provisions: The following minimum provisions apply to IMD facilities provider types B6 and 71:

i. The IMD facility shall keep track of the number of days a Title XIX or Title XXI behavioral health recipient is in the facility and may only bill for services within the limitations of the IMD expenditure authority for Title XIX services. The Title XIX service limitations are thirty (30) days per admission, and sixty (60) days per contract year for those aged 21 through 64 for services provided in IMDs. Service limitations are cumulative across providers. For persons under 21 and over 64, there are no IMD service limitations.

ii. The IMD facility shall notify AHCCCS Member Services according to the requirements outlined in the ADHS/DBHS/CPSA Provider Manual.

iii. The IMD facility shall provide written notification to Title XIX and Title XXI behavioral health recipients aged 21 through 64 that their AHCCCS eligibility may end if they remain in an IMD longer than thirty (30) days per admission or sixty (60) days per contract year.

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3. Notification Requirements for Changes to the Network

a. The Contractor shall notify and obtain written approval from CPSA before making any expected network material changes in the size, scope, configuration, or change in location of sites of the Contractor’s provider network as indicated in the most recent network inventory. This includes any significant reduction in a provider’s workforce or any plan to not fill, or delay filling, key staff vacancies.

b. The Contractor shall notify CPSA in writing within one (1) day of becoming aware of any unexpected network material change, or learning of a network deficiency, or anticipating a network material change that could impair the provider network. The notice shall include:

i. Information about how the change will affect the delivery of covered services;

ii. The Contractor’s plan to ensure that there is minimal disruption to the behavioral health recipient’s care and provision of service. The plan shall also address that clinical team meetings with the behavioral health recipient will be provided to discuss the options available to the behavioral health recipient and that treatment plans will be revised to address any changes in services or service providers; and

iii. The Contractor’s plan to address and resolve any network deficiency.

c. The Contractor shall notify CPSA in writing within five (5) days of a decision by the Contractor to terminate, suspend or limit a subcontract, if the decision impacts the sufficiency of the network, including situations that require behavioral health recipients to transition care to a different provider.

i. The notice shall include:

a) The number of individuals to be impacted by the termination, limitation or suspension decision including the number of Title XIX and Title XXI and Non-Title XIX/XXI behavioral health recipients affected by program category.

b) The Contractor’s plan to ensure that there is minimal disruption to the behavioral health recipient’s care and provision of service. The plan shall also address that clinical team meetings with the behavioral health recipient will be provided to discuss the options available to the behavioral health recipient and that treatment plans will be revised to address any changes in services or service providers.

c) The Contractor’s plan for communicating changes to affected behavioral health recipients. Such plan must include the provision of written notice to affected members within fifteen (15) days of issuance of termination notice.

d. The Contractor shall track all persons transitioned due to a subcontract suspension, limitation or termination to ensure service continuity. Required elements to be tracked include: Name, Title XIX/XXI status, date of birth, population type, current services that the behavioral health recipient is receiving, services that the behavioral health recipient will be receiving, new agency assigned, and date of first appointment and activities to re-engage persons who miss their first appointment at the new provider. Other elements to be tracked may be added based on the particular circumstances.

G. DESIGNATED SERVICE PROVIDER:

The Contractor shall function as the Designated Service Provider for the following rural geographic subdivisions:

1. Marana - Subdivision B and Ba, which includes:

Marana; Saguaro; Silver Bell; Avra Valley; Rillito; Cortaro; and Catalina.

As a Designated Service Provider, the Contractor will maintain a physical presence in each rural subdivision indicated above throughout the term of this Subcontract.

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H. CONTRACTOR ADMINISTRATIVE ORGANIZATION

The Contractor shall maintain organizational, managerial and administrative systems and staff capable of fulfilling all contractual requirements and shall employ staff persons with adequate time designated to carry out the required functions. Contractor shall maintain the following required staff positions:

1. Medical Director: The Contractor shall designate a Medical Director who shall be available on a continuing basis to work with CPSA medical staff to ensure administration and delivery of high quality, medically appropriate care including care provided by Subcontracted Providers.

a. Contractor shall have a board qualified/ board certified psychiatrist who serves as the Medical Director of the network. “The Medical Director shall have ultimate clinical authority, but must function as a collaborator and team member, both with the administration and with clinicians or other disciplines, in order to be maximally effective in accomplishing the goals and functions of the position.” (Adapted from APA Guidelines for Psychiatric Practice in State and Community Psychiatry Systems, 1993).

b. The Medical Director shall have sufficient time to perform administrative duties. Administrative duties include, but are not limited to, attendance at required meetings convened by CPSA and shall have ultimate authority for ensuring psychiatric oversight in:

i. Emergency Services. Review of all dispositions through a defined protocol.

ii. Acute Care Services. Admissions and discharge decisions, level of care determinations, direct supervision of care, and denial of requested services based on established medical necessity criteria as established by CPSA.

iii. Outpatient and Residential Services. Provide participation and/or leadership in regular interdisciplinary team case reviews, including review and signature of treatment plans and Individual Service Plans that address the entire spectrum of bio-psychosocial needs of members.

iv. Other medical care delivery and coordination with member’s primary care physician.

c. Additional duties include:

i. Development of job descriptions for provider psychiatrists, nurse practitioners and physician assistants.

ii. Assuring the adequacy of psychiatric staffing to meet members’ needs in a timely and clinically safe manner.

iii. Recruitment and supervision of provider psychiatric staff.

iv. Staff training.

v. Direct involvement in the quality management and utilization management processes of the Contractor.

vi. In conjunction with other provider Medical Directors and the CPSA Chief Medical Officer, development, refinement and implementation of clinical best practices and implementation of documentation standards for psychiatrists, nurse practitioners and physician assistants

vii. Involvement in the grievance and appeal process.

viii. Involvement in the Title 36 and process, including the assurance that psychiatric providers will be available for required testimony and court appearances in any and all Title 36 and proceedings.

ix. Assurance of ongoing coordination of care of members confined to the Arizona State Hospital (ASH).

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2. Clinical Liaison: shall be assigned to each member to complete the assessment and service planning processes and provide clinical oversight to ensure the provision of necessary covered services.

3. Intake Staff: shall be available to provide routine and urgent intakes according to established time frames.

4. HB 2003 Children’s Staff: The Contractor shall deploy two (2) HB 2003 Children’s staff positions that are co-located, one at the PCJCC, and one at designated DES offices.

5. Liaison to the Detoxification Service Provider: The Contractor will designate an appropriately qualified person to oversee and manage the care of its established and newly enrolled members receiving services at the DSP.

6. Arizona State Hospital Liaison: State Hospital Liaison for all covered populations who has the authority to commit resources of the Subcontractor in finalizing discharge planning for its enrolled members in the State Hospital.

7. Special Child Populations: The Contractor shall be responsible for identifying one or more contact person(s) for each Special Population, in addition to those listed above. These populations include the following:

a. Children assigned to ADES/CPS;

b. Children assigned to AOC;

c. Children assigned to ADES/DDD; and

d. Children assigned to ADJC.

The contact person shall interact with CPSA staff member assigned to each population.

8. Quality Management (QM)/Utilization Management (UM): The Contractor shall designate an appropriately qualified person to oversee it’s QM/UM function both internally and externally

9. Teleconferencing: The Contractor shall designate a staff member with sufficient time allocated to be responsible for the coordination of the telecommunications system

10. Planning: The Contractor shall identify a staff member who is responsible for both coordinating planning activities and interfacing with CPSA in its planning process.

11. Subcontract Administration: The Contractor shall assign a staff member to coordinate the contract administration functions.

12. Child and Family Team Staff: The Contractor shall have a sufficient number of staff to implement the Child and Family Team Process.

13. Cultural Liaison: The Contractor shall appoint a Cultural Liaison to interact and collaborate with CPSA Cultural Diversity Specialist on cultural proficiency issues, including any new initiatives relating to culture.

14. RBHA Development Plan Liaison: The Contractor shall appoint a RBHA Development Plan Liaison to interact and coordinate with CPSA Network Development Manager or designee as the single-point of contact responsible for gathering and reporting of all related activities/achievements that support the goals of the plan.

I. MEMBER REFERRAL, ENROLLMENT AND ASSIGNMENT

1. The Contractor shall accept and act upon referrals and requests for Covered Services made by any person or person’s legal guardian, family member, an AHCCCS health plan, primary care provider, hospital, jail, court, probation or parole officer, tribal government, Indian Health Services, school, or other state or community agency. The Contractor and its Subcontracted Providers shall follow all referral procedures outlined in the ADHS/DBHS/CPSA Provider Manual, Section 3.3, Referral Process.

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2. Contractor shall ensure that any Level I, II or III facility that it operates or subcontracts with is required to accept all referrals of behavioral health recipients made by the Contractor and may not arbitrarily or prematurely deny, suspend or terminate services to a behavioral health recipient without prior notification to the Contractor.

3. The Contractor shall ensure that all eligible persons who receive Covered Services are enrolled in the CPSA PACE Enrollment System in a timely manner and in accordance to the ADHS/DBHS/CPSA Provider Manual provisions governing timeliness of service.

4. Member assignment to the Contractor shall be based upon member choice, geographic location, and on an equitable, proportional assignment procedure. Assignment of members to the Contractor shall be at the sole discretion of CPSA. CPSA may adjust assignments to the Contractor based upon subcontract performance or QM findings at its discretion. The Contractor must accept enrollment of all members assigned. In the event a Member’s eligibility or assignment is questioned, the Contractor will seek assistance from CPSA Member Services. Members are the responsibility of the Contractor effective the member’s assignment date to the Contractor. CPSA will provide notification of assignment within 48 hours of member’s assignment date to the Contractor. Under no circumstances shall the Contractor be financially or clinically responsible for services provided to a member, pursuant to this Subcontract, prior to a member’s assignment to the Contractor.

5. Members may change their assigned Network at the discretion of CPSA based upon established criteria and guidelines established in ADHS/DBHS/CPSA Provider Manual Section The Contractor will facilitate the transfer of clinical information necessary to accomplish such a change in Network assignment. The Contractor shall accept responsibility programmatically and financially as of the date of the member’s assignment to the Contractor, which shall occur upon the complete transfer of the member’s clinical information.

6. Eligible persons currently enrolled with a Contractor shall remain enrolled with the Contractor regardless of subsequent move out of that Contractor’s GSA unless and until the enrolled person is transitioned to an ALTCS Contractor, other Contractor or service provider, as applicable, and such transfer occurs in accordance with the ADHS/DBHS/CPSA Provider Manual Section 3.17, Transition of Persons.

7. The Contractor shall ensure that complete, timely and accurate enrollment, assessment and disenrollment data is submitted to CPSA in accordance to ADHS/DBHS/CPSA Provider Manual Section 7.5, Enrollment, Disenrollment and Other Data Submission.

8. The Contractor member roster is available to the Contractor via intranet within an hour of data transmission. The Contractor is responsible for reconciliation of the member roster and reporting of corrections to CPSA at least monthly according to the established Roster Reconciliation Protocols. The Contractor is responsible for the identification of AHCCCS eligibility, program indicator, and eligible fund type assignment at point of intake and throughout duration of enrollment of services. The Contractor must ensure that internal agency enrollment rosters coincide with CPSA enrollment information. The Contractor submits this report to CPSA as required in Schedule III, Contract Deliverables.

9. The Contractor will maintain a current roster of children enrolled in CMDP (Comprehensive Medical and Dental Plan) and provide CPSA with a list monthly by the 15th of the month for the previous month.

J. COMMUNICATIONS WITH BEHAVIORAL HEALTH RECIPIENTS, FAMILY MEMBERS, STAKEHOLDERS, AND PROVIDERS

1. The Contractor shall participate and cooperate with CPSA’s outreach activities designed to inform eligible and enrolled persons of the availability of behavioral health services in accordance with the ADHS/DBHS/CPSA Provider Manual, Section 3.8, Outreach, Engagement, Re-engagement and Closure.

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2. Within 10 days of their first service, Contractor shall provide enrolled members or their guardians or families the CPSA Member Handbook which identifies procedures for accessing emergency services, individual member rights, SMI grievance, appeal procedures, and co-payment policies. The Contractor shall ensure that handbooks are available at all provider sites and easily accessible to all enrolled persons. The Contractor shall supplement the CPSA Member Handbook with specific information that at minimum includes the following: Clinical Liaison, list of Subcontract Providers, available services, service locations and access to emergency services. The Contractor shall ensure that these supplements are written at a 4th grade reading level, and that the information be printed in a type, style, and size that can be easily read by members with varying degrees of visual impairment or limited reading proficiency. The Contractor must notify members that alternative formats are available and how to access them. The Contractor shall assist CPSA in its efforts to annually make available a Member Handbook to all enrolled persons.

3. The Contractor shall distribute CPSA developed written materials to members and family members and make such materials available in the lobbies of their service sites. The Contractor will assist members in understanding the content of these materials.

4. The Contractor shall maintain a website. The website shall be organized to allow for easy access of information by behavioral health recipients, family members, providers and stakeholders. The website shall contain at a minimum the following information or links:

a. Provider Name

b. Provider Address

c. Provider telephone number

d. Locations and sites at which members may receive services

e. Provider’s hours of operation

f. Available spoken languages

The Contractor shall ensure that the website is in compliance with the Americans with Disabilities Act.

K. QUALITY MANAGEMENT/UTILIZATION MANAGEMENT

1. Quality Management

The Contractor shall have a quality management program that fulfills all requirements contained in the CPSA Quality Management/Utilization Management Plan (QM/UM Plan). In addition to Quality Management requirements set forth in Standard Terms, Paragraph H, the Contractor shall submit a QM/UM Plan within thirty (30) days of the initial execution of the subcontract and annually thereafter. The plan shall comply with the CPSA QM/UM Plan and ensure reporting of incidents, accidents, and deaths according to ADHS/DBHS/CPSA Provider Manual Section 7.4, Reporting of Incidents, Accidents and Deaths and when applicable, reporting of incidents of seclusion and restraint according to ADHS/DBHS/CPSA Provider Manual section 7.3, Seclusion and Restraint Reporting.

The Contractor shall meet ADHS Minimum Performance Standards included in the QM/UM Plan and CPSA shall require a corrective action plan from, and may impose sanctions on Contractor if it does not achieve the minimum standard for any indicator, performance for any indicator declines to a level below the ADHS Minimum Performance Standard or there is a statistically significant drop in the Contractor’s performance on any indicator without a justifiable explanation. The Contractor’s QM/UM Plan shall use methods to address the ADHS Minimum Performance Standards.

The Contractor will provide sufficient space for the CPSA QM Liaison to perform QM review and analysis at the contractor’s site.

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2. Utilization Management

a. General:

i. The contractor will assume certain Utilization Management Functions specified in the CPSA Utilization Management Plan. The Contractor and subcontractors will comply with this plan and requirements contained in the ADHS/DBHS/CPSA Provider Manual, Chapter 3.14, Securing Services and Prior Authorization.

ii. The Contractor shall participate in CPSA processes that monitor for under and over utilization of services.

iii. The Contractor shall maintain a risk management program and ensure that appropriate action is taken as needed. The Contractor shall use information obtained to improve the quality of care.

iv. The Contractor shall address discharge from inpatient services as follow-up to a special event and develop a discharge plan according to the ADHS/DBHS/CPSA Provider Manual Section 3.8.6-C.

b. Utilization Management Reporting Requirements

i. Utilization (Census) Data for Level II placements are required as referenced in Schedule III, Subcontract Deliverables. Census data for all CPS and DDD children placed out of home including; Level 3 Group Home, Therapeutic Foster Care, Unlicensed Out of Home Placement, and Foster Placement are also required.

ii. The Contractor will submit additional reports as required by special program provisions or in response to identified discrepancies identified through monitoring efforts.

L. PHYSICIAN INCENTIVES

The Contractor must comply with all applicable physician incentive requirements and conditions defined in 42 CFR 417.479. These regulations prohibit physician incentive plans that directly or indirectly make payments to a doctor or a group an inducement to limit or refuse medically necessary services to a member. The Contractor is required to disclose all physician incentive agreements to CPSA and to enrolled persons who request them.

The Contractor shall not enter into contractual arrangements that place providers at significant financial risk as defined in CFR 417.479 unless specifically approved in advance by CPSA. In order to obtain approval, the following must be submitted to CPSA 90 days prior to the implementation of the subcontract:

1. A complete copy of the subcontract

2. A plan for the member satisfaction survey

3. Details of the stop-loss protection provided

4. A summary of the compensation arrangement that meets the substantial financial risk definition

The Contractor shall disclose to CPSA the information on physician incentive plans listed in 42 CFR 417.479 (h)(1) through 417.479(I) in accordance with the AHCCCS Physician Incentive Plan Disclosure by Contractor’s Policy and upon subcontract renewal, prior to the initiation of a new subcontract, or upon the request from ADHS, AHCCCSA, CMS or CPSA.

The Contractor shall also provide for compliance with physician incentive plan requirements as set forth in 42 CFR 422.

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M. ADVANCE DIRECTIVES

The Contractor shall ensure compliance with requirements contained in the ADHS/DBHS/CPSA Provider Manual, Section 3.12, Advance Directives, addressing advanced directives for adult enrolled members.

Each subcontract or agreement with a hospital, nursing facility, home health agency, hospice or organization responsible for providing personal care, must comply with Federal and State law regarding advance directives for adult members.

N. SUPERVISORY CARE HOMES AND UNLICENSED BOARD & CARE HOMES

In accordance with the ADHS/DBHS/CPSA Provider Manual, Section 10.1, Members Residing in Boarding Homes, the Contractor shall assess the living situation for all persons with a serious mental illness to ensure that the person’s basic needs are met in an environment that is safe, secure and consistent with their behavioral needs. The Contractor shall ensure that any situations observed that pose a threat to the health or safety of a person are promptly resolved.

O. HOUSING PROGRAM:

The Contractor shall participate with CPSA in delivering housing services in compliance and with CPSA’s Housing Plan and the ADHS/DBHA/CPSA Provider Manual.

The Contractor shall deliver Housing Support Services in accordance with the ADHS/DBHS Covered Services Guide and ADHS/DBHS/CPSA Provider Manual, Section 10.3, Housing Support Services.

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SUBCONTRACT AGREEMENT   THE PROVIDENCE SERVICE CORPORATION

CONTRACT NUMBER: A0508 FY05/06

STANDARD TERMS

A. PROVISION OF SERVICES

The Contractor, subject to the terms of this Subcontract, at the maximum dollar amounts and rates set forth herein or in any Schedule hereto, agrees to provide Covered Services to members as the Contractor may be authorized to do so by CPSA as provided herein.

B. ARIZONA SYSTEM PRINCIPLES

The Contractor agrees to participate with CPSA to ensure that the behavioral health delivery system operates and services are delivered in accordance with the following System Principles.

1. Easy Access to Care:

a. Accurate information is readily available that informs behavioral health recipients, family members and stakeholders how to access services.

b. The behavioral health network is organized in a manner that allows for easy access to behavioral health services.

c. Services are delivered in a manner, location and timeframe that meet the needs of behavioral health recipients and their families.

2. Behavioral Health Recipient and Family Member Involvement:

a. Behavioral health recipients and family members are active participants in behavioral health delivery system design, prioritization of behavioral health resources and planning for and evaluating the services provided to them.

b. Behavioral health recipients, family members and other parties involved in the person’s and family’s lives are central and active participants in the assessment, service planning and delivery of behavioral health services and connection to natural supports.

3. Collaboration with the Greater Community:

a. Stakeholders including general medical, child welfare, criminal justice, education and other social service providers are actively engaged in the planning and delivery of integrated services to behavioral health recipients and their families.

b. Relationships are fostered with stakeholders to maximize access by behavioral health recipients and their families to other needed resources such as housing, employment, medical and dental care, and other community services.

c. Providers of behavioral health services collaborate with community stakeholders to assist behavioral health recipients and family members in achieving their goals.

4. Effective Innovation:

a. Behavioral health providers are continuously educated in, and use, best practices.

b. The services system recognizes that substance use disorder and other mental health disorders are inextricably intertwined, and integrated substance abuse and mental health assessment and treatment are the community standard.

c. Behavioral health recipients and family members (who want to) are provided training and supervision to become, and be retained as, providers of peer support services.

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5. Expectation for Improvement:

a. Services are delivered with the explicit goal of assisting people to achieve or maintain success, recovery, gainful employment, success in age-appropriate education; return to or preservation of adults, children and families in their own homes; avoidance of delinquency and criminality; self-sufficiency and meaningful community participation.

b. Services are continuously evaluated, and modified if they are ineffective in helping to meet these goals.

c. Behavioral health providers instill hope, even for the most disabled, that achievement of goals is possible.

6. Cultural Competency:

a. Behavioral health service providers are recruited, trained and evaluated based upon competence in linguistically and culturally appropriate skills for responding to the individual needs of each behavioral health recipient and family members.

b. Corporate management reflects cultural diversity in values and action.

c. Corporate management and behavioral health service providers strive to improve through periodic cultural self assessment and modify individual services or the system as a whole as needed to achieve this goal.

C. REQUIREMENTS, MANAGEMENT AND REPORTING

1. Contractor registration:

Contractor must be and ensure that its Subcontractors are registered with AHCCCS (or ADHS as applicable) as provider types that are specified in the ADHS/DBHS Covered Behavioral Health Services Guide. Services must be delivered by Providers that meet all provider qualifications and operate within the scope of their practice as specified in the ADHS/DBHS Covered Behavioral Health Services Guide.

2. Licenses and Permits:

The Contractor, unless otherwise exempt by law, shall obtain and continuously maintain and shall require all of its Subcontracted Providers and their employees and contractors who participate in the provision of Covered Services, unless otherwise exempt by law, to obtain and continuously maintain all licenses, permits, certifications, credentials and authority necessary to do business and render Covered Services under this Subcontract. Copies of all licenses shall be provided to CPSA, Contracts Department as specified in the Subcontract Deliverables Schedule of this subcontract.

3. Minimum Staffing:

The Contractor shall maintain organizational, managerial and administrative systems and staff capable of fulfilling all Subcontract requirements. The Contractor shall ensure the following:

a. All staff have appropriate training, education, experience, orientation and credentialing as applicable, to fulfill the requirements of their position;

b. Staff who require credentialing and privileging under the terms of ADHS/DBHS/CPSA Provider Manual Section 3.20, Credentialing and Privileging, receive such as required by that section.

The Contractor shall inform CPSA in writing within five (5) days of personnel changes in any of its key staff, including psychiatrists, psychologists, registered nurse practitioners, and physician assistants.

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4. Cultural Competence:

a. The Contractor shall develop, maintain, promote and monitor a culturally competent system of behavioral health care and engage in culturally competent practices with members served, as well as within their organizational structures.

b. The Contractor shall maintain a cultural competency development and implementation policy that clearly delineates how it will self-assess, implement improvements, and monitor the success of such improvements.

c. Contractor shall ensure that interpreters of any language are available free of charge for eligible or enrolled persons to ensure appropriate delivery of covered services.

d. The Contractor is required to comply with the CPSA Cultural Proficiency Strategic Plan and any additional requirements as delineated in the ADHS/DBHS/CPSA Provider Manual.

5. Participation in ADHS Reporting Requirements:

Upon request, the Contractor will participate and cooperate with CPSA in providing timely information and data necessary to prepare quarterly and annual reports as required in the ADHS/DBHS/CPSA Provider Manual. Reports include, but are not limited to:

a. Network Assurance of Sufficiency

b. Annual Provider Network Development and Management Plan

c. Quarterly Network Status Reports

d. Network Inventory

e. Other Spending Plans as required by ADHS.

D. SERVICE DELIVERY SYSTEM

1. Customer Service:

a. The Contractor shall have a customer service function that is responsive to behavioral health recipients, family members and stakeholders. At a minimum the customer service function shall:

i. Be customer oriented;

ii. Be warm and welcoming to members and families;

iii. Respond to inquiries and assist behavioral health recipients, family members and stakeholders in a manner that resolves their inquiry, including having the ability to respond to, and provide language assistance services for, those with limited English proficiency;

iv. Assist in referring behavioral health recipients, family members or stakeholders to the crisis line when indicated;

2. Coordination of Behavioral Health Benefits and Collection Practices:

a. Coordination of Behavioral Health Benefits

i. ADHS is the payer of last resort in the event any one or more other third party payers is responsible for covered services provided to CPSA members.

ii. The Contractor agrees to identify Medicare and other third party liability coverage and seek such Medicare or third party liability payment before submitting claims/encounters to CPSA. Contractor shall coordinate benefits and adhere to coordination of benefits and third-party liability requirements described in the ADHS/DBHS/CPSA Provider Manual, Section 3.5, Third Party Liability and Coordination of Benefits.

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b. Reporting.

The Contractor shall communicate any known change in health insurance information, including Medicare, to CPSA not later than ten (10) days from the date of discovery.

c. Co-payments.

The Contractor will assess and collect co-payments as provided in the ADHS/DBHS/CPSA Provider Manual, Section 3.4, Co-Payments.

Neither the Contractor nor any Subcontracted Provider shall bill or attempt to collect any charge or fee except permitted co-payments from any Title XIX or Title XXI eligible or enrolled person for any Title XIX or Title XXI covered service.

d. Notice to Members Concerning Non-Covered Services.

When the Contractor provides members with services other than Covered Services, the Contractor shall, prior to the provision of such services, and except in emergencies, exercise all reasonable efforts to inform the member in writing: (1) of the service(s) to be provided; (2) that neither CPSA nor ADHS will pay in full for or be liable for such services; and (3) that the member may be financially liable for such services.

E. TRAINING OF CONTRACTOR PERSONNEL AND SERVICE PROVIDERS

The Contractor shall comply with the ADHS/DBHS/CPSA Provider Manual, Section 9.1, Training Requirements, regarding staff training, competency and development for Contracted Provider Agencies.

F. SYSTEM COLLABORATION

System Collaboration with State Agencies/County Agencies: The Contractor shall abide by all applicable written collaborative protocols and letters of agreement developed by CPSA with State and County Agencies and communicated through the CPSA website.

G. COMMUNICATION WITH BEHAVIORAL HEALTH RECIPIENTS, FAMILY MEMBERS, STAKEHOLDERS, AND PROVIDERS

1. The Contractor shall ensure timely and accurate dissemination and communication of information required by CPSA and ADHS. Upon request, the Contractor shall assist CPSA and ADHS in the dissemination of information to behavioral health recipients prepared by the federal government, AHCCCS, or ADHS.

2. All advertisements, publications, and printed materials which are produced by the Contractor and refer to Title XIX and Title XXI covered services shall state that such services are funded under a contract between AHCCCS and ADHS. All advertisements, publications, and printed materials, which are produced by the Contractor and refer to covered services shall state that such services are funded through CPSA and ADHS.

H. QUALITY MANAGEMENT

The Contractor agrees to comply with ADHS’s and CPSA’s quality management programs. The Contractor agrees to participate in and be evaluated in accordance with the Quality Management/Performance Improvement and Utilization Management Plan established by CPSA. CPSA agrees to provide the Contractor written notice of any changes to the Quality Management/Performance Improvement and Utilization Management Plan. CPSA requires the Contractor to develop quality management/performance improvement and utilization management requirements in accordance with CPSA Quality Management/Performance Improvement and Utilization Management Plan requirements.

The Contractor shall participate in other required quality management activities, including but not limited to, an Annual Independent Case Review, Performance Improvement Projects (PIP) as mandated by ADHS, Performance Improvement activities designed to improve compliance with the

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ADHS Performance Standards, Case Reviews, Critical Incident Investigations, Mortality Investigations, Root Cause Analyses, Training and Technical Assistance Efforts, Member Satisfaction Survey and other activities that may be required from time to time by CPSA, ADHS or AHCCCS.

The Contractor and its Subcontracted Providers shall comply with and implement CPSA endorsed best or promising practice guidelines. The Contractor shall comply and ensure its Subcontracted Providers comply with guidelines pertaining to competence in linguistically and culturally appropriate practices.

I. COMPLAINTS, SMI GRIEVANCES, MEMBER APPEALS, AND PROVIDER CLAIM DISPUTES

The Contractor will comply with CPSA complaint, SMI grievance, and member appeal processes and may file provider claim disputes consistent with the ADHS/DBHS/CPSA Provider Manual sections contained in Chapter 5.0, Member Rights and Provider Claims Disputes.

Contractor shall assist eligible and enrolled persons in understanding their right to make complaints and file grievances (SMI) and appeals. Contractors are required to advise Members of CPSA complaint, grievance and appeals processes as outlined in the ADHS/DBHS/CPSA Provider Manual and to assist members in accessing these processes.

The Contractor may attempt to resolve member complaints and disputes through an internal agency complaint process, however, the Contractor must advise Members that they may use CPSA grievance and appeals process as outlined in the ADHS/DBHS/CPSA Provider Manual instead of the Contractor’s and may not interfere with a Member’s right to file a grievance or appeal with CPSA.

The Contractor must require that its staff participate effectively in CPSA, ADHS and AHCCCS grievance and appeals processes.

The Contractor shall carry out ADHS, AHCCCS or CPSA decisions issued with respect to a complaint, SMI Grievance, Member appeal and/or provider claim dispute.

Pending the final resolution of any dispute involving a complaint, grievance, appeal, or claims dispute, the Contractor shall proceed with performance in accordance with CPSA’s instructions, unless informed otherwise in writing.

J. CORPORATE COMPLIANCE

Contractor is responsible for participating in and complying with the CPSA Compliance Program pertaining to fraud and abuse, including the reporting requirements contained in ADHS/DBHS/CPSA Provider Manual Section 7.1, Fraud and Abuse Reporting. The Contractor shall ensure that subcontractors comply with the Corporate Compliance Program. Failure to comply may result in the penalty described in A.R.S. §13-2310.

K. STANDARD PROVISIONS

1. Warranty of Services:

Contractor, by execution of this subcontract, warrants that it has the ability, authority, skill, expertise and capacity to perform the services specified in this subcontract and that all services shall be performed in conformity with the requirements of this Subcontract by qualified personnel in accordance with standards required by Federal or State law, rules and regulations.

2. No Guaranteed Quantities:

CPSADHS does not guarantee Contractor any minimum or maximum quantity of services or goods to be provided under this Subcontract.

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3. Subcontract Interpretation and Amendment:

a. No Parole Evidence: This Subcontract is intended by the parties as a final and complete expression of their agreement. No course of prior dealings between the parties and no usage of the trade shall supplement or explain any terms used in this document.

b. No Waiver: Either party’s failure to insist on strict performance of any term or condition of the Subcontract shall not be deemed a waiver of that term or condition even if the party accepting or acquiescing in the nonconforming performance knows of the nature of the performance and fails to object to it.

c. Written Subcontract Amendments: The Subcontract shall be modified only through a written Subcontract amendment within the scope of the Subcontract signed by the Chief Executive Officer on behalf of CPSA; however, written amendment to this Subcontract shall not be required for:

i. Change of non-licensable behavioral health facility address or administrative address.

ii. Change of telephone number.

iii. Change of authorized signatory.

iv. Changes in the name and/or address of the person to whom notices are to be sent.

v. Change in the name of the Contractor where the ownership remains the same.

vi. Funding source(s) changes by CPSA when the amount of the Subcontract remains unchanged; or

vii. Funding source(s) transfers by CPSA when the amount of the Subcontract remains the same.

CPSA shall give written notice to the Contractor of Subcontract funding source(s) changes or transfers within 30 days following the effective date thereof, including any changes in program requirements.

Above notwithstanding, the Contractor shall give notice to CPSA and ADHS within 30 days of any non-material alteration to this Subcontract.

a. Merger, Reorganization and Change in Ownership: A merger, reorganization or change in ownership of Contractor, or of a subcontracted provider that is related or affiliated with Contractor, shall require a written subcontract amendment and the prior approval of CPSA and ADHS.

b. Changes to Documents Incorporated by Reference: Changes to any of the documents incorporated by reference do not require a written contract amendment and are effective upon notification to Contractor.

c. Notices: Whenever notice is required pursuant to the terms of this Subcontract, such notice shall be in writing, shall be delivered in person or by certified mail, return receipt requested, and shall be directed to the person(s) and address (es) specified for such purpose on the first page of this Subcontract or to such other person(s) and/or address (es) as either party may designate to the other party by written notice.

d. Renegotiation: Any request to renegotiate this Subcontract must be delivered in writing to CPSA by certified mail, return receipt requested.

e. Subcontract Order of Precedence: In the event of a conflict in the provisions of the subcontract the following shall prevail in the order set forth below:

i. Scope of Work

ii. Standard Terms

iii. Special Terms

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f. Severability: The provisions of this subcontract are severable. Any term or condition deemed illegal or invalid shall not affect any other term or condition of the subcontract.

g. Entire Agreement: This Subcontract and its appendices, schedules, and attachments, including all amendments and modifications incorporated by reference, shall constitute the entire agreement between the parties, and supersedes all other understandings, oral or written.

h. Applicable Law:

i. Arizona Law: The law of Arizona applies to this Subcontract including, where applicable, the Uniform Commercial Code as adopted by the State of Arizona.

ii. Implied Contract Terms: Each provision of law and any terms required by law to be in this Subcontract are a part of this Subcontract as if fully stated in it.

4. Subcontract Performance:

a. Measurement: Contractor agrees that its retention as a provider will be based upon performance and quality improvement data acquired while delivering services under this subcontract.

b. Deliverables: The Contractor shall, within the timeframes specified, submit deliverables in accordance with requirements outlined in the Special Terms, Scope of Work, and Subcontract Deliverables Schedule

c. Corrective Actions: At its discretion, CPSA may require corrective action when it is determined that the Contractor is out of compliance with the terms of the Subcontract or not adhering with the ADHS/DBHS/CPSA Provider Manual or other incorporated document. The corrective action shall be outlined and documented on a Corrective Action Plan using the format prescribed by CPSA. This document will be the means of communication between the Contractor and CPSA regarding progress of the corrective action.

d. Right to Assurance: If CPSA in good faith has reason to believe that the Contractor does not intend to, or is unable to perform or continue performing this Subcontract, CPSA may demand in writing that the Contractor give a written assurance of intent or ability to perform. The demand shall be sent to the Contractor by certified mail, return receipt required. Failure by the Contractor to provide written assurance within the number of days specified in the demand may, at CPSA’s option, be considered a default by the Subcontract.

5. Definition of Terms:

The definition of terms pertaining to this subcontract are contained in Attachment A.

6. Records:

a. Contractor shall maintain and require its subcontractors to maintain all forms, records, reports and working papers used in the preparation of reports, files, correspondence, financial statements, records relating to quality of care, medical records, prescription files, statistical information and other records specified by ADHS or CPSA for purposes of audit and program management.

b. Contractor shall preserve and make available for audit all records for a period of five (5) years from the date of final payment under this subcontract except as provided in paragraphs (i) and (ii) below:

i. If this subcontract is completely or partially terminated, the records relating to the work terminated shall be preserved and made available for a period of five (5) years from the date of any such termination.

ii. Records which relate to disputes, litigation or the settlement of claims arising out of the performance of this subcontract, or costs and expenses of this subcontract to which

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exception has been taken by the state, shall be retained by Contractor until such disputes, litigation, claims or exceptions have been disposed of.

c. In addition to the requirement to retain business records as provided above, Contractor shall ensure that all medical records are created, maintained and retained as required in the ADHS/DBHS/CPSA Provider Manual, Section 4.2, Behavioral Health Medical Record Standards.

d. The Contractor shall ensure that information regarding behavioral health recipients is shared in accordance with confidentiality and HIPAA rules and policy as outlined in Federal and State law and the ADHS/DBHS/CPSA Provider Manual, Section 4.1, Disclosure of Behavioral Health Information. Confidentiality of records containing member information will be handled in accordance with that same section. The contractor must comply with applicable security requirements governing protected health information contained in 45 CFR Parts 160, 162, and 164.

e. All records shall be subject to inspection and audit by CPSA or the State at reasonable times. Upon request, the Contractor shall produce a legible copy of any or all such records.

L. SUPPORTING DOCUMENTS

1. Subjection of ADHS Contract with AHCCCS:

The terms of this subcontract shall be subject to the applicable material terms and conditions of the contract existing between ADHS and AHCCCS for the provision of Title XIX and Title XXI covered behavioral health services.

2. Subjection of this subcontract to CPSA/ADHS Contract Number HP532003:

The terms of this subcontract shall be subject to the applicable material terms and conditions of the contract existing between CPSA and ADHS for the provision of covered behavioral health services, including the Uniform Terms and Conditions, which are incorporated by reference herein as applicable.

3. Documents Incorporated by Reference:

The Contractor and its Subcontracted Providers shall have access to the internet and agree to access documents incorporated by reference through internet connections. Documents incorporated by reference are available from the following websites (www.azdhs.gov, www.ahcccs.state.az.us, and www.cpsa-rbha.org). Additionally, www.cpsa-rbha.org provides a link to the ADHS and AHCCCS sites.

a. Document Listing:

The following documents, and any subsequent amendments, modifications, and supplements to these documents adopted by CPSA, ADHS, or AHCCCS (as applicable) during the Contract period, are incorporated and made a part of this subcontract by reference:

i. ADHS/DBHS Covered Behavioral Health Services Guide

ii. ADHS/DBHS/CPSA Provider Manual

iii. ADHS Accounting and Auditing Procedures Manual

iv. ADHS/DBHS Quality Management/Utilization (QM/UM) Plan

v. CPSA Quality Management/Utilization Management (QM/UM) Plan

vi. AHCCCS Medical Policy Manual (AMPM) - Chapters 900 and 1000

vii. ADHS/DBHS Strategic Plan

viii. CPSA Strategic Plan

ix. Arizona Families First Protocol

x. ADHS/DBHS Clinical Guidance Documents:

a) Performance Improvement Projects (PIPS)

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b) Technical Assistance Document (TADS)

xi. Title XIX Children’s Behavioral Health Annual Action Plan

xii. ADHS/DBHS Cultural Competence Plan

xiii. CPSA Cultural Proficiency Strategic Plan

xiv. CPSA Provider Financial Reporting Guide

xv. CPSA Service Authorization Matrix

xvi. CPSA Information Management Guide

xvii. CPSA Program Protocol Manual

xviii. CPSA Housing Program Guide

b. Revisions to Documents Incorporated by Reference:

Contractor shall comply with the terms, conditions, and requirements of these documents, as amended/revised from time to time, consistent with State and Federal law as if the terms and conditions of the documents had been fully set forth in this subcontract.

c. Other Supporting Documents:

This section contains references to documents that guide the development of the behavioral health system requirements.

i. Administrative Rules:

a) Arizona Administrative Code Title 2, Chapter 19, Administrative hearing rules.

b) Arizona Administrative Code Title 9, Chapter 20, ADHS rules for the licensing of behavioral health agencies.

c) Arizona Administrative Code Title 9, Chapter 21, ADHS rules for service delivery for persons with a serious mental illness.

d) Arizona Administrative Code Title 9, Chapter 22, AHCCCS rules for the Title XIX acute program.

e) Arizona Administrative Code Title 9, Chapter 28, AHCCCS rules for the Title XIX DDD ALTCS program.

f) Arizona Administrative Code Title 9, Chapter 31, AHCCCS rules for the Title XXI program.

g) Arizona Administrative Code Title 9, Chapter 34, AHCCCS rules for the grievance system.

ii. Legal Document:

a) JK vs. Eden Settlement Agreement

iii. Federal Block Grants:

a) Community Mental Health Services Performance Partnership Program pursuant to Division B, Title XXXII, Section 3204 of the Children’s Health Act of 2000 (CMHS)

b) Substance Abuse Prevention and Treatment Performance Partnership Program pursuant to Division B, Title XXXIII, Section 3303 of the Children’s Health Act of 2000 and pursuant to Section 1921-1954 of the Public Health Service Act and 45 CFR Part 96 Interim Final Rules (SAPT)

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iv. Intergovernmental Agreements, Interagency Service Agreements and Memorandums of Understanding:

c) Intergovernmental Agreements:

1) Intergovernmental Agreement between ADHS and the Arizona Department of Economic Security/Division of Children, Youth and Families (DCYF) (This IGA is under review.)

2) Intergovernmental Agreement between ADHS and the Arizona Department of Economic Security/Division of Developmental Disabilities (DDD)

3) Intergovernmental Agreement between ADHS and the Arizona Department of Economic Security (ADES)-Joint Substance Abuse Treatment Fund (Expires June 30, 2005 but may be extended.)

4) Intergovernmental Agreement between ADHS and Pima County (for GSA 5.)

d) Interagency Service Agreements:

1) Interagency Service Agreement between ADHS and the Arizona Administrative Office of the Courts (AOC)

2) Interagency Service Agreement between ADHS and Arizona Department of Economic Security (ADES) for Vocational Rehabilitation for the Seriously Mentally Ill

3) Interagency Service Agreement between ADHS and the Arizona Department of Economic Security/Rehabilitation Services Administration (ADES/RSA)

4) Interagency Service Agreement between ADHS and the Arizona Department of Juvenile Corrections (ADJC)

5) Interagency Service Agreement between ADHS and the Arizona Department of Corrections-Correctional Officer/Offender Liaison (COOL) Program

6) Interagency Service Agreement between ADHS and the Arizona Department of Housing

e) Memorandum of Understanding:

Memorandum of Understanding between ADHS and the Arizona Department of Economic Security, Arizona Health Care Cost Containment System, Arizona Department of Education, Arizona Department of Juvenile Corrections and Administrative Office of the Arizona Supreme Court (Children’s Executive Memorandum of Understanding)

v. Other:

a) State Plan – AHCCCS State Plan with Center for Medicare and Medicaid Services (CMS)

b) AHCCCS Medical Policy Manual

M. ADMINISTRATION PROVISIONS

1. Requests for Information:

ADHS or CPSA may request financial or other information from Contractor. Upon receipt of a request for information, Contractor shall provide complete and accurate information no later than thirty (30) days after the receipt of the request unless otherwise specified by ADHS or CPSA.

2. Cooperation with Other Contractors:

Contractor shall cooperate fully with other contractors and/or State employees in scheduling and coordinating its services with other related services for enrolled persons. Contractor shall afford other contractors reasonable opportunity to provide services and shall not commit or permit any act that interferes with the performance of services by other contractors or by State employees.

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N. SUBCONTRACTING

1. Subcontracts and Assignment:

The Contractor shall be responsible for contract performance whether or not subcontracts are used. No subcontract shall operate to terminate the responsibility of the Contractor to assure that all activities carried out by the Subcontracted Provider conform to the provisions of this Subcontract. Subject to such conditions, any function required to be provided by the Contractor pursuant to this Subcontract may be subcontracted to a qualified person or organization. All such subcontracts shall be in writing.

All subcontracts entered into by the Contractor are subject to prior review and approval by CPSA and shall incorporate by reference the documents set forth in paragraph L of the Standard Terms of this subcontract. The Contractor must enter into a subcontract with any provider the Contractor anticipates will be providing covered services on its behalf except in the following circumstances:

a. A provider is anticipated to provide services less than 25 times during the contract year;

b. A provider refuses to enter into a subcontract with the Contractor in which case the Contractor shall submit documentation of such refusal to CPSA within 7 days of the final attempt to gain such agreement; or

c. A provider performs emergency services.

The Contractor shall maintain a fully executed original of all subcontracts, which shall be accessible to CPSA or ADHS within two (2) working days of request. All subcontracts will comply with the applicable provisions of Federal and State laws, regulations and policies.

Contractor shall submit to CPSA a copy of all fully executed subcontracts and any subsequent amendments for each Subcontracted Provider within ten (10) days of contract execution.

Contractor shall not include covenant-not-to-compete requirements in its subcontracts. Specifically, Contractor shall not prohibit a subcontracted provider from providing services to ADHS, AHCCCS or any other ADHS or AHCCCS contractor. Contractor and its subcontracted providers shall not contract with any individual or entity that has been debarred, suspended or otherwise lawfully prohibited from participating in any public procurement activity.

2. Behavioral Health Provider Subcontract Provisions:

Each behavioral health provider subcontract shall contain the following:

a. Identification of the name and address of the subcontractor.

b. Full disclosure of the method and amount of compensation or other consideration to be received by the subcontractor.

c. Identification of the population, to include behavioral health recipient capacity, to be served by the subcontractor.

d. The amount, duration and scope of covered services to be provided, and for which compensation shall be paid.

e. The term of the subcontract including beginning and ending dates, procedure for extension, termination and renegotiation.

f. The specific duties of the subcontractor relating to coordination of benefits and determination of third party liability.

g. A provision that the subcontractor agrees to identify Medicare and other third party liability coverage and to seek such Medicare or third party liability payment before submitting claims and/or encounters to Contractor.

h. A provision that the subcontractor shall maintain a cost record keeping system.

i. A provision that the subcontractor shall comply with ADHS’ and CPSA’s quality management programs.

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j. A provision that a merger, reorganization or change in ownership or control of a subcontractor that is related to or affiliated with Contractor shall require a Contract amendment and prior approval of CPSA and ADHS.

k. A provision that the subcontractor shall obtain and maintain all applicable insurance as outlined in paragraph ON of the Standard Terms of this subcontract and shall submit a copy of insurance certificates to the Contractor.

l. A provision that the subcontractor shall be fully responsible for all tax obligations, Worker’s Compensation Insurance, and all other applicable insurance coverage obligations as stated in Standard Terms, Section TS, Miscellaneous Provisions, Applicable Taxes of this subcontract, for itself and its employees, and that CPSA, AHCCCS or ADHS shall have no responsibility or liability for any such taxes or insurance coverage.

m. Incorporate by reference the ADHS/DBHS Covered Behavioral Health Services Guide and the ADHS/DBHS/CPSA Provider Manual. Require that the subcontractor adhere to all requirements stated within these documents.

n. A provision that the subcontractor shall comply with encounter reporting and claims submission requirements as described in the ADHS/DBHS/CPSA Provider Manual.

o. A provision that the subcontractor may file a Provider Claim Dispute in accordance with the ADHS/DBHS/CPSA Provider Manual.

p. A provision that the subcontractor shall assist eligible and enrolled clients in understanding their right to file grievances and appeals and follow requirements stated in the ADHS/DBHS/CPSA Provider Manual with regard to these processes.

q. A provision that the subcontractor shall comply with audits, inspections and reviews that are outlined in the ADHS/DBHS/CPSA Provider Manual and any reviews the CPSA, ADHS, or AHCCCS may conduct.

r. A provision that the subcontractor shall cooperate fully with other contractors and/or State employees in scheduling and coordinating its services with other related services for enrolled persons. The Subcontractor shall afford other contractors reasonable opportunity to provide services and shall not commit or permit any act that interferes with the performance of services by other contractors or by State employees.

s. A provision that the subcontractor shall carry out ADHS, AHCCCS, or CPSA decisions issued with respect to a complaint, SMI grievance, member appeal, and/or claim dispute.

O. INSURANCE PROVISIONS

1. General:

The Contractor shall obtain and maintain and ensure that its subcontractors obtain and maintain all applicable insurance as outlined below. The Contractor shall obtain and keep on file copies of provider insurance certificates, and shall make them available for review by CPSA and ADHS upon request.

Contractor and subcontractors shall procure and maintain, until all of their obligations have been discharged, including any warranty periods under this subcontract, are satisfied, insurance against claims for injury to persons or damage to property which may arise from or in connection with the performance of the work hereunder by the Contractor, his agents, representatives, employees or subcontractors.

The insurance requirements herein are minimum requirements for this Subcontract and in no way limit any indemnity covenants contained in this Subcontract. The State of Arizona and CPSA in no way warrant that the minimum limits contained herein are sufficient to protect the Contractor from liabilities that might arise out of the performance of the work under this subcontract by the Contractor, its agents, representatives, employees or subcontractors, and Contractor is free to purchase additional insurance.

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2. Minimum Scope and Limits of Insurance:

Contractor shall provide coverage with limits of liability not less than those stated below.

a. Commercial General Liability – Occurrence Form

Policy shall include bodily injury, property damage, personal injury and broad form contractual liability coverage.

General Aggregate	$	2,000,000
Products – Completed Operations Aggregate	$	1,000,000
Personal and Advertising Injury	$	1,000,000
Blanket Contractual Liability – Written and Oral	$	1,000,000
Fire Legal Liability	$	50,000
Each Occurrence	$	1,000,000

i. The policy shall be endorsed to include coverage for sexual abuse and molestation. This coverage shall apply to any provider with responsibility for consumer interaction in person.

ii. The policy shall be endorsed to include the following additional insured language: “The State of Arizona, its departments, agencies, boards, commissions, universities and its officers, officials, agents, and employees, and CPSA shall be named as additional insured with respect to liability arising out of the activities performed by or on behalf of the Contractor”. For GSA 5 Contractor, Pima County must also be named as additional insured.

iii. Policy shall contain a waiver of subrogation against the State of Arizona, its departments, agencies, boards, commissions, universities and its officers, officials, agents, and employees and CPSA for losses arising from work performed by or on behalf of the Contractor.

b. Automobile Liability:

Bodily Injury and Property Damage for any owned, hired, and/or non-owned vehicles used in the performance of this Subcontract.

Combined Single Limit (CSL) $ 1,000,000

i. The policy shall be endorsed to include the following additional insured language: “The State of Arizona, its departments, agencies, boards, commissions, universities and its officers, officials, agents, and employees and CPSA shall be named as additional insured with respect to liability arising out of the activities performed by or on behalf of the Contractor, involving automobiles owned, leased, hired or borrowed by the Contractor”. For GSA 5 Contractor, Pima County must also be named as additional insured.

c. Worker’s Compensation and Employer’s Liability:

Worker’s Compensation	Statutory
Employer’s Liability
Each Accident	$	500,000
Disease – Each Employee	$	500,000
Disease – Policy Limit	$	1,000,000

i. Policy shall contain a waiver of subrogation against the State of Arizona, its departments, agencies, boards, commissions, universities and its officers, officials, agents, and employees and CPSA for losses arising from work performed by or on behalf of the Contractor.

ii. This requirement shall not apply to: Separately, EACH contractor or subcontractor exempt under A.R.S. §23-901, AND when such contractor or subcontractor executes the appropriate waiver (Sole Proprietor/Independent Contractor) form.

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d. Professional Liability (Errors and Omissions Liability):

Each Claim	$	1,000,000
Annual Aggregate	$	2,000,000

i. In the event that the professional liability insurance required by this Subcontract is written on a claims-made basis, Contractor warrants that any retroactive date under the policy shall precede the effective date of this Subcontract; and that either continuous coverage will be maintained or an extended discovery period will be exercised for a period of two (2) years beginning at the time work under this Subcontract is completed.

ii. Policy shall contain a waiver of subrogation against the State of Arizona, its departments, agencies, boards, commissions, universities and its officers, officials, agents, and employees and CPSA for losses arising from work performed by or on behalf of the Contractor.

iii. The policy shall cover professional misconduct or lack of ordinary skill for those positions defined in the Scope of Work of this subcontract.

iv. Professional Liability shall include Medical Malpractice for licensed medical providers.

3. Additional Insurance Requirements:

The policies shall include, or be endorsed to include, the following provisions:

a. The State of Arizona, its departments, agencies, boards, commissions, universities and its officers, officials, agents, and employees and CPSA wherever additional insured status is required such additional insured shall be covered to the full limits of liability purchased by the Contractor, even if those limits of liability are in excess of those required by this Subcontract. For GSA 5, Contractor shall name Pima County as an additional insured.

b. The Contractor’s insurance coverage shall be primary insurance with respect to all other available sources.

c. Coverage provided by the Contractor shall not be limited to the liability assumed under any indemnification provisions of this Subcontract.

4. Notice of Cancellation:

Each insurance policy required by the insurance provisions of this Subcontract shall provide the required coverage and shall not be suspended, voided, canceled, or reduced in coverage or in limits except after thirty (30) days prior written notice has been given to CPSA. Such notice shall be sent directly to CPSA, Contracts Department, 4575 E. Broadway, Tucson, AZ 85711 and shall be sent by certified mail, return receipt requested.

5. Acceptability of Insurers:

Insurance is to be placed with duly licensed or approved non-admitted insurers in the State of Arizona with an “A.M. Best” rating of not less than A-VII. The State of Arizona nor CPSA in no way warrants that the above-required minimum insurer rating is sufficient to protect the Contractor from potential insurer insolvency.

6. Verification of Coverage:

Contractor shall furnish CPSA with certificates of insurance (ACORD form or equivalent approved by the State of Arizona) as required by this subcontract. The certificates for each insurance policy are to be signed by a person authorized by that insurer to bind coverage on its behalf.

All certificates and endorsements are to be received and approved by the CPSA Contract Department before work commences. Each insurance policy required by this subcontract must be in effect at or prior to commencement of work under this Subcontract and remain in effect for the duration of the project. Failure to maintain the insurance policies as required by this Subcontract, or to provide evidence of renewal, is a material breach of contract.

All certificates required by this subcontract shall be sent directly to CPSA, Contracts Department, 4575 E. Broadway, Tucson, AZ 85711. The CPSA Contract Number and project description shall be noted on the certificate of insurance.

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7. Subcontractors:

Contractor’s certificate(s) shall include all subcontractors as insured under its policies or Contractor shall obtain from the subcontractor(s) separate certificates and endorsements for each subcontractor. The Contractor shall maintain certificates of insurance from all subcontractors and providers and ensure adequate coverage is provided throughout the term of the subcontractors’ agreement. All coverages for subcontractors shall be subject to the minimum requirements identified above.

8. Approval:

Any modification or variation from the insurance requirements in this Subcontract shall be submitted to CPSA. CPSA will discuss this requirement with ADHS. Such action will not require a formal Contract amendment, but may be made by administrative action.

9. Exceptions:

In the event the Contractor or sub-contractor(s) is/are a public entity, then the Insurance Requirements shall not apply. Such public entity shall provide a Certificate of Self-Insurance. If the contractor or sub-contractor(s) is/are a State of Arizona agency, board, commission, or university, none of the above shall apply.

P. FINANCIAL PROVISIONS

1. General:

a. Contractor shall have adequate professional staff and sufficient internal controls and systems in place designed to account for all related revenue/expenses.

b. Contractor agrees to submit financial statements and reports as required by the CPSA Provider Financial Guide.

c. Contractor agrees to submit Financial Audits and Reports as required by the CPSA Provider Financial Guide.

2. Compensation:

The method of compensation under this subcontract is delineated in Special Terms, Schedule I A-B), and Schedule II of this Subcontract.

3. Availability of Funds:

Payments made by CPSA pursuant to this Subcontract are conditioned upon the availability to CSPA of funds from ADHS authorized for expenditure in the manner and for the purposes provided herein. CPSA and ADHS shall not be liable for any purchases or subcontracts entered into by any subcontracted provider in anticipation of funding.

4. Termination for Non-availability of Funds:

If monies are not appropriated or otherwise available to CPSA to support continuation of performance of the subcontract, the Subcontract shall, upon written notice from CPSA, be canceled in whole or in part or at CPSA’s election, suspended until such monies are so appropriated or available.

5. Payments:

Payments made by CPSA to the Contractor are conditioned upon receipt of applicable, accurate and complete reports and encounters, documentation and information then due from the Contractor, except to the extent excused by CPSA with the consent of ADHS. Reports, documentation and information required to be submitted by the Contractor and the associated

time frames are outlined in Subcontract Deliverables Schedule of this subcontract and the CPSA Provider Financial Guide.

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6. Compliance by the Contractor:

If the Contractor is in any manner in default in the performance of any material obligation as outlined in this Subcontract, or if financial, compliance or performance audit exceptions are identified, CPSA or ADHS may, at its option and in addition to other available remedies, either adjust the amount of payment or withholding or cause payment to be withheld until satisfactory resolution of the default or exception. CPSA shall be entitled to offset against any sums due the Contractor, any expenses or costs incurred by CPSA as a result of nonconforming performance or failure to perform the Subcontract. The Contractor shall have the right to ten (10) business days prior written notice of any such action in adjusting the amount of payment or withholding payment. Under no circumstances shall payments be authorized that exceed an amount specified in this Subcontract without an approved written amendment to this Subcontract. CPSA may, at its option, withhold final payment to the Contractor until receipt of all final reports and deliverables.

7. Billing:

a. Billing Generally:

The Contractor and its Subcontracted Providers shall submit claims or encounters for covered services, in accordance with ADHS/DBHS/CPSA Provider Manual, Section 6.1, Submitting Claims and Encounters

b. Review/Disallowance:

Each encounter submitted by the Contractor shall be subject to disallowance in the event and to the extent such encounter is incomplete, does not conform to the applicable service authorization or to this Subcontract, any applicable Subcontract, or the ADHS/DBHS/CPSA Provider Manual, or is otherwise incorrect

c. Sources of Payment/Adjustments:

The parties acknowledge that other than donations and grants to the Contractor and funds otherwise generated by the Contractor independently from this Subcontract, and except for funds, if any, made available from third party payers by reason of coordination of benefits and collection of permitted co-payments, the only source of payment to the Contractor for Covered Services provided is funds from CPSA payable hereunder. Any error discovered by CPSA or ADHS with or without an audit in the amount of compensation paid to the Contractor will be subject to and shall require adjustment or repayment by or to the Contractor, by making a corresponding increase or decrease in a current payment to the Contractor or by making an additional payment by CPSA to the Contractor, or vice versa.

d. State Not Liable:

The Contractor acknowledges and agrees that the obligations for payment to the Contractor for Covered Services hereunder are those solely and exclusively of CPSA and that neither the State, ADHS nor AHCCCS shall have any liability or obligation to the Contractor for the payment for Covered Services to members, or otherwise. The obligations of the State with respect to payment for Covered Services are solely those set forth in the contract between CPSA and ADHS.

e. Provisional Nature of Payments:

All payments to the Contractor shall be provisional and shall be subject to review and audit for their conformity with the provisions hereof and of any applicable subcontract. The Contractor agrees to reimburse CPSA immediately upon demand for all Subcontract funds expended which are determined by CPSA, ADHS or the Auditor General not to have been disbursed by the Contractor in accordance with the terms of this Subcontract. If the party responsible to repay the Subcontract payments is other than the Contractor, the Contractor and CPSA shall work together to identify and to obtain the funds from the responsible party(ies).

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Q. COMPLIANCE PROVISIONS

1. The contractor will comply with all Audits, Surveys, Reviews and Inspections as specified in the CPSA Provider Financial Guide and the ADHS/DBHS/CPSA Provider Manual or otherwise conducted by CPSA, ADHS or AHCCCS.

2. At any time during the term of this Subcontract, Contractor and its subcontractors shall fully cooperate with financial, program, service and/or organizational reviews conducted by CPSA, ADHS, AHCCCS, the U.S. Department of Health and Human Services, the U.S. Office of Civil Rights, The Center for Medicaid and Medicare Services or any authorized representative of the state or federal governments and allow them:

a. access to Contractor’s and Subcontractors’ staff and behavioral health recipients;

b. access to, inspection and reproduction of books and records related to the performance of the Subcontract or second tier Subcontracts; and

c. through on-site inspection, or other means, to evaluate the quality, appropriateness and timeliness of services performed under this Subcontract.

3. Contractor and its subcontractors will support CPSA when ADHS shall conducts an Annual Administrative Review of CPSA. Contractor and its Subcontractors will assist CPSA in complying with these Reviews.

R. DISPUTES, NON-PERFORMANCE, TERMINATION, AND CANCELLATION PROVISIONS

1. Contract Disputes:

In the event of a dispute under this Subcontract, the parties agree to make a good faith attempt to resolve the dispute prior to taking formal action.

ADHS Claims Dispute procedures shall be the exclusive manner by which the Contractor may challenge denial of claims, non-payment of claims, or sanctions.

Additionally, a Contractor must advise its Subcontracted Providers that they may dispute denial or non-payment of claims by the Contractor, in accordance with the ADHS/DBHS/CPSA Provider Manual, Section 5.6, Provider Claims Disputes.

2. Termination:

a. Termination Upon Mutual Agreement:

This Subcontract may be terminated by mutual written agreement of the parties effective upon the date specified in the written agreement.

b. Termination for Convenience:

CPSA and the Contractor, in addition to other rights set forth elsewhere in this Subcontract, reserve the right to terminate this Subcontract in whole or in part, without cause, effective 60 days after mailing written notice of termination, by certified mail, return receipt requested.

c. Termination for Default: CPSA, in addition to other rights set forth elsewhere in this Subcontract, may at any time terminate this Subcontract in whole or in part if CPSA determines that the Contractor has failed to perform any material requirement hereunder and is not cured within 30 days of receipt of written notice thereof (such period shall be reduced to three (3) days in the event of a failure that may pose a threat to Members or personnel of the Contractor).

d. Continuing Performance: The Contractor shall continue the performance of this Subcontract to the extent not terminated under the provisions of this Section.

3. Voidability of Contract:

This subcontract is voidable and subject to immediate termination by CPSA upon Contractor becoming insolvent or filing proceedings in bankruptcy or reorganization under the United States

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Code, or upon assignment or delegation of the subcontract without the prior written approval of CPSA.

4. Rights & Obligations Upon Termination:

In case of default, CPSA reserves the right to purchase services, or to complete the required work. CPSA may recover any reasonable excess costs from contractor by deduction from an unpaid balance.

The Contractor shall stop all work as of the effective date of the termination and shall immediately notify all Subcontracted providers, in writing, to stop all work as of the effective date of the notice of termination.

Upon receipt of the notice of termination and until the effective date of the notice of termination, the Contractor shall perform work consistent with the requirements of this Subcontract and in accordance with a written plan approved by CPSA for the orderly transition of eligible and enrolled persons and clinical information necessary for their continued treatment to another Contractor.

The Contractor shall comply with all terms of the Subcontract and shall be paid the Subcontract price for all services and items completed as of the effective date of the notice of termination and shall be paid its reasonable and actual costs for work in progress as determined by GAPP, however, no such amount shall cause the sum of all amounts paid to the Contractor to exceed the compensation limits set forth in the Subcontract.

S. MANAGEMENT INFORMATION SYSTEM

All contractors will participate in the CPSA Information System to the extent necessary to perform this subcontract. Management Information System Requirements are defined in the CPSA Management Information Guide. This Guide contains specific information on Encounter Submissions, Enrollment and Demographic Data Submission. Additionally, the ADHS/DBHS/CPSA Provider Manual contains information on Eligibility Inquiries and AHCCCS Eligibility Application Status Reports.

T. MISCELLANEOUS PROVISIONS

1. Conflict of Interest:

The Contractor shall not undertake any work that represents a potential conflict of interest, or which is not in the best interest of CPSA, ADHS or the State without prior written approval by CPSA. The Contractor shall fully and completely disclose any situation, which may present a conflict of interest.

2. Anti-Kickback:

a. Contractor or any director, officer, agent, employee or volunteer of the Contractor shall not request or receive any payment or other thing of value either directly or indirectly, from or for the account of any Subcontractor (except such performance as may be required of a Subcontractor under the terms of its subcontract) as consideration for or to induce Contractor to enter into a subcontract with the Subcontractor or any referrals of enrolled persons to the Subcontractor for the provision of covered services.

b. Contractor certifies that it has not engaged in any violation of the Medicare Anti-kickback statute (42 USC 130a-7b) or the “Stark I” and “Stark II” laws governing related-entity referrals (PL101-239 and PL 101-432) and compensation.

3. Lobbying:

a. Contractor shall not use funds paid to Contractor by CPSA, or interest earned, for the purpose of influencing or attempting to influence any officer or employee of any State or Federal agency; or any member of, or employee of a member of, the United States Congress or the Arizona State Legislature in connection with awarding of any Federal or State Contract, the making of any Federal or State grant, the making of any Federal or State loan, the entering into of any cooperative agreement, and the extension, continuation, renewal,

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amendment or modification of any Federal or State Contract, grant, loan, or cooperative agreement.

b. Contractor shall not use funds paid to Contractor by CPSA, or interest earned, for the purpose of influencing or attempting to influence any officer or employee of any State or Federal agency; or any member of, or employee of a member of, the United States Congress or the Arizona State Legislature in which it asserts authority to represent CPSA or ADHS or advocate the official position of CPSA or ADHS in any matter before a State or Federal agency; or any member of, or employee of a member of, the United States Congress or the Arizona State Legislature.

4. Offshore Performance of Work Prohibited:

Due to security and identity protection concerns, all service under this subcontract shall be performed within the borders of the United States. All storage and processing of information shall be performed within the borders of the United States. This provision applies to work performed by subcontractors at all tiers.

5. Choice of Forum:

The parties agree that jurisdiction over any action arising out of or relating to this Subcontract shall be brought or filed in a court of competent jurisdiction located within the State of Arizona.

6. Relationship of Parties:

The Contractor under this subcontract is an independent Contractor. Neither party to this Subcontract shall be deemed to be the employee or agent of the other party to the subcontract.

7. Assignment And Delegation:

The Contractor shall not assign any right or payment nor delegate any duty under the Subcontract without the prior written approval of CPSA and ADHS. No assignment or delegation of the duties of this subcontract shall be valid without the above written approval.

8. General Indemnification:

Indemnification-Patent and Copyright. The Contractor shall indemnify and hold harmless the State and CPSA against any liability, including costs and expenses, for infringement of any patent, trademark or copyright arising out of Contract performance or use by the State or CPSA of materials furnished or work performed under this Subcontract. The State shall reasonably notify the Contractor of any claim for which it may be liable under this paragraph. If the contractor is insured pursuant to A.R.S.§41-621 and §35-154, this section shall not apply.

9. Non-Exclusive Remedies:

The rights and remedies of CPSA, ADHS and AHCCCS under this Subcontract are not exclusive and shall be in addition to any other rights and remedies provided by this Subcontract or available at law or in equity.

10. Non-Discrimination:

The Contractor shall comply with State Executive Order No. 99-4 which mandates that all persons, regardless of race, color, religion, sex, age, national origin or political affiliation, shall have equal access to employment opportunities, and all other applicable Federal and State laws, rules and regulations, including the Americans with Disabilities Act and Title VI.

11. Assignment of Overcharges:

The Contractor, CPSA and ADHS recognize that in actual practice overcharges resulting from antitrust violations are in fact borne by the purchaser. Therefore, the Contractor hereby assigns to CPSA and ADHS any and all claims for such overcharges relating to items or services to be provided by the Subcontract hereunder.

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12. Force Majeure:

Except for payment of sums due, neither party shall be liable to the other nor deemed in default under this Subcontract if and to the extent that such party’s performance of this Subcontract is prevented by reason of force majeure. The term “force majeure” means an occurrence that is beyond the control of the party affected and occurs without its fault or negligence. Without limiting the foregoing, force majeure includes acts of God; acts of the public enemy; war; riots; strikes; mobilization; labor disputes; civil disorders; fire; flood; lockouts; injunctions-interventions-acts; or failures or refusals to act by government authority; and other similar occurrences beyond the control of the party declaring force majeure which such party is unable to prevent by exercising reasonable diligence.

13. Applicable Taxes:

Tax Indemnification: Contractor and all subcontractors shall pay all Federal, state and local taxes applicable to its operation and any persons employed by the Contractor. Contractor shall, and require all subcontractors to hold CPSA and the State harmless from any responsibility for taxes, damages and interest, if applicable, contributions required under Federal, and/or state and local laws and regulations and any other costs including transaction privilege taxes, unemployment compensation insurance, Social Security and Worker’s Compensation.

14. Institutional Review Board For Research:

Any research that a Contractor undertakes that includes RBHA Members must be reviewed and approved by an Institutional Review Board for Research maintained by the Contractor and forwarded to CPSA’s Research/Human Subjects Review Committee for final approval. In the absence of an Institutional Review Board maintained by the Contractor, approval for research involving RBHA Members must be obtained from CPSA’s Research/Human Subjects Review Committee.

15. Excluded Providers:

If the Contractor declines to include individuals or groups of providers in its network, it shall give the affected providers written notice of the reason for its decision. The Contractor may not include providers excluded from participation in Federal health care programs, pursuant to Section 1128 or Section 1128 A of the Social Security Act.

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SUBCONTRACT AGREEMENT   COMPREHENSIVE SERVICE NETWORK   THE PROVIDENCE SERVICE CORPORATION

CONTRACT NUMBER: A0508 FY05/06

SPECIAL TERMS

(Inclusive of Provisions for Title XIX, Non-Title XIX and Title XXI services – Children and Adults)

A. FINANCIAL VIABILITY/PERFORMANCE BONDS

The Contractor shall meet the financial viability criteria described in the CPSA Provider Financial Guide, applying Generally Accepted Accounting Principles (GAAP), within 30 days prior to the effective date of this Subcontract. If the Contractor cannot meet the financial viability criteria the Contractor shall post a performance bond equal to one monthly payment less pharmacy withhold. The performance bond shall be payable to CPSA. Further details regarding Performance Bonds are described in the CPSA Provider Financial Guide.

B. FINANCIAL WITHHOLDING

1. Pharmacy

a. CPSA will withhold the amount of the pharmacy used by the Contractor’s Members against the gross 1/12th installment payment. The actual pharmacy cost is withheld two months after the month in which the usage occurred. An estimated amount is withheld against the 1/12th installment payment until actual pharmacy costs are available. Reconciliation is made at the end of the fiscal year through the withholding against the 1/12th installment payment.

b. CPSA will pay the contracted Third Party Pharmacy Administrator on a bimonthly basis for all pharmacy costs related to members from the respective Comprehensive Service Network withhold amounts.

2. Hospital

a. CPSA will withhold the amount of the hospitalization used by the Contractor’s members against the gross 1/12th installment payment. The actual hospital per diem cost is withheld two months after the month in which the usage occurred. An estimated amount is withheld against the 1/12th installment payment during the two-month lag; reconciliation is made at the end of the fiscal year.

C. METHOD OF COMPENSATION

1. All payments made to the Contractor shall be subject to the availability of funds and the terms and conditions of the Subcontract. CPSA shall disburse payments in accordance with the Subcontract, provided that the Contractor’s performance complies with the terms and conditions of the Subcontract.

2. CPSA reserves the right to renegotiate the services, rates, program budget, and/or method of compensation as set forth in these Special Provisions.

3. CPSA reserves the right to convert the payment mechanisms described in these special provisions to alternative mechanisms at its discretion and within thirty (30) days notice to the Contractor.

4. The annual funding allocation for services is identified and incorporated herein as Schedule II, Funding Allocation Schedule. All payments made by CPSA to the Contractor for the provision of services are conditioned upon the availability of authorized funds for expenditure to CPSA from the funding source.

5. Full compensation to the Contractor for all services rendered pursuant to this Subcontract will be paid subject to all requirements delineated in the CPSA Provider Financial Guide.

6. Contractor agrees to render the Covered Services set forth in the Scope(s) of Work throughout the entire contract year.

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7. The Contractor and its Subcontracted Providers shall submit 100% of claims/encounters for all Covered Services provided to Members, even if the claim amount/encounter data value exceeds the annual funding allocation. All submissions shall meet CPSA’s Claims/Encounter System requirements.

8. At the discretion of CPSA, supplemental or additional payments may be distributed in addition to the annual funding allocation.

9. CPSA shall distribute scheduled payments to Contractor as long as CPSA has received funding from ADHS/DBHS. If funding from ADHS to CPSA is delayed, funding to Contractor may occur the day funds are deposited and verified to CPSA accounts.

10. CPSA reserves the option to make payments by wire or Automated Clearinghouse (ACH) and shall provide at least thirty (30) days notice prior to the effective date of any such change.

11. Payments to the Contractor shall be as follows for each population served:

ADULT SERVICES (as applicable):

a. Title XIX SMI adult-DD: Prospective monthly one-twelfth (1/12th) payment as detailed in Schedule I-A.

b. Title XIX SMI adult- non-DD: Prospective monthly one-twelfth (1/12th) payment as detailed in Schedule I-A.

c. Non-Title XIX SMI adult: Prospective monthly one-twelfth (1/12th) payment as detailed in Schedule I-A

d. Title XIX adult General Mental Health and Substance Abuse Non-DD: Prospective monthly one-twelfth (1/12th) payment as detailed in Schedule I-A.

e. Title XIX adult General Mental Health and Substance Abuse-DD: Prospective monthly one-twelfth (1/12th) payment as detailed in Schedule I-A.

f. Adult Substance abuse Federal Block Grant SAPT MCAS Program: Monthly one-twelfth (1/12th) payment as detailed in Schedule I-A.

g. Title XXI, HIFA: Prospective monthly one-twelfth (1/12th) payment methodology as detailed in Schedule I-A.

CHILDREN SERVICES:

a. Title XIX Children, Non-CMDP: Prospective monthly one-twelfth (1/12th) payment as detailed in Schedule I-A.

b. Title XIX Children, CMDP: Prospective monthly one-twelfth (1/12th) payment as detailed in Schedule I-A.

c. Title XIX Children, DD: Prospective monthly one-twelfth (1/12th) payment as detailed in Schedule I-A.

d. Non-Title XIX Children: Prospective monthly one-twelfth (1/12th) payment as detailed in Schedule I-A.

e. Title XXI, KidsCare: Prospective monthly one-twelfth (1/12th) payment as detailed in Schedule I-A.

f. Non-Title XIX Children HB2003: Cost reimbursement payment methodology as described in Schedule I- B.

D. ACCOUNTING FOR FUNDS

1. The practices, procedures, and standards specified in the CPSA Provider Financial Guide shall be used by the Contractor in the management, recording and reporting of funds.

2. Contractor shall manage available funding to ensure that Non-Title XIX/XXI covered services are available on a continuous basis throughout the Contract Year.

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3. Records/Administrative Costs: The Contractor shall establish and maintain financial and personnel records to verify that administrative monies expended do not exceed the total amount allowed for such administrative service expenditures. Administrative services are defined in Attachment A, Definitions.

a. Federal Block Grant Monies: The management of block grant funds will be handled in accordance with procedures specified in the CPSA Provider Financial Guide.

b. All funds received shall be separately accounted for in accordance with the requirements outlined in the CPSA Provider Financial Guide.

c. CPSA reserves the right to withhold and/or recoup funds in accordance with any remedies allowed under this Subcontract. Any recoupments imposed by AHCCCS and/or ADHS against CPSA and passed through to the Contractor shall be reimbursed to CPSA upon demand.

d. Funding withholds applicable to this contract are contained in paragraph B above.

E. ADVANCEMENT OF FUNDS BY THE CONTRACTOR

CPSA may, in its sole and absolute discretion, advance payments to the Contractor if necessary or appropriate in the judgment of CPSA to develop, salvage or maintain an essential service to members.

F. FINANCIAL AUDITS

In addition to the audit requirements contained in Standard Terms, Section P, of this contract, financial audit requirements apply to this contract. These requirements are delineated in the CPSA Provider Financial Guide.

G. PERFORMANCE INCENTIVE SYSTEM

1. ADHS shall use a Performance Incentive System to encourage improved quality of care for behavioral health recipients. Incentives are performance based and CPSA will be eligible to receive financial reimbursements based on meeting or exceeding set performance targets. If incentives are received, the Contractor will be eligible to receive a portion of the incentive amounts. The Contractor’s portion of the incentive will be prorated based on the Contractor’s contribution to meeting the performance targets.

2. Amount of Incentives

a. The Contractor can receive a portion of any incentive earned by CPSA if the Contractor meets or exceeds the following indicators:

Performance Indicator	Measured through	Thresholds that shall be met to earn incentive
Access to Care/ Appointment Availability: Emergency appointments are made available within 24 hours of referral	Contractor/ Subcontractor Logs	85%
Access to Care/ Appointment Availability: Routine assessment appointments are made available within 7 days of referral	Contractor/ Subcontractor Logs	85%
Access to Care/ Appointment Availability: Routine appointments for ongoing services within 23 days of initial assessment	CIS	85%

3. Earning Incentives

Earning the Incentives. In order to qualify for incentive payments, the Contractor shall meet all contractually required data submission requirements, including encounter submission requirements, as outlined in the CPSA Provider Financial Guide and the ADHS/DBHS/CPSA Financial Reporting Guide. For purposes of qualifying for incentive payments, an 85% data submission requirement must be met. Contractor shall participate in any earned incentive money by satisfying the criteria for the above performance indicators and meeting all the contractually required data and encounter submission requirements.

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4. Time Frames for Measuring, Meeting and Payment for Performance Indicators

The time frame for measuring and meeting performance indicators shall be from July 1 through June 30. The indicators shall be measured through existing performance measures and required data submission requirements. For indicators derived from routinely collected data submission requirements, the average of the data collected across the twelve (12) months shall be used to determine if the indicator is met. Payment shall be made in or about the month of October for the preceding State fiscal year.

H. SANCTIONS:

1. CPSA may impose financial sanctions for failure to comply with the terms of this Subcontract or requirements set forth in the documents incorporated by reference or failure to comply with a corrective action. Sanctions shall be assessed according to the severity of the violation. Unless explicitly stated otherwise in this Subcontract or document incorporated by reference, at the discretion of CPSA, sanctions shall be applied as follows:

2. Non-compliance with a contract requirement by the Contractor that has an extreme negative impact on the service delivery system or that causes or results in extreme harm to a behavioral health recipient shall result in a severe financial sanction ranging from $5,000 to $100,000.

3. Additional sanctions may be phased in over the course of this contract term. These sanctions will be described in the CPSA Provider Financial Guide. Prior to becoming effective, the Contractor will be provided a 30 day written notice of intent to add further sanctions.

4. CPSA may also impose upon Contractor any sanction imposed against CPSA by ADHS or AHCCCS that is attributable to an act, omission, or performance of Contractor.

5. Contractor shall complete all steps necessary to correct the violation and to avoid future sanctions or corrective actions within the time frame established by CPSA in the notice of sanction. Following the notice of sanction, the full sanction amount shall be withheld from the next monthly payment. If the Contractor does not correct the violation within the timeframes established in the notice of sanction CPSA may impose an additional penalty, which at the discretion of CPSA, may be equal to or greater than the penalty for the first violation multiplied by one (1) plus the number of additional months (or portion of a month) during which the violation continues. CPSA shall offset against any payment due Contractor until the full sanction amount is paid.

6. The Contractor may challenge any sanctions imposed by CPSA in accordance with the ADHS/DBHS/CPSA Provider Manual Section 5.6, Provider Claims Disputes.

I. OWNERSHIP OF PROPERTY

1. Real Property

Any real property or buildings and improvements to buildings (“the property”) purchased by the Contractor with funds provided by ADHS through CPSA under the Contract, excluding net profits earned under the Subcontract, for delivering or coordinating the delivery of behavioral health services to behavioral health recipients shall include (1) a use restriction in the deed, or (2) covenants, conditions, or restrictions, or (3) another legal instrument acceptable to DHS that requires the property to be used solely for the benefit of behavioral health recipients. Notwithstanding the funding source used to purchase the property, prior to the purchase the Contractor shall:

a. Disclose to CPSA the funding source used to purchase the property to demonstrate whether the purchase is to be made with funds provided by DHS under the Contract, funds from net profits earned under the Contract or other funds;

b. Disclose to CPSA the financing arrangements made to purchase the property; and

c. If the property is purchased with funds provided by DHS under the Contract, submit to CPSA, for prior approval, a deed containing the use restrictions, covenants, conditions or restrictions or another legal instrument that ensures the property is used solely for the benefit of behavioral health

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recipients and that failure to comply with the use restrictions allows the State to take title to the property or otherwise enforce the restrictions.

2. HB 2003 Funded Property

a. Notwithstanding the preceding paragraph, any real property acquired or buildings constructed on real property with HB 2003 funds for the purpose of providing housing for persons with serious mental illness, shall be governed by any provisions of this subcontract that apply to services, if applicable.

b. Any real property, including land, buildings and improvements purchased by the Contractor or its subcontractor with HB 2003 funding, shall include a deed restriction and reversionary clause that requires the real property to be used solely for the benefit of enrolled persons. Prior to the purchase of any real property, the Contractor shall submit to CPSA and the ADHS, for prior approval, a deed containing the use restrictions and a reversionary clause that ensures the property is used for the benefit of enrolled persons and that failure to comply with the use restrictions allows the property to revert to the state.

J. INSURANCE PROVISIONS

1. Professional Liability Insurance

a. In addition to the insurance requirements contained in Standard Terms, Section O, 2(d) of this contract, the following requirement applies to Professional Liability Insurance:

b. The policy shall be endorsed to include the following additional insured language: “The State of Arizona, its departments, agencies, boards, commissions, universities and its officers, officials, agents, and employees, and CPSA shall be named as additional insured with respect to liability arising out of the activities performed by or on behalf of the Contractor”. For GSA 5 Contractor, Pima County must also be named as additional insured.

2. Indemnification

The parties to this contract agree that the State of Arizona, its departments, agencies, boards and commissions and CPSA shall be indemnified and held harmless by the contractor for the vicarious liability of CPSA and the State as a result of entering into this contract. However, the parties further agree that the State of Arizona, its departments, agencies, boards, and commissions shall be responsible for its own negligence. Each party to this contract is responsible for its own negligence.

K. BUSINESS CONTINUITY PLAN

1. The Contractor shall develop a Business Continuity Plan to deal with unexpected events that may negatively and significantly affect its ability to adequately serve members. This plan shall, at a minimum include planning and training for:

a. Behavioral health facility closure/loss of a major provider;

b. Electronic/telephonic failure at the Contractor’s main place of business;

c. Complete loss of use of the main site;

d. Loss of primary computer system/records; and

e. How the Contractor will communicate with CPSA in the event of a business disruption.

2. The Business Continuity Plan shall be reviewed annually by the Contractor, updated as needed, and provided to CPSA for review upon request. All key staff shall be trained and familiar with the Plan.

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SUBCONTRACT AGREEMENT   COMPREHENSIVE SERVICE NETWORK   THE PROVIDENCE SERVICE CORPORATION

CONTRACT NUMBER: A0508 FY05/06

SCHEDULE I–A

SPECIAL PROVISIONS

MONTHLY ONE-TWELFTH PAYMENT METHODOLOGY

(This methodology is used for the following populations as applicable)

a. Title XIX SMI adult-DD

b. Title XIX SMI adult- non DD

c. Non-Title XIX SMI adult

d. Title XIX Children, Non-CMDP

e. Title XIX Children, CMDP

f. Title XIX Children, DD

g. Non-Title XIX Children

h. Title XIX General Mental Health and Substance Abuse-DD

i. Substance Abuse Federal SAPT MCAS Program

j. COOL

A. Monthly One-Twelfth Payments: Payments due to the Contractor will be determined on a monthly basis and paid to the Contractor in accordance with the following:

1. Payment of monthly prospective installment amount equal to 1/12th the annual program funding allocation will be made by CPSA on the second Friday of the month, beginning with the first month of the contract year.

2. On an on-going monthly basis, CPSA will monitor and reconcile year-to-date encounter values approved by the CPSA Claims/Encounter System to the corresponding year-to-date payments in accordance to the scheduled Reconciliation Period.

3. To ensure full recognition of encounter data, reconciliation will continue up to 180 days following the end of the contract year. CPSA will recoup funds paid to the Contractor that are not supported by encounter data at the end of the reconciliation period.

4. CPSA reserves the right to suspend one-twelfth payments if the year-to-date encounter data is not sufficient to support the year-to-date payments at any time during the contract year. In the event of such a suspension, payments to the Contractor shall continue in accordance to the Monthly Encounter payment mechanism described below.

B. Monthly Encounter Payments: In the event the monthly one-twelfth payments are suspended in accordance with A. 4. above, payments due to the Contractor will be determined on a monthly basis and paid to the Contractor in accordance with the following:

1. Payment of monthly installment amounts will be made by RBHA on the last Friday of each month.

2. At CPSA’s discretion, the monthly payment to Contractor will be the lesser of

a. an amount equal to one-twelfth (1/12th) of the annual program funding allocation, or

b. the value of the services for which clean claims/encounters have been accepted and approved for the month during each reconciliation period as scheduled.

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3. If CPSA makes a 1/12th payment for a month in which the value of approved encounters is less than the 1/12th installment amount, that payment will be considered provisional and subject to recoupment by a corresponding decrease in any succeeding monthly payment unless encounters sufficient to warrant the provisional 1/12th payment are subsequently approved.

4. If CPSA makes a monthly payment equal to the actual value of approved encounters for that month, any portion of the deficiency between that amount and the possible 1/12th installment may be compensated for by adjusting upward payments in subsequent months in which the value of approved encounters exceeds the 1/12th installments possible for those months.

5. On an on-going, monthly basis, CPSA will reconcile year-to-date clean claim/encounter values adjudicated and approved by the CPSA Claims/Encounter System to the corresponding year-to-date payments. Adjustments to payments may be made on an on-going basis with the intent that, by the end of the contract term, Contractor will have received payment of at most the annual program funding allocation or at least the value of services provided and successfully encountered, adjudicated and approved. To ensure recognition of complete encounters, reconciliation will continue for up to 180 days following the end of the contract year, but in no event will the total payment under the contract exceed the annual program funding allocation.

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SUBCONTRACT AGREEMENT   COMPREHENSIVE SERVICE NETWORK   THE PROVIDENCE SERVICE CORPORATION

CONTRACT NUMBER: A0508 FY05/06

SCHEDULE I-B

SPECIAL PROVISIONS

COST REIMBURSEMENT (CER) METHODOLOGY

(This methodology used for applicable Grant Funded Programs)

A. PAYMENTS

Payments due to the Contractor shall be determined on a cost reimbursement basis.

B. HB 2003

1. Reimbursable HB 2003 expenses are limited to the expenses incurred for Contractor’s staff salary/wage, ERE, mileage, and cellular expenses for the two HB 2003 specific positions of DES/CPS Co-located liaison and PCJCC Co-located liaison following approved expenditures as reported on the Contractor Expenditure Report (CER).

2. On a monthly basis, the Contractor shall complete and submit to CPSA the CER by the fifteenth (15^th) day following the end of the month for which expenses for the two HB 2003 positions, requesting reimbursement for actual salary/wage, ERE, mileage, and cellular expenditures were incurred.

3. Reimbursements will be distributed based on actual expenditures reported by the Contractor and approved by CPSA. CPSA shall reimburse the Contractor within fifteen (15) days of receipt and approval of the CER.

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SUBCONTRACT AGREEMENT   COMPREHENSIVE SERVICE NETWORK   THE PROVIDENCE SERVICE CORPORATION

CONTRACT NUMBER: A0508 FY05/06

SCHEDULE II

PROGRAM FUNDING ALLOCATION

Pending receipt of the final Fiscal Year 2006 Budget from ADHS, the payment methodologies for Fiscal Year 2005 will remain unchanged. Once funding is received CPSA will amend funding allocation schedules to coincide with the approved budget effective October 1, 2005.

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Funding Allocation Schedule

Fiscal Year 2006

Providence Service Corporation

GSA Program	Program funding Source	Program Description	CFDA No	Federal Agency	Compensation Methodology	Contract Type	Contract Amount
TXIX Children	Comprehensive Medical and Dental Plan	Network Service	93.779	CMS, DHHS	1/12th of Annual	Block Purchase - Network	$	6,352,000
TXIX Children	Health Care Financing Research, Demonstrations and Evaluations	Network Services	93.779	CMS, DHHS	1/12th of Annual	Block Purchase - Network	$	6,957,848
TXIX Children	DES / DD Arizona Long Term Care System	Network Services	93.779	CMS, DHHS	1/12th of Annual	Block Purchase - Network	$	383,800
						Program Total:	$	13,693,648
TXXI Children	Health Care Financing Research, Demonstrations and Evaluations	Network Services -Title 21	93.767	CMS, DHHS	1/12th of Annual	Block Purchase - Network	$	789,817
						Program Total:	$	789,817
Non-TXIX Children	Block Grant for Community Mental Health	Federal	93.958	SAMHSA, DHHS	1/12th of Annual	Block Purchase - Network	$	260,068
Non-TXIX Children	Block Grant for Community Mental Health	Flex Funds	93.958	SAMHSA, DHHS	l/12th of Annual	Block Purchase - Network	$	54,720
Non-TXIX Children	State	Children			l/12th of Annual	Block Purchase - Network	$	177,537
Non-TXIX Children	State	Children Mental Health			l/12th of Annual	Block Purchase - Network	$	48,000
Non-TXIX Children	House Bill 2003	Staffing - CPS Liaison (DES Funds)			1/12th of Annual -CER required	Cost Reimbursement	$	62,250
						Program Total:	$	602,575
						Provider Total:	$	15,086,040

Footnotes:

FDA Number: Catalog of Federal Domestic Assistance

Note for Providers with Title XIX and Title XXI Funding: Both Title XIX and Title XXI funds are subject to a state matching funds requirement. The exact state dollar amounts and percentages are not determinded until year end in the ADHS confirmation. CPSA treats all Title XIX and Title XXI funds as federal until ADHS confirms the state match at year end.

Payments to providers are subject to modification should CPSA funding from ADHS be revised.

Version: 20050701-01

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SUBCONTRACT AGREEMENT   COMPREHENSIVE SERVICE NETWORK   THE PROVIDENCE SERVICE CORPORATION

CONTRACT NUMBER: A0508 FY05/06

SCHEDULE III

CONTRACT DELIVERABLES

DELIVERABLE REQUIREMENTS

(7/18/05)

Reference	Deliverable	Due Date	Submit To	Form Req’d
AHCCCS Rules, ADHS Policy	Office of Behavioral Health Licensure (OBHL) License(s)	15 days prior to contract execution. Renewed or amended license within 15 days of issuance	Contracts Unit
AHCCCS Rules, ADHS Policy	Copy of OBHL/DES Licensure Audit Report/Findings	30 days after receipt	Contracts Unit
AHCCCS Rules, ADHS Policy	OBHL/DES Licensure Corrective Action Plan	15 days after due date to OBHL/DES	Contracts Unit
AHCCCS Rules, ADHS Policy	Proof of Accreditation	15 days prior to contract execution. Renewed or amended license within 15 days of issuance	Contracts Unit
RBHA Contract	Professional and Personal Liability Certificate of Insurance	15 days prior to contract execution. Renewed or amended license within 15 days of issuance	Contracts Unit
	General Liability Certificate of Insurance	15 days prior to contract execution. Renewed or amended license within 15 days of issuance	Contracts Unit
	Automobile Liability Certificate of Insurance	15 days prior to contract execution. Renewed or amended license within 15 days of issuance	Contracts Unit
	Worker’s Compensation Insurance	15 days prior to contract execution. Renewed or amended license within 15 days of issuance.	Contracts Unit
RBHA Contract	Contractor’s Subcontract Agreements with Subcontracted Providers and any subsequent amendments.	Within 10 days of execution of new Subcontract Agreement or Amendment	Contracts Unit
RBHA Contract	Organization Chart	Within 30 days of contract award renewal. Within 30 days of any changes.	Contracts Unit
RBHA Contract	List of Board of Directors or equivalent that includes members’ Name, Affiliation, Address and Telephone Number.	Within 30 days of contract award/renewal. Within 30 days of any changes.	Contracts Unit
RBHA Contract	Independent Practitioner (M.D., D.O., R.N., P.A. & Ph.D, N.P, CISW, CPC, CMFT)	Within 5 days of any changes.	Contracts Unit	X

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DELIVERABLE REQUIREMENTS

(7/18/05)

Reference	Deliverable	Due Date	Submit To	Form Req’d
RBHA Contract	HB 2003 Children’s Staff Monthly CER	15 days following the month in which expenses were incurred	Finance Unit	X
RBHA Contract	Schedule of Budgeted Revenue and Expenses	Annually no later August 15 each fiscal year	Finance Unit	X
RBHA Contract	Cost Allocation Plan	Annually no later than August 15 each fiscal year.	Finance Unit
RBHA Contract	Balance Sheet Statement of Operations and Changes in Net Assets Statement of Cash Flow	30 calendar days after month end	Finance Unit
	Supplemental Schedule of Revenue and Expenses	30 calendar days after month end	Finance Unit	X
	Certification Statement	30 calendar days after month end	Finance Unit	X
	Certified audited financial statement Management letter from Contractor’s auditor including any provider responses OMB Circular A-133 Reports, if applicable	150 calendar days following Contractor’s fiscal year end.	Finance Unit
RBHA Contract	Audited Supplemental Schedule of Revenue and Expenses	150 calendar days following Contractor’s fiscal year end	Finance Unit	X
	Attestation of Privileges	Upon completion of a thorough competency assessment of each individual who will perform initial assessments	QM Unit
Office of Behavioral Health Licensure; ADHS/RBHA Contract	Incident/Accident/Mortality Report	Within 24 hours following incident.	QM Unit	X
RBHA Contract	Fraud & Abuse Report	Per incident within 5 days.	QM Unit
RBHA Contract	Restraint and Seclusion Report (SMI & Children Level 1 Facility)	5th day of each month.	QM Unit	X
ADHS Policy; AHCCCS Rules	Medical Care Evaluation Studies (Inpatient/RTC/PHF)	Annually no later than August 15 each fiscal year.	QM Unit	X
RBHA Contract	Contractor’s Policies & Procedures	Annually no later than October 15 each fiscal year; updates within 30 days of revision.	QM Unit
RBHA Contract	Policies or Codes Governing Agency’s Operational Ethics	Prior to implementation for review/approval and Annually thereafter.	QM Unit

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DELIVERABLE REQUIREMENTS

(7/18/05)

Reference	Deliverable	Due Date	Submit To	Form Req’d
RBHA Contract, AHCCS Rules	Agency QM/UM Plan and Annual Review	30 days from initial execution of Subcontract, Annually thereafter by no later than November 15 each fiscal year.	QM Unit
RBHA Contract	QM Site Visit and/or Chart Audit Plan of Correction Report	30 days after receipt of report.	QM Unit
RBHA Contract	Minimum Network Standard and Staff Inventory Report	Quarterly, 30 days following the end of quarter	Systems Development and Evaluation Unit
RBHA Contract	Utilization (Census) Data of Members Out of Home placements	Weekly for Networks including facility subcontractors	Utilization Management Manager
RBHA Contract; ADHS Policy; AHCCCS Rules	Certification of Need (CON) (For TXIX/TXXI members in a Level 1 RTC)	Initial CONs weekly; renewal CONs every 30 days thereafter.	Utilization Management Manager
RBHA Contract	Member Roster Reconciliation	Exception corrections submitted 15 days after month-end.	Information Systems Manager
ADHS Policy & RBHA Contract	Agency’s Training Plan	Annually no later than August 15 each fiscal year, updates within 30 days of revision	Training Manager
ADHS Policy & RBHA Contract	Agency’s Training Report	Annually no later than August 15 each fiscal year.	Training Manager
RBHA Contract	Member Enrollment (PACE electronic submission)	Enrollment, closure and initial demographic assessment within 5 days of intake and closure.	Information Systems Manager
RBHA Contract	Progress Updates toward meeting targeted outcomes	By the 5th day of the month following quarter	Network Development Manager

Page 48

SUBCONTRACT AGREEMENT   COMPREHENSIVE SERVICE NETWORK   THE PROVIDENCE SERVICE CORPORATION

CONTRACT NUMBER: A0508 FY05/06

ATTACHMENT A

Definitions

The terms contained in this subcontract are defined as follows:

“638 Tribal Facility” means a facility owned and operated by a Native American tribe authorized to provide services pursuant to Public Law 93-638, as amended.

“834 Transaction Enrollment/Disenrollment” means the HIPAA-compliant transmission, by a behavioral health provider to a T/RBHA and by a T/RBHA to ADHS/DBHS, of information to establish or terminate a person’s enrollment in the ADHS/DBHS behavioral health service delivery system.

“A.A.C.” means the Arizona Administrative Code.

“A.R.S.” means the Arizona Revised Statutes.

“ACYF” means the Administration for Children, Youth and Families within ADES.

“ADES” means the Arizona Department of Economic Security.

“ADHS” means the Arizona Department of Health Services.

“ADHS Information System” means the ADHS/DBHS Information Systems in place or any other data collection and information system as may from time to time be established by the ADHS/DBHS.

“ADHS/DBHS” means the Arizona Department of Health Services, Division of Behavioral Health Services.

“ADJC” means the Arizona Department of Juvenile Corrections.

“Administrative Costs” means administrative expenses incurred to manage the behavioral health system, including, but not limited to: provider relations and contracting, provider billing, accounting, information technology services, processing and investigating grievances and appeals, legal services (including any legal representation of the Contractor at administrative hearings concerning the Contractor’s decisions, and actions), planning, program development, program evaluation, personnel management, staff development and training, provider auditing and monitoring, utilization review and quality assurance. Administrative costs do not include expenses related to direct provision of behavioral health services including case management. See also Financial Reporting Guide for categories of classification.

“ADOC” means the Arizona Department of Corrections.

“ADOE” means the Arizona Department of Education.

“Adult” means a person 18 years of age or older, unless the term is given a different definition by statute, rule, or policies adopted by the ADHS or AHCCCS.

“AHCCCS” means the Arizona Health Care Cost Containment System.

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“AHCCCS Health Plan” means an organization or entity agreeing through a direct contracting relationship with AHCCCS to provide the goods and services specified by contract in conformance with the stated contract requirements, AHCCCS statute and rules and federal law and regulations.

“ALTCS” means the Arizona Long Term Care System.

“AMPM” meant the AHCCCS Medical Policy Manual.

“AOC” means the Administrative Office of the Courts of the Arizona Supreme Court.

“Arizona Administrative Code (A.A.C.)” means the State regulations established pursuant to relevant statutes.

“Arizona Long Term Care System (ALTCS)” means a program under AHCCCS that delivers long term, acute and behavioral health care services to eligible members, as authorized by A.R.S. §36-2931 et seq.

“Arizona Revised Statute (A.R.S.)” means the laws of the State of Arizona.

“Attachment” means documents that information only and do not affect the scope, terms, or conditions of the contract.

“BBA” means the Balanced Budget Act of 1997.

“Behavioral Health Disorder” means any behavioral or mental diagnosis and/or substance use (abuse/dependence) diagnosis found in the most current version of the Diagnostic and Statistical Manual or International Classification of Disorders.

“Behavioral Health Paraprofessional” means a staff member of a licensed behavioral health service agency as specified in A.A.C. Title 9, Chapter 20.

“Behavioral Health Professional” means a psychiatrist, behavioral health medical practitioner, psychologist, social worker, counselor, marriage and family therapist, substance abuse counselor or registered nurse with at least one year of full time behavioral health work experience and who meets the requirements of A.A.C. Title 9, Chapter 20.

“Behavioral Health Provider” means any individual or facility that delivers behavioral health services in the network. This may be the Contractor or a subcontracted behavioral health provider.

“Behavioral Health Recipient” means any adult or child receiving services in/through ADHS funded programs.

“Behavioral Health Services” means those services listed in the ADHS Covered Behavioral Health Services Guide.

“Behavioral Health Technician” means a staff member of a licensed behavioral health service agency as specified in A.A.C. Title 9, Chapter 20.

“Best Practices” means evidence-based practices, promising practices, or emerging practices.

“Board Eligible for Psychiatry” means documentation of completion of an accredited psychiatry residency program approved by the American College of Graduate Medical Education, or the American Osteopathic Association. Documentation would include either a certificate of residency training including exact dates, or a letter of verification of residency training from the training director including the exact dates of training.

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“Capitation” is a method by which a Contractor or Subcontractor is paid to deliver covered services for the duration of a contract to eligible persons based on a fixed rate per member per month notwithstanding (a) the actual number of eligible persons who receive care from the Contractor and (b) the amount of services provided to any enrolled person; a cost containment alternative to fee-for-service.

“Center for Medicare and Medicaid Services” (CMS, formerly HCFA) means the organization within the United States Department of Health and Human Services, which administers the Medicare and Medicaid program and the State Children’s Health Insurance Program.

“CFR” means the Code of Federal Regulations.

“Child” means an eligible person who is under the age of 18, unless the term is given a different definition by statute, rule or policies adopted by the ADHS or AHCCCS.

“Child and Family Team” means a defined group of people that includes, at a minimum, the child and his/her family, a behavioral health representative, and any individuals important in the child’s life and who are identified and invited to participate by the child and family. This may include, for example, teachers, extended family members, friends, family support partners, healthcare providers, coaches, community resource providers, representatives from churches, synagogues or mosques, agents from other service systems like CPS or DDD, etc. The size, scope and intensity of involvement of the team members are determined by the objectives established for the child, the needs of the family in providing for the child, and by which individuals are needed to develop an effective service plan, and can therefore expand and contract as necessary to be successful on behalf of the child.

“CIS” means the Client Information System.

“Client Information System” means the data system used by DHS.

“Clinical Liaison” means a behavioral health professional or a behavioral health technician who has been credentialed and privileged by the T/RBHA or their designee in accordance with ADHS/DBHS requirements to perform this function. The Clinical Liaison: (1) Assumes the primary responsibility of clinical oversight of the person’s care (2) Ensures the clinical soundness of the assessment/treatment process (3) Serves as the point of contact, coordination and communication with the person’s team and other systems where clinical knowledge of the case is important.

“CMDP” means the Comprehensive Medical and Dental Plan, an AHCCCS Health Plan administered through DES who provide for medical needs of children in the care and custody of the state.

“CMHS” means the Community Mental Health Services Performance Partnership Program Pursuant to Division B, Title XXXII, Section 3204 of the Children’s Health Act of 2000.

“CMS” (formerly HCFA) means Center for Medicare and Medicaid Services.

“Collaborative Team” means a team of individuals whose primary function is to develop a comprehensive and unified service or treatment plan for an enrolled person. The team may include an enrolled person, member of the enrolled person’s family, health, mental health or social service providers including professionals representing disciplines related to the person’s needs, or other persons that are not health, mental health or social service providers identified by the person or family. Collaborative Teams include child and family teams and adult teams.

“Community Service Agency” means an agency that is contracted directly by the Contractor or a provider network and registered with AHCCCS to provide rehabilitation and support services consistent with the staff qualifications and training. Community Service Agencies are not required to be licensed through the ADHS Office of Behavioral Health Licensure. Refer to the ADHS/DBHS Covered Behavioral Health Services Guide for details.

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“Contract” means the written agreement between CPSA and ADHS under which CPSA operates as the Regional Behavioral Health Authority.

“Contract Amendment” means a written document signed by the parties to a subcontract for the purpose of making changes in the Contract.

“Contract Year” means a period from July 1 of a calendar year through and including June 30 of the following year.

“Contractor” means the person or entity bound by the terms of a subcontract with CPSA.

“Covered Services” means those services listed in the ADHS/DBHS Covered Behavioral Health Services Guide.

“CPS” means the Child Protective Services within the ADES.

“Credentialing” means the process of obtaining, verifying and assessing information (e.g. validity of the license, certification, training and/or work experience) to determine whether a behavioral health professional or a behavioral health technician has the required credentials to provide behavioral health services to persons enrolled in the ADHS/DBHS behavioral health system. It also includes the review and verification of applicable licensure, accreditation and certification of behavioral health providers.

“Cultural Competence” means a set of congruent behaviors, attitudes and policies that come together in a system, agency, or among professionals which enables that system, agency or those professionals to work effectively in cross-cultural situations.

“Days” means calendar days unless otherwise specified.

“DBHS” means the Division of Behavioral Health Services within ADHS.

“DDD” means the Division of Developmental Disabilities within ADES.

“Department” means the Arizona Department of Health Services.

“Deputy Director” means the Deputy Director for the ADHS or his or her duly authorized representative.

“DHS” means the Arizona Department of Health Services.

“Eligible Person” means an individual who needs or is at risk of needing ADHS covered services.

“Emerging Practices” means new innovations in clinical or administrative practice that address critical needs of a particular program, population or system, but do not yet have scientific evidence or broad expert consensus support.

“Encounter” means a record of a covered service rendered by a provider to a person enrolled with a capitated RBHA on the date of service.

“Enrolled Person” means a Title XIX, Title XXI or Non-Title XIX/XXI eligible person recorded in the ADHS Information System as specified by the ADHS.

“Enrollment” means the process by which a person is enrolled into the Contractor and DHS data system.

“Evidence-based practice” means an intervention that is an integration of science-based evidence; the skill and judgment of health professionals; and the unique needs, concerns and preferences of the person receiving services. Evidence-based practices are not intended to be automatically and uniformly applied, but instead considered as a combination of all three factors.

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“Formulary” means a list of medications that are made available by individual T/RBHAs for their enrolled members. The list must encompass all medications included on the ADHS/DBHS minimum list of medications.

“Fraud” means an intentional deception or misrepresentation made by a person with the knowledge that the deception could result in some unauthorized benefit to the person or some other person. It includes any act that constitutes fraud under applicable Federal or State Law.

“GAAP” means Generally Accepted Accounting Principles.

“General Mental Health Adults” means a classification of adult persons age eighteen and older who have general behavioral health issues and have not been determined to have a serious mental illness.

“Geographic Service Area” means a specific county or defined grouping of counties that are available for contract award. The Contractor is responsible to provide covered services to eligible residents of their contracted GSA (s) except as otherwise stated in this Contract.

“GMH” means General Mental Health and is used to designate adult fund type.

“GMH/SA” means General Mental Health and Substance Abuse and is used to designate adult fund type.

“Gratuity” means a payment, loan, subscription, advance, deposit of money, services, or anything of more than nominal value, present or promised, unless consideration of substantially equal or greater value is received.

“GSA” means Geographic Service Area.

“HB2003” means House Bill 2003 enacted 2000 Arizona Session Laws, Chapter 2, Section 1 (5^th Special Session).

“Health Insurance Portability and Accountability Act of 1996 (HIPAA)” means Public Law 104-291 Title II Subtitle F and regulations published by the United States Department of Health and Human Services, the administrative simplification provisions and modifications thereof, and the Administrative Simplification Compliance Act of 2001.

“HIPAA” means Health Insurance Portability and Accountability Act of 1996.

“HUD” means the United States Department of Housing and Urban Development.

“IBNR” means claims for covered services that have been Incurred But Not Reported.

“IGA” means an Intergovernmental Agreement.

“IHS” means the Indian Health Service of the United States Department of Health and Human Services.

“IMD” means an Institution for Mental Disease.

“Incurred But Not Reported (IBNR)” means liability for service rendered for which claims have not been reported.

“Indian Health Service (IHS)” means the bureau of the United States Department of Health and Human Services that is responsible for delivering public health and medical services to American Indians throughout the country. The federal government has direct and permanent legal obligation to provide health services to most American Indians according to treaties with Tribal Governments.

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“Institution for Mental Disease (IMD)” means a hospital, nursing facility, or other institution of more than 16 beds that is primarily engaged in providing diagnosis, treatment, or care of persons with mental diseases, including medical attention, nursing care, and related services. An institution is an IMD if its overall character is that of a facility established and maintained primarily for the care and treatment of individuals with mental diseases (42 CFR 435.1009). In the State of Arizona, Level I facilities with more than 16 beds are IMDs except when licensed as a unit of a General Medical Hospital.

“Interagency Service Agreement (ISA)” means an agreement between two or more agencies of the State wherein an agency is reimbursed for services provided to another agency or is advanced funds for services provided to another agency.

“Intergovernmental Agreement (IGA)” means an agreement conforming to the requirements of A.R.S. Title 11, Chapter 7, Article 3 (A.R.S. § 11-951 et. seq.).

“ISA” means an Interagency Service Agreement.

“KidsCare” means the Arizona version implementing the Title XXI of the Social Security Act, referred to in federal legislation as the “State Children’s Health Insurance Program” (SCHIP).

“Level I Behavioral Health Facility” means a behavioral health agency as defined in A.A.C. Title 9, Chapter 20.

“Level II Behavioral Health Facility” means a behavioral health agency as defined in A.A.C. Title 9, Chapter 20.

“Level III Behavioral Health Facility” means a behavioral health agency as defined in A.A.C. Title 9, Chapter 20.

“Materials” means all property including equipment, supplies, printing, insurance and leases of property but does not include land, a permanent interest in land or real property or leasing space. ¹

“Medically Necessary Covered Services” means those covered services provided by qualified service providers within the scope of their practice to prevent disease, disability and other adverse health conditions or their progression or to prolong life.

“Member” means a person receiving behavioral health services.

“Member Appeal” means a request for a review of an action in accordance with 42 CFR 438.400, and for a person with an SMI, an appeal of an SMI eligibility determination; decisions regarding eligibility for behavioral health services, including Title XIX services, fees and waivers; assessments and further evaluations; service and treatment plans and planning decisions; and the implementation of those decisions.

“Network Material Change” means an alteration or development within a provider network that may reasonably be foreseen to affect the quality or delivery of covered services provided under this Contract.

“Non-Title XIX/XXI Funding” means fixed, non-capitated funds, including funds from CMHS and SAPT, State appropriations (other than state appropriations to support the Title XIX and Title XXI program), counties and other funds, which are used for services to Non-Title XIX/XXI eligible persons and for services not covered by Title XIX or Title XXI provided to Title XIX and Title XXI eligible persons.

“Non-Title XIX/XXI Person” means an individual who needs or may be at risk of needing covered services, but does not meet Federal and State requirements for Title XIX or Title XXI eligibility.

“Outreach” means activities to identify and encourage individuals who may be in need of behavioral health services to receive them.

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“PCP” means Primary Care Provider.

“Primary Care Provider/Practitioner (PCP)” is an individual who meets the requirement of A.R.S. 36-2901, and who is responsible for the management of a member’s health care. A PCP may be a physician defined as a person licensed as an allopathic or osteopathic physician according to A.R.S. Title 32, Chapter 13 or Chapter 17, or a practitioner defined as physician assistant licensed under A.R.S. Title 32, Chapter 25, or a certified nurse practitioner licensed under A.R.S. Title 32, Chapter 15.

“Prior Authorization” means an action taken by ADHS/DBHS, a RBHA or a subcontracted provider that approves the provision of a covered service prior to the service being provided.

“Privileging” means the process used to determine if credentialed clinicians are competent to perform their assigned responsibilities, based on training, supervised practice and/or competency testing.

“Profit” means the excess of revenues over expenditures, in accordance with Generally Accepted Accounting Principles, regardless of whether the Contractor is a for-profit or a not-for-profit entity.

“Promising Practices” means clinical or administrative practices for which there is considerable evidence or expert consensus and which show promise in improving client outcomes, but which are not yet proven by the highest or strongest scientific evidence.

“Provider” means an organization and/or behavioral health professional who provides behavioral health services to behavioral health recipients.

“Provider Network” means the agencies, facilities, professional groups or professionals under subcontract to the Contractor to provide covered services to behavioral health recipients and includes the Contractor to the extent the Contractor directly provides covered services to behavioral health recipients.

“Psychiatrist” means a person who is a licensed physician as defined in A.R.S. Title 32, Chapter 13 or Chapter 17 and who holds psychiatric board certification from the American Board of Psychiatry and Neurology, the American College of Osteopathic Neurologist and Psychiatrist; or the American Osteopathic Board of Neurology and Psychiatry; or is board eligible.

“RBHA” means a Regional Behavioral Health Authority.

“Referral for Behavioral Health Services” means any oral, written, faxed, or electronic request for behavioral health services made by any person, or person’s legal guardian, family member, an AHCCCS health plan, primary care provider, hospital, jail, court, probation and parole officer, tribal government, Indian Health Services, school, or other state or community agency.

“Regional Behavioral Health Authority” means an organization under contract with the ADHS to coordinate the delivery of behavioral health services to eligible and/or enrolled persons in a geographically specific service area of the state.

“Related Party” means a party that has, or may have, the ability to control or significantly influence a Contractor, or a party that is, or may be, controlled or significantly influenced by a Contractor. “Related parties” include, but are not limited to, agents, managing employees or persons with an ownership or controlling interest in the disclosing entity, and their immediate families, subcontractors, wholly-owned subsidiaries or suppliers, parent companies, sister companies, holding companies, and other entities controlled or managed by any such entities or persons.

“RSA” means the Rehabilitation Services Administration within the ADES.

“RTC” means Level 1 Residential Treatment Center.

“SA” means Substance Abuse and is used to designate adult fund type.

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“SAPT” means Substance Abuse Prevention and Treatment. Performance Partnership Program pursuant to Division B. Title XXXIII, Section 3303 of The Children’s Health Act of 2000 pursuant to Section 1921 – 1954 of the Public Health Service Act and 45 CFR Part 96 Interim Final Rules.

“Serious Mental Illness” means a condition of persons who are eighteen years of age or older and who, as a result of a mental disorder as defined in A.R.S §36-501, exhibit emotional or behavioral functioning which is so impaired as to interfere substantially with their capacity to remain in the community without supportive treatment or service of a long term or indefinite duration. In these persons mental disability is severe and persistent, resulting in long term limitation of their functional capacities for primary activities of daily living such as interpersonal relationships, homemaking, self-care, employment and recreation.

“Seriously Emotionally Disturbed” means those children from birth up to age 18 who meet diagnostic requirements as set forth by the ADHS.

“Services” means the behavioral health, prevention or management services provided under the terms of a subcontract.

“SMI” means Seriously Mentally Ill.

“State” means the State of Arizona and Department or Agency of the State that executes the contract.

“State Fiscal Year” means the period beginning with July 1 and ending June 30.

“State Plan” means the written agreements between the State of Arizona and CMS which describe how the AHCCCS programs meet all CMS requirements for participation in the Medicaid program and the Children’s Health Insurance Program.

“Statistical Significance” means a mathematical measure of change within the sample population, when the sample population is large enough to be considered representative of the overall population. The change is said to be statistically significant if it is greater than what might be expected to happen by chance alone. The mathematical threshold is a statistically significant change would occur less than 5% of the time by chance alone.

“Subcontract” means any Contract, express or implied, between the Contractor and another party or between a subcontractor and another party delegating or assigning, in whole or in part, the making or furnishing of any material or any service required for the performance of the Contract.

“Subcontractor” means any third party under contract with the Contractor, in a manner conforming to the ADHS requirements.

“Substance Abuse Adults” means a classification of adults age eighteen and older who have a substance use disorder and have not been determined to have a serous mental illness.

“Support Services” means covered services provided to facilitate the delivery of or enhance the benefit received from other behavioral health services. Refer to the ADHS/DBHS Covered Behavioral Health Services Guide for additional information.

“T/RBHA” means a reference to both RBHAs and Tribal RBHAs.

“Team” means a group of individuals working in collaboration who are actively involved in a person’s assessment, service planning and service delivery. At a minimum, the team consists of the person, family members as appropriate in the case of children and a qualified behavioral health clinician. As applicable, the team would also include representatives from other state agencies, clergy, other relevant practitioners involved with the person and any other individuals requested by the person.

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“Third Party Liability” means sources available to pay all or a portion of the cost of services incurred by a person.

“Title XIX” means Title XIX of the Social Security Act, as amended. This is the Federal statute authorizing Medicaid which is administered by the AHCCCS.

“Title XIX Covered Services” means those covered services identified in the ADHS/DBHS Covered Behavioral Health Services Guide as being Title XIX reimbursable.

“Title XIX Eligible Person” means an individual who meets Federal and State requirements for Title XIX eligibility.

“Title XIX Member” means an AHCCCS member eligible for Federally funded Medicaid programs under Title XIX of the Social Security Act including those eligible under Section 1931 provisions of the Social Security Act (previously AFDC), Sixth Omnibus Budget Reconciliation Act (SOBRA), Supplemental Security Income (SSI), SSI-related groups, and Title XIX Waiver Groups.

“Title XIX Waiver Member” means all AHCCCS Medical Expense Deduction (MED) members, and adults or childless couples at or below 100% of the Federal Poverty Level who are not categorically linked to another Title XIX program. This would also include Title XIX linked individuals whose income exceeds the limits of the categorical program.

“Title XXI” means Title XXI of the Social Security Act, referred to in federal legislation as the State Children’s Health Insurance Program (SCHIP). The Arizona version of SCHIP is referred to as KidsCare.

“Title XXI Covered Services” means those covered services identified in the ADHS/DBHS Covered Behavioral Health Services Guide as being Title XXI reimbursable.

“Title XXI Eligible Person” means an individual who meets Federal and State requirements for Title XXI eligibility.

“Title XXI Member” means a person eligible for acute care services under Title XXI of the Social Security Act, referred to in federal legislation as the “State Children’s Health Insurance Program” (SCHIP). The Arizona version of the SCHIP is referred to as KidsCare.

“Treatment” means the range of behavioral health care received by a behavioral health recipient.

“Treatment Services” means covered services provided to identify, prevent, eliminate, ameliorate, improve or stabilize specific symptoms, signs and behaviors related to, caused by, or associated with a behavioral health disorder.

“Tribal RBHA” means a Native American Indian tribe under Contract with ADHS to coordinate the delivery of behavioral health services to eligible and enrolled persons who are residents of the Federally recognized Tribal Nation that is the party to the Contract.

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SUBCONTRACT AGREEMENT

COMPREHENSIVE SERVICE NETWORK

THE PROVIDENCE SERVICE CORPORATION

CONTRACT NUMBER: A0508 FY05/06

ATTACHMENT B

SERVICE SITE LISTING

Contractor Name:	Providence of Arizona, Inc.			License #:	BH 1229
Facility Address:	620 N. Craycroft			AHCCCS #:	421397	Loc:	01
City/State/Zip:	Tucson, AZ 85711			E.I.N./T.I.N./SS#:	86-0706547
Phone Number:	520.748.7108	Fax Number:	520.747.6605	Provider Type:	77
E-Mail Address:	www.provcorp.com			COS:	01, 12, 23, 26, 47
Mailing Address:	Same as Facility			eCura Site ID:	530

Intake Site: x Yes ¨ No Operating Hours: Monday – Friday, 8 AM – 5 PM

Contract Effective Dates: Start Date: July 1, 2005                     End Date: June 30, 2006

Benefit Plans:
x Children’s Services:	x Title XIX	x Title XXI	x Non-Title XIX	x Non-Title XXI

Contractor Name:	Providence of Arizona, Inc.			License #:	BH 2200
Facility Address:	3602 W. Thomas Road			AHCCCS #:	796021	Loc:	01
City/State/Zip:	Phoenix, AZ 85019			E.I.N./T.I.N./SS#:	86-0706547
Phone Number:	602.455.4626	Fax Number:	602.455.4624	Provider Type:	77
E-Mail Address:	www.provcorp.com			COS:	01, 26, 39, 47
Mailing Address:	620 N. Craycroft, Tucson, AZ 85711			eCura Site ID:	2775

Intake Site: ¨ Yes x No Operating Hours: Monday –Friday, 8 AM – 5 PM

Contract Effective Dates: Start Date: July 1, 2005             End Date: June 30, 2006

Benefit Plans:
x Children’s Services:	x Title XIX	x Title XXI	x Non-Title XIX	x Non-Title XXI

Contractor Name:	Providence of Arizona, Inc.			License #:	BH 2551
Facility Address:	6261 N. La Cholla Blvd # 131			AHCCCS #:	798415	Loc:	01
City/State/Zip:	Tucson, AZ 85741			E.I.N./T.I.N./SS#:	86-0706547
Phone Number:	520.744.4376	Fax Number:	520.579.1138	Provider Type:	77
E-Mail Address:	www.provcorp.com			COS:	01, 26, 39, 47
Mailing Address:	620 N. Craycroft, Tucson, AZ 85711			Site ID:	2624

Intake Site: x Yes ¨ No Operating Hours: Monday – Friday, 8 AM – 5 PM

Contract Effective Dates: Start Date: November 1, 2005 End Date: June 30, 2006

Benefit Plans:
x Children’s Services:	x Title XIX	x Title XXI	x Non-Title XIX	x Non-Title XXI

Page 58

SUBCONTRACT AGREEMENT

COMPREHENSIVE SERVICE NETWORK

THE PROVIDENCE SERVICE CORPORATION

CONTRACT NUMBER: A0508 FY05/06

ATTACHMENT C

INDEPENDENT PRACTITIONERS (M.D., D.O., R.N.P, P.A. Ph.D.)

Name:	Michael J. Mardis		Credentials:    MD	License #:	27301
Mailing Address:	620 N. Craycroft			AHCCCS #:	483454
City/State/Zip:	Tucson, AZ 85711			E.I.N./T.I.N./SS#:	86-0706547
Phone Number:	748-7108	FAX Number:	745-1707	Provider Type:	08
E-Mail Address:	mmardis@provcorp.com			1COS:	01, 47

Effective Dates:	Start Date:	July 1, 2005	End Date:    November 30, 2005
Service Site (1):	620 N. Craycroft		Site ID:    2645

Prescribing Privileges:         x Yes ¨ No DEA # BM6302284 DEA Start: 7/19/99 DEA End: 1/31/02

Children’s Services: x Title XIX     x Title XXI     x Non-Title XIX     x Non-Title XXI

Name:	Ann Maier		Credentials:    NP		License #:	RN034351
Mailing Address:	620 N. Craycroft				AHCCCS #:	563769
City/State/Zip:	Tucson, AZ 85711				E.I.N./T.I.N./SS#:	86-0706547
Phone Number:	748-7108	FAX Number:		745-1707	Provider Type:	19
E-Mail Address:	___________________________________________________________________				COS	01, 47
Effective Dates:	Start Date:    July 1, 2005			End Date:     November 30, 2005
Service Site (1):	620 N. Craycroft				Site ID:     1016

Prescribing Privileges: x Yes ¨ No DEA# MM0333839 DEA Start: 12/3/03 DEA End: 1/31/07

Children’s Services: x Title XIX x Title XXI x Non-Title XIX x Non-Title XXI

Name:	Karen Van Wie		Credentials:     NP		License #:	RN037770
Mailing Address:	620 N. Craycroft				AHCCCS #:	948408
City/State/Zip:	Tucson, AZ 85711				E.I.N./T.I.N./SS#:	86-0706547
Phone Number:	748-7108	FAX Number:		745-1707	Provider Type:	19
E-Mail Address:	___________________________________________________________________				COS	01, 47

Effective Dates:	Start Date:     August 1, 2005	End Date:     October 16, 2005
Service Site (1): 620 N. Craycroft			Site ID:     4304

Prescribing Privileges:     x Yes ¨ No DEA# MM0333839 DEA Start: 12/3/03 DEA End: 1/31/07

Children’s Services: x Title XIX x Title XXI x Non-Title XIX x Non-Title XXI

¹ AHCCCS Category of Service (COS) – For Provider Types 08 (Physician, Specialty Code 192 or 195); 18 (Physician Assistant); 19 (Registered Nurse Practitioner, Specialty Code 098); or 31(Osteopath, Specialty Code 192) must have COS 47 – Mental Health Services.

Page 59

SUBCONTRACT AGREEMENT   COMPREHENSIVE SERVICE NETWORK   THE PROVIDENCE SERVICE CORPORATION

CONTRACT NUMBER: A0508 FY05/06

ATTACHMENT D

CONTRACTOR’S EXPENDITURE REPORT – HB2003 CER

(FOLLOWING PAGE)

Page 60

CONTRACTOR’S EXPENDITURE REPORT

1. Contractor’s Name: Providence

2. Title of Program: House Bill 2003 Children’s - GSA 5

3. Period Covered: From July 1, 2005 To June 30, 2006

BUDGET			ACTUAL EXPENDITURES
	Current Budget	One Month Budget	Jul-05	Aug-05	Sep-05	Qtr. 1	Oct-05	Nov-05	Dec-05	Qtr. 2	Jan-06	Feb-06	Mar-06	Qtr. 3	Apr-06	May-06	Jun-06	Qtr. 4	YTD Actual Expense
Personnel Expenses
CPS Liaison (1)
DES	40,000	3,333				—				—				—				—	—
Court Care Coordinator (1)	40,000	3,333
AOC	7,167	597				—				—				—				—	—
DES	32,833	2,736				—				—				—				—	—
Service Expenses																			—
Family Preservation Service
DES						—				—				—				—	—
Total Expenses	80,000	6,667	—	—	—	—	—	—	—	—	—	—	—	—	—	—	—	—	—

CPSA CHILDREN’S NETWORK MANAGER

¨ Performance Satisfactory for Payment

¨ Performance Unsatisfactory, withhold payment

¨ No payment due

Network Manager Signature                                         Date

CONTRACTOR’S CERTIFICATION

I certify that this report has been examined by me, and to the best of my knowledge and belief, the reported expenditures are valid, based upon our official accounting records (book of account) and are consistent with terms of the contract. It is also understood that the contract payments are calculated by CPSA based upon information provided in this report.

Authorized Contractor Signature/Title                         Date

Page 61

	SUBCONTRACT AGREEMENT THE PROVIDENCE SERVICE CORPORATION
Contract Number: A0508	Amendment #1	FY05/06

Effective July 1, 2005 the Subcontract Agreement between Community Partnership of Southern Arizona and The Providence Service Corporation is amended as follows:

The language on page 36 Section B., is revised and should read as follows:

B. Financial Withholding

2. Hospital:

a. CPSA will withhold the prorated contractor’s share of hospital block payments from this contract. On a quarterly basis, CPSA will reconcile actual contractor hospital utilization to the hospital block purchase payments. Within 30 days of the completion of the hospital block purchase bed day reconciliation, CPSA will adjust the contractor’s payments accordingly.

All other terms, conditions and provisions of the Subcontract Agreement shall remain the same.

CPSA:	Community Partnership of Southern Arizona
Signature:	/s/ Neal Cash
Print Name and Title:	Neal Cash, Chief Executive Officer
Date:	October 11, 2005
CONTRACTOR:	The Providence Service Corporation
Signature:	/s/ Craig A. Norris
Print Name and Title:	Craig A. Norris, Chief Operating Officer The Providence Service Corporation
Date:	September 19, 2005

Page 62

	SUBCONTRACT AGREEMENT THE PROVIDENCE SERVICE CORPORATION
Contract Number: A0508	Amendment #2	FY05/06

Effective July 1, 2005 the Subcontract Agreement between Community Partnership of Southern Arizona and The Providence Service Corporation is amended as follows:

1. Program Funding Allocation is added to Schedule II and is attached.

All other terms, conditions and provisions of the Subcontract Agreement shall remain the same.

CPSA:	Community Partnership of Southern Arizona
Signature:	/s/ Neal Cash
Print Name and Title:	Neal Cash, President/Chief Executive Officer
Date:	December 21, 2005
CONTRACTOR:	The Providence Service Corporation
Signature:	/s/ Craig A. Norris
Print Name and Title:	Craig A. Norris, Chief Operating Officer
Date:	December 13, 2005

Page 63

EX-10.12

Exhibit 10.12

Annual Incentive Compensation Plan

The Annual Incentive Compensation Plan is designed as a team bonus and is not triggered unless the Company meets or exceeds its budgeted net income and earnings per share for fiscal 2006 (calculated after giving effect to any bonuses accrued under the Annual Incentive Compensation Plan and the Quarterly Incentive Bonus Plan).

The bonus team participants include Fletcher J. McCusker (Chief Executive Officer), Michael N. Deitch (Chief Financial Officer), William Boyd Dover (President), Craig A. Norris (Chief Operating Officer), Fred D. Furman (Executive Vice President and General Counsel), (the “Named Executive Officers”).

Individuals of the bonus team are eligible to receive a cash bonus as follows: (1) if net income and earnings per share exceeds budgeted target amounts by 1% to 5%, the cash bonus payable to each individual will be 25% of the individual’s 2006 base salary; and (2) if net income and earnings per share exceeds budgeted target amounts by more than 5%, the cash bonus payable to each individual will be 50% of the individual’s 2006 base salary.

Quarterly Incentive Bonus Plan

Each Named Executive Officer is eligible to receive a bonus under the Quarterly Incentive Bonus Plan. The Quarterly Incentive Bonus Plan is designed as a team bonus and is triggered if the Company meets or exceeds its budgeted net income and earnings per share for each quarter during the Company’s fiscal year (calculated after giving effect to any bonuses accrued under the Quarterly Incentive Bonus Plan and the Annual Incentive Compensation Plan). Individuals of the bonus team are eligible to receive a cash bonus of $5,000 for each quarter the bonus is triggered under the Quarterly Incentive Bonus Plan. The total annual amount each individual of the bonus team may receive under the Quarterly Incentive Bonus Plan is $20,000.

EX-10.13

EXHIBIT 10.13

SUMMARY SHEET OF DIRECTOR FEES AND EXECUTIVE OFFICER COMPENSATION

I.    Director Compensation

As compensation for their service as directors of The Providence Service Corporation (the “Company”), each non-employee member of the Board of Directors (the “Board”) receives a $10,000 annual stipend, except for the Audit Committee Chair who receives a $28,800 annual stipend. Payment of the annual stipends is made on a quarterly basis following each quarter of service. Additionally, each non-employee member of the Board receives $3,500 for each Board meeting attended in person, $1,000 for each telephonic meeting of the Board participated in, and $1,000 for each committee meeting attended or participated in by telephone of which such non-employee member of the Board is a member that is not held the same day as a Board meeting, except that the Audit Committee Chair receives $2,500 for each Audit Committee meeting attended or participated in by telephone that is not held the same day as a Board meeting.

In addition, each non-employee member then serving on the first business day of each January receives a ten year option to purchase 10,000 shares of the Company’s common stock under the Company’s 2003 Stock Option Plan with an exercise price equal to the closing market price of the Company’s common stock on the date of grant. For services to be rendered in 2006, each non-employee director was awarded an option to purchase 10,000 shares of the Company’s common stock on December 6, 2005 under the Company’s 2003 Stock Option Plan in lieu of receiving the award in January 2006. On December 29, 2005, the vesting of all unvested options then outstanding, including those options awarded to non-employee directors, were accelerated.

II.    Executive Compensation

Base Salaries

The following table sets forth current base salaries of the Company’s CEO and each of the executive officers who were named in the Summary Compensation Table in the Company’s definitive proxy statement filed with the SEC on April 20, 2005 and each executive officer expected to be named in the Summary Compensation Table in the Company’s definitive proxy statement to be filed with the SEC with respect to the Company’s 2006 annual stockholders meeting (the “Named Executive Officers”).

Name	Base Salary
Fletcher Jay McCusker	$	250,000
William Boyd Dover		190,000
Michael N. Deitch		195,000
Fred D. Furman		195,000
Craig A. Norris		200,000

Bonuses

Annual Incentive Compensation Plan

Each Named Executive Officer is eligible to receive a bonus under the Annual Incentive Compensation Plan. The Annual Incentive Compensation Plan is designed as a team bonus and is not triggered unless the Company meets or exceeds its budgeted net income and earnings per share for fiscal 2006 (calculated after giving effect to any bonuses accrued under the Annual Incentive Compensation Plan and the Quarterly Incentive Bonus Plan). Individuals of the bonus team are eligible to receive a cash bonus as follows: (1) if net income and earnings per share exceeds budgeted target amounts by 1% to 5%, the cash bonus payable to each individual will be 25% of the individual’s 2006 base salary; and (2) if net income and earnings per share exceeds budgeted target amounts by more than 5%, the cash bonus payable to each individual will be 50% of the individual’s 2006 base salary.

Quarterly Incentive Bonus Plan

Each Named Executive Officer is eligible to receive a bonus under the Quarterly Incentive Bonus Plan. The Quarterly Incentive Bonus Plan is designed as a team bonus and is triggered if the Company meets or exceeds its budgeted net income and earnings per share for each quarter during the Company’s fiscal year (calculated after giving effect to any bonuses accrued under the Quarterly Incentive Bonus Plan and the Annual Incentive Compensation Plan). Individuals of the bonus team are eligible to receive a cash bonus of $5,000 for each quarter the bonus is triggered under the Quarterly Incentive Bonus Plan. The total annual amount each individual of the bonus team may receive under the Quarterly Incentive Bonus Plan is $20,000.

Participation in Stock Option Plan and Other Arrangements

The Named Executive Officers are also eligible to:

• Participate in the Company’s 2003 Stock Option Plan;

• Participate in certain group life, health, medical and other non-cash benefits generally available to all salaried employees; and

• Participate in certain health and dental benefits for their family, which are not available to all salaried employees.

EX-21.1

EXHIBIT 21.1

Name of Subsidiary	State Incorporation
Camelot Care Corporation	Delaware
Cypress Management Services, Inc.	Florida
Family Preservation Services, Inc.	Virginia
Family Preservation Services of Florida, Inc.	Florida
Family Preservation Services of North Carolina, Inc.	North Carolina
Family Preservation Services of West Virginia, Inc.	West Virginia
Providence of Arizona, Inc.	Arizona
Providence Service Corporation of Delaware	Delaware
Providence Service Corporation of Maine	Maine
Providence Service Corporation of Oklahoma	Oklahoma
Providence Service Corporation of Texas	Texas
Rio Grande Management Company, LLC	Arizona
Family Preservation Services of Washington DC, Inc.	Dist. of Columbia
Dockside Services, Inc.	Indiana
Pottsville Behavioral Counselling Group, Inc.	Pennsylvania
Providence Community Services, LLC	California
College Community Services	California
Choices Group, Inc.	Delaware
Providence Management Corporation of Florida	Florida
Providence Service Corporation of New Jersey, Inc.	New Jersey
Social Services Providers Captive Insurance Co.	Arizona
Drawbridges Counseling Services, LLC	Kentucky
Oasis Comprehensive Foster Care, LLC	Kentucky
Children’s Behavioral Health, Inc.	Pennsylvania
Maple Star Nevada	Nevada
Transitional Family Services, Inc.	Georgia
AlphaCare Resources, Inc.	Georgia
Family-Based Strategies, Inc.	Delaware
A to Z In-Home Tutoring, LLC	Nevada

EX-23.1

EXHIBIT 23.1

Consent of Independent Registered Public Accounting Firm

We consent to the incorporation by reference in the following Registration Statements:

1. Shelf Registration Statement (Form S-3—No. 333-129993) of The Providence Service Corporation and related prospectus;

2. Shelf Registration Statement (Form S-3—Registration No. 333-129518) of The Providence Service Corporation and related prospectus;

3. Registration Statements on Forms S-8 (No. 333-112586, 333-117974 and 333-127852) pertaining to The Providence Service Corporation 2003 Stock Option Plan

of our report dated February 13, 2004, with respect to the consolidated financial statements and schedule of The Providence Service Corporation included in this Annual Report (Form 10-K) for the year ended December 31, 2005.

/s/ Ernst & Young LLP

Houston, Texas

March 13, 2006

EX-23.2

EXHIBIT 23.2

Consent of Independent Registered Public Accounting Firm

We consent to the incorporation by reference in the registration statement (Form S-3—Registration No. 333-129993) pertaining to the registration of 1,000,000 shares of common stock of The Providence Service Corporation, the Amendment No. 1 to the Registration Statement (Form S-3—Registration No. 333-129518) pertaining to the registration of 1,725,000 shares of common stock of The Providence Service Corporation and the registration statements on Form S-8 (Registration Nos. 333-112586, 333-117974 and 333-127852) of our report dated March 15, 2006, appearing in the Annual Report on Form 10-K relating to our audits of the consolidated financial statements and the financial statement schedule and management’s assessment of the effectiveness of internal control over financial reporting of The Providence Service Corporation as of and for the year ended December 31, 2005.

/s/ McGladrey & Pullen, LLP

Phoenix, Arizona

March 15, 2006

EX-31.1

EXHIBIT 31.1

CERTIFICATIONS

I, Fletcher Jay McCusker, certify that:

1. I have reviewed this annual report on Form 10-K of The Providence Service Corporation;

2. Based on my knowledge, this 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 which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this 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 report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 16, 2006

/s/    FLETCHER J. MCCUSKER        

Fletcher J. McCusker

Chief Executive Officer

(Principal Executive Officer)

EX-31.2

EXHIBIT 31.2

CERTIFICATIONS

I, Michael N. Deitch, certify that:

1. I have reviewed this annual report on Form 10-K of The Providence Service Corporation;

2. Based on my knowledge, this 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 which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this 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 report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 16, 2006

/s/    MICHAEL N. DEITCH        

Michael N. Deitch

Chief Financial Officer

(Principal Financial and Accounting Officer)

EX-32.1

EXHIBIT 32.1

THE PROVIDENCE SERVICE CORPORATION

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Section 1350 of Chapter 63 of Title 18 of the United States Code), the undersigned officer of The Providence Service Corporation (the “Company”), does hereby certify with respect to the Annual Report of the Company on Form 10-K for the year ended December 31, 2005 (the “Report”) that:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: March 16, 2006	/s/    FLETCHER J. MCCUSKER
	Fletcher J. McCusker
	Chief Executive Officer
	(Principal Executive Officer)

The foregoing certification is being furnished solely pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Section 1350 of Chapter 63 of Title 18 of the United States Code) and is not being filed as part of the Report or as a separate disclosure document.

EX-32.2

EXHIBIT 32.2

THE PROVIDENCE SERVICE CORPORATION

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Section 1350 of Chapter 63 of Title 18 of the United States Code), the undersigned officer of The Providence Service Corporation (the “Company”), does hereby certify with respect to the Annual Report of the Company on Form 10-K for the year ended December 31, 2005 (the “Report”) that:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: March 16, 2006	/s/    MICHAEL N. DEITCH
	Michael N. Deitch
	Chief Financial Officer
	(Principal Financial and Accounting Officer)

The foregoing certification is being furnished solely pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Section 1350 of Chapter 63 of Title 18 of the United States Code) and is not being filed as part of the Report or as a separate disclosure document.