UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2006March 31, 2007

OR

For the transition period fromto            

Commission File No. 000-50364

The Providence Service Corporation

(Exact name of registrant as specified in its charter)

(520) 747-6600

(Registrant’s telephone number, including area code)

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

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

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

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

As of November 7, 2006,May 8, 2007, there were outstanding 12,018,34211,574,546 shares (excluding treasury shares of 146,905)609,405) of the registrant’s Common Stock, $0.001 par value per share.

TABLE OF CONTENTS

2

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

The Providence Service Corporation

Consolidated Balance Sheets

See accompanying notes to unaudited consolidated financial statements

3

The Providence Service Corporation

Unaudited Consolidated Statements of Income

See accompanying notes to unaudited consolidated financial statements

4

The Providence Service Corporation

Unaudited Consolidated Statements of Cash Flows

See accompanying notes to unaudited consolidated financial statements

5

The Providence Service Corporation

Notes to Unaudited Consolidated Financial Statements

September 30, 2006March 31, 2007

1. Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for fair presentation have been included. Operating results for the ninethree months ended September 30, 2006March 31, 2007 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2006.2007.

The consolidated balance sheet at December 31, 20052006 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. The consolidated financial statements contained herein should be read in conjunction with the audited financial statements and notes included in The Providence Service Corporation’s annual report on Form 10-K for the year ended December 31, 2005.2006.

2. Summary of Critical Accounting Estimates 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, education and workforce development 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 3537 states and the District of Columbia.

Seasonality

The Company’s quarterly operating results and operating cash flows normally fluctuate as a result of seasonal variations in its business, principally due to lower client demand for the Company’s home and community based services during the holiday and summer seasons. Historically, these seasonal variations have had a nominal affect on the Company’s operating results and operating cash flows. As the Company has grown its home and community based services business, the Company’s exposure to seasonal variations has grown and will continue to grow, particularly with respect to its school based services, educational services and tutoring services. The Company experiences lower home and community based services revenue when school is not in session. The Company’s expenses, however, do not vary significantly with these changes and, as a result, such expenses domay not fluctuate significantly on a quarterly basis. The Company expects quarterly fluctuations in operating results and operating cash flows to continue as a result of the uneven seasonal demand for its home and community based services. In addition,Moreover, as the Company enters new markets, the Companyit could be subject to additional seasonal variations along with any competitive response to itsthe Company’s entry by other social services providers.

Restricted Cash

At December 31, 20052006 and September 30, 2006,March 31, 2007, the Company had approximately $2.0$8.5 million and $5.3$7.9 million of restricted cash, respectively. Of the restricted cash amount at DecemberMarch 31, 2005 and September 30, 2006,2007, $175,000 served

as collateral for irrevocable standby letters of credit that provide financial assurance that the Company will fulfill its obligations with respect to certain contracts.

6

Furthermore, at DecemberMarch 31, 2005 and September 30, 2006,2007, approximately $1.8$6.2 million and $5.2 million, respectively, served 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. programs and was classified as noncurrent assets in the accompanying balance sheets. The remaining balance of approximately $1.6 million at March 31, 2007 is held in escrow related the Company’s obligations under arrangements with various governmental agencies through the Correctional Services Business (“Correctional Services”) the Company acquired from Maximus, Inc. in October 2006.

At September 30, 2006,March 31, 2007, approximately $6.4 million of the restricted 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. The remaining balance of approximately $1.6 million of the restricted cash is also restricted as to withdrawal or use, and is currently held in various non-interest bearing bank accounts related to Correctional Services.

Stock-Based Compensation Arrangements

The Company provides stock-based compensation under the Company’s 1997 Stock Option and Incentive Plan (the “1997 Plan”) and 2003 Stock Option Plan (the “2003 Plan”) to employees, non-employee directors and consultants. These plans have contributed significantly to the success of the Company by enabling the Company to attract and retain the services of employees, including executive officers, directors and consultants of exceptional ability. On May 25, 2006, the Company’s stockholders approved The Providence Service Corporation 2006 Long-Term Incentive Plan (the “2006 Plan”). The Company, upon stockholder approval of the 2006 Plan, replaced the 1997 Plan and 2003 Plan with the 2006 Plan. While all awards outstanding under the 1997 Plan and 2003 Plan will remain in effect in accordance with their terms, no additional grants or awards will be made under either plan.

The 2006 Plan is intended to advance the interests of the Company and its stockholders by providing for the grant of stock-based and other incentive awards to enhance the Company’s ability to attract and retain employees, directors, consultants, advisors and others who are in a position to make contributions to the success of the Company and any entity in which the Company owns, directly or indirectly, 50% or more of the outstanding capital stock as determined by aggregate voting rights or other voting interests and encourage such persons to take into account the long-term interests of the Company and its stockholders through ownership of the Company’s common stock or securities with value tied to the Company’s common stock. To achieve this purpose, the 2006 Plan allows the flexibility to grant or award stock options, stock appreciation rights, restricted stock, unrestricted stock, stock units including restricted stock units and performance awards to eligible persons.

Stock option awards granted under the 1997 Plan, 2003 Plan and 2006 Plan are generally ten year options granted at fair market value on the date of grant with time based vesting over a period determined at the time the options are granted, ranging from one to four years (which is equal to the requisite service period). The Company does not intend to pay dividends on unexercised options. In addition, these stock options are subject to accelerated vesting provisions if there is a change of control as defined in the respective plan. New shares of the Company’s common stock are issued when the options are exercised.

The following table summarizes the activity under the 1997 Plan, 2003 Plan and 2006 Plan as of September 30, 2006:

On December 6, 2005, the Company’s board of directors approved the acceleration of the vesting dates of all unvested stock options outstanding under the 1997 Plan and 2003 Plan as of December 29, 2005. The purpose of accelerating the vesting of outstanding unvested options was to enable the Company to avoid recognizing approximately $3.8 million in associated stock-based compensation expense in future

7

periods, of which approximately $2.0 million would have been recognized in 2006, as a result of the adoption of Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (“SFAS 123R”), on January 1, 2006. As a result of the acceleration of vesting of these options, stock-based compensation expense of approximately $549,000 was recognized in 2005. 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 consultants 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.

Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123R, which requires companies to measure and recognize compensation expense for all share based payments at fair value. The Company adopted the requirements of SFAS 123R using the modified prospective method in which compensation costs are recognized beginning with the effective date based on the requirements of SFAS 123R for all awards granted to employees prior to the effective date of SFAS 123R that remain unvested on the effective date. Other than certain options previously issued at amounts below fair market value for accounting and reporting purposes in 2003 and the expense associated with the acceleration of vesting of all outstanding stock options in 2005, no other stock-based compensation cost has been reflected in the Company’s net income prior to the adoption of SFAS 123R. Financial results for prior periods have not been restated for the adoption of SFAS 123R.

The Company calculates the transition tax effects of stock-based compensation under SFAS 123R using the long-form transition method to establish the beginning balance of the additional paid-in capital pool (“APIC pool”) related to the tax effects of employee stock-based compensation and to determine the subsequent impact on the APIC pool and the consolidated statements of cash flows of the tax effects of employee stock-based compensation awards that are outstanding upon adoption of SFAS 123R.

The Company calculates the fair value of stock options using the Black-Scholes-Merton option-pricing formula. Stock-based compensation expense for stock options granted prior to December 31, 2005 is not reflected in the Company’s consolidated income statements for the three and nine months ended September 30, 2006 as all of the outstanding stock options granted prior to December 31, 2005 were vested at December 31, 2005.

Stock-based compensation expense charged against income for stock options and stock grants awarded subsequent to December 31, 2005 for the three and nine months ended September 30,March 31, 2006 and 2007 was based on the grant-date fair value adjusted for estimated forfeitures based on awards expected to vest in accordance with the provisions of Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (“SFAS 123R123R”) and amounted to approximately $150,000$0 and $173,000,$286,000 (net of tax of $199,000), respectively. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if the actual forfeitures differ from those estimates.

Prior to the adoption of SFAS 123R, the Company presented all benefits of tax deductions resulting from the exercise of stock-based awards as operating cash flows in the consolidated statement of cash flows. Under SFAS 123R, the benefits of tax deductions in excess of the compensation costs recognized for those options are classified as financing cash flows. For the ninethree months ended September 30, 2005March 31, 2006 and 2006,2007, the amount of excess tax benefits resulting from the exercise of stock options was approximately $516,000$59,000 and $1.8 million,$0, respectively. These amounts are reflected as cash flows from operating activities for the nine months ended September 30, 2005 and financing activities for the ninethree months ended September 30,March 31, 2006 and 2007 in the accompanying consolidated statements of cash flows.

Stock-based compensation expense is amortized over the vesting period of three years with approximately 19%38% recorded as client services expense and 81%62% as general and administrative expense in the Company’s consolidated income statementsstatement for the three and nine months ended September 30, 2006.

8

The following tables summarize the stock option activity for the three and nine months ended September 30, 2005 and 2006:

The weighted-average grant-date fair value, total intrinsic value and cash received by the Company related to options granted/exercised during the three and nine months ended September 30, 2005 and 2006 were as follows:

9

The following table summarizes the number of shares and weighted-average grant date fair value of the Company’s common stock granted during the nine months ended September 30, 2006:

Stock grants were not made prior to the approval of the 2006 Plan on May 25, 2006. The fair value of a non-vested stock grant is determined based on the closing market price of the Company’s common stock on the date of grant.March 31, 2007.

As of September 30, 2006,March 31, 2007, there was approximately $1.6$3.7 million of unrecognized compensation cost related to non-vested stock-based compensation arrangements granted under the 2006 Long-Term Incentive Plan. The cost is expected to be recognized over a weighted-average period of 2.72.6 years. The total fair value of shares vested during the three months ended September 30, 2005 and 2006March 31, 2007 was approximately $806,000 and $0, respectively. The total fair value of shares vested during the nine months ended September 30, 2005 and 2006 was approximately $2.0 million and $0, respectively.$0.

The fair value of each stock option awarded during the ninethree months ended September 30, 2005 and 2006March 31, 2007 was estimated on the date of grant using the Black-Scholes-Merton option-pricing formula and amortized over the option’s vesting periods with the following assumptions:

The risk-free interest rate was based on the U.S. Treasury security rate in effect as of the date of grant. The expected lives of options for the nine months ended September 30, 2005 and 2006 were based on an average of the contractual terms and vesting periods, andupon historical data, respectively.data. The expected stock price volatility was based on the Company’s historical data. Implied volatility was not considered.

10

Prior to January 1, 2006, the Company followed 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 for the periods prior to January 1, 2006:

Reinsurance and Self-Funded Insurance Programs

Reinsurance

The Company reinsures 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 the Company manages under reinsurance programs through the Company’sits wholly-owned captive insurance subsidiary, Social Services Providers Captive Insurance Company (“SPCIC”). 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.

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

11

up to $250,000 per occurrence with no annual aggregate limit. The third-party insurer provides the Company with a deductible buy back policy with a limit of $250,000 per occurrence that provides coverage for all states where coverage is required. The gross written premium for this policy is approximately $1.2 million which is ceded to SPCIC. The expected loss as predicted by the most recent independent actuarial report dated January 27, 2006 is approximately $1.2 million. In addition, the Company has two workers’ compensation policies with this third-party insurer providing statutory limits in excess of the $250,000 reinsurance limit; one for California and one for all other states for which the Company is required to provide workers’ compensation insurance.

SPCIC had restricted cash of approximately $1.8$6.2 million at December 31, 20052006 and approximately $5.2 million at September 30, 2006,March 31, 2007, 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 data, 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. At September 30, 2006,March 31, 2007, approximately 23% 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.

Health Insurance

The Company offers its employees and, through June 30, 2006, 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, 2007. Health insurance claims are paid as they are submitted to the plan administrator. 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. The liability for the self-funded health plan of approximately $658,000$746,000 and $592,000$654,000 as of December 31, 20052006 and September 30, 2006,March 31, 2007, respectively, is recorded in “Reinsurance liability reserve” in the accompanying consolidated balance sheets.

The Company charges its employees a portion of the costs of its self-funded and group health insurance 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. Effective July 1, 2006, the managed entities that previously participated in the Company’s self-funded and non-self funded health insurance programs obtained separate health insurance policies. 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.

Critical Accounting Estimates

The Company has made a number of estimates relating to the reporting of assets and liabilities, revenues and expenses and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with accounting principles generally accepted in the United States for interim financial information. Some of the more significant estimates impact billed and unbilledrevenue recognition, accounts receivable long-livedand allowance for doubtful accounts, accounting for business combinations, goodwill and other intangible assets, and loss reserves for the Company’s reinsurance and self-funded insurance programs.programs and stock-based compensation. We have reviewed our critical accounting estimates with our board of directors, audit committee and disclosure committee.

12

New Accounting Pronouncements

TheIn June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Financial Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement 109”Taxes” (“FIN 48”) in June 2006,, which clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements underin accordance with FASB Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes.” ThisThe interpretation provides thatprescribes a recognition threshold and measurement attribute criteria for the tax effects from an uncertainfinancial statement recognition and measurement of a tax position cantaken or expected to be recognizedtaken in an enterprise’s financial statements only if the enterprise determines that it is more likely than not that the position will be sustained upon examination, baseda tax return. The interpretation also provides guidance on the technical merits of the position.derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. This interpretation is effective for fiscal years beginning after December 15, 2006. Early applicationThe Company adopted FIN 48 on January 1, 2007. Upon adoption of FIN 48, the provisions of this interpretation is encouraged.Company had no unrecognized tax benefits. The Company is evaluatingnot aware of any issues that would cause a significant increase to the effect, if any,amount of adopting FIN 48 onunrecognized tax benefits within the Company’s consolidated financial statements.next 12 months. The Company recognizes interest and penalties as a component of income tax expense. The Company is subject to taxation in the United States and various state jurisdictions. The statute of limitations is three years for the United States and four years for states. The Company is subject to the following material taxing jurisdictions: United States, Arizona, California, Maine, North Carolina, Pennsylvania, and Virginia. The tax years that remain open to examination by the United States, Maine, North Carolina and Virginia jurisdictions are years ended June 30, 2003, December 31, 2003, December 31, 2004, December 31, 2005, and December 31, 2006; the Arizona and California filings that remain open to examination are years ended June 30, 2002, June 30, 2003, December 31, 2003, December 31, 2004, December 31, 2005, and December 31, 2006; the Pennsylvania filings that remain open to examination are years ended December 31, 2004, December 31, 2005, and December 31, 2006.

FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurement” (“SFAS 157”) in September 2006, to define fair value and require that the measurement thereof be determined based on the assumptions that market participants would use in pricing an asset or liability and

expand disclosures about fair value measurements. Additionally, SFAS 157 establishes a fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from sources independent of the reporting entity and (2) the reporting entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances. SFAS 157 is effective for fiscal years beginning after November 15, 2007. Early application of the provisions of SFAS 157 is encouraged. The Company has not determinedis evaluating the effect, if any, of adopting SFAS 157 on the Company’s consolidated financial statements.

The Securities and Exchange Commission issued Staff Accounting Bulletin No. 108 (“SAB 108”) in September 2006 setting forth guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for purposes of a materiality assessment. The staff believes registrants must quantify the impact of correcting all misstatements, including both the carryover and reversing effects of prior year misstatements, on the current year financial statements by applying the following methodologies: (1) quantify misstatements based on the amount of the error originating in the current year income statement and (2) quantify misstatements based on the effects of correcting the misstatement existing in the balance sheet at the end of the current year, irrespective of the misstatement’s year(s) of origination. Under this guidance a registrant’s financial statements would require adjustment when either approach results in quantifying a misstatement that is material, after considering all relevant quantitative and qualitative factors. The guidance in SAB 108 is effective for evaluations made on or after November 15, 2006. The provisions of SAB 108 did not have, and the Company does not believe that these provisions will have, a significant impact, if any, on its consolidated financial statements.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB Statement No. 115” (“SFAS 159”). This statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The fair value option established by SFAS 159 permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity will report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. SFAS 159 is effective for fiscal years beginning after November 15, 2007. Early application of the provisions of SFAS 159 is permitted. The Company is evaluating the effect, if any, of adopting SFAS 159 on its consolidated financial statements.

3. Other Receivables

Based on certain provisions of the Company’s loan and security agreement with CIT Healthcare LLC (“CIT”), alla significant portion of the Company’s collections on accounts 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 accounts related to the Company’s operating activities and amounts due to CIT under the Company’s loan and security agreement as of the Company’s reporting period cut-off date. As of December 31, 20052006 and September 30, 2006,March 31, 2007, the amount due to the Company from CIT under this arrangement totaled approximately $2.3$828,000 and $1.4 million, and $2.4, respectively, and was classified as “Other receivables” in the Company’s consolidated balance sheet.

13

4. Prepaid Expenses and Other

Prepaid expenses and other comprise the following:

5. 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.

On FebruaryEffective January 1, 2006,2007, the Company acquired all of the equity interestassets of the Behavioral Health Rehabilitation Services business of Raystown Development, Inc. (“Raystown”). The business provides in-home counseling and school based services in A to Z In-Home Tutoring, LLC (“A to Z”), a Tennessee based provider of home based educational tutoring.Pennsylvania. The purchase price includedconsisted of cash of $500,000, of which $100,000 was placed in cash and approximately $900,000 in debt excluding a $250,000 bridge loan owing to escrow to cover possible indemnity obligations by the Company by A to Z at the date of acquisition. On July 7, 2006, the Company entered into a settlement agreement with a seller of A to Z to release the Company from its obligation to make any additionalseller. The purchase price payments to that seller under certain earn out provisions of the purchase agreement in exchange for $625,000 inwas funded by cash the payment of which was made by the Company to the seller on July 12, 2006. The settlement amount was added to the cost of acquiring A to Z.flow from operations. This acquisition further 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.in Pennsylvania.

The following represents the Company’s preliminary allocation of the purchase price:price and associated acquisition costs:

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

On February 27, 2006, the Company acquired all of the equity interest in Family Based Strategies, Inc. (“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. This portion of the purchase price will be paid upon the final determination of FBS’s working capital. The purchase price also included the payoff of certain debt of FBS in the amount of approximately $180,000 that was paid by the Company on the date of acquisition. This acquisition expands the Company’s presence in North Carolina and New Jersey.

14

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

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

On April 25, 2006, the Company acquired all of the equity interest in W.D. Management, L.L.C., (“WD Management”), a Missouri based management company that provides management services in Missouri. The purchase price included $1.0 million in cash. This acquisition was retroactively effective as of April 1, 2006 and expands the workforce development services managed by the Company.

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

The fair value of the assets acquired in this transaction exceeded that portion of the purchase price paid by the Company at the acquisition date. The Company recorded this excess fair value as a contingent liability. The Company will continue to record the excess fair value as a contingent liability due to the contingent consideration provisions of the purchase agreement under which the Company may be obligated to pay contingent consideration at a future date as more fully described in note 10. When the contingency is resolved and the consideration becomes distributable, any excess of the fair value of the contingent consideration distributed over the amount of the contingent liability will be recognized as an additional cost to acquire WD Management. If the amount of the contingent liability exceeds the fair value of the contingent consideration distributed, the excess will be allocated as a pro rata reduction of the amounts assigned to the assets acquired.

On August 4, 2006, the Company acquired substantially all of the assets of Innovative Employment Solutions (“IES”), a division of Ross Education, LLC. IES is a Michigan based provider of workforce development services. IES also provides workforce development services in Pennsylvania, West Virginia and New York. The purchase price consisted of cash of $9.0 million which included $1.2 million for excess working capital received at closing under a working capital adjustment provision of the purchase agreement (less approximately $1.3 million placed into escrow as security against indemnification obligations, working capital adjustments and payment of the purchase price). The purchase price was funded from proceeds from the Company’s follow-on offering of its common stock completed in April 2006. This acquisition was retroactively effective as of August 1, 2006 and expands the Company’s existing workforce development service continuum.

15

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

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

Goodwill and Intangibles

The amount allocated to intangibles represents acquired customer relationships and management contracts. The Company valued customer relationships and the management contract 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 entity with respect to the acquired management contract. No significant residual value is estimated for these intangibles. Amortization of the acquired customer relationships will be recognized on a straight-line basis over an estimated useful life of 5 - 15 years.

Changes in goodwill were as follows:

The following unaudited pro forma information presents a summary of the consolidated results of operations of the Company as if the acquisition of A to Z, FBS, WD Management and IESRaystown had occurred on January 1, 2005.2006 or 2007. The pro forma financial information is not necessarily indicative of the results of operations that would have occurred had the transactions been effectedaffected on January 1, 2005.

162006 or 2007.

6. Long-Term Obligations

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

The Company’s second amended loan agreement with CIT provides for a revolving line of credit and an acquisition term loan from which the Company may borrow up to $25.0 million under each instrument 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.

17

The maturity date of the revolving line of credit and acquisition term loan is 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 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 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 Company is required to 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.

Upon the completion of the Company’s follow-on offering of its common stock in April 2006, the Company prepaid approximately $15.8 million of the principal and accrued interest then outstanding under its credit facility with CIT out of the net proceeds from this offering.

At December 31, 2005 and September 30, 2006, the Company’s available credit under the revolving line of credit was $12.5 million and $16.0 million, respectively.

7. Stockholders’ Equity

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.

On April 17, 2006,During the three months ended March 31, 2007, the Company completedgranted a follow-on offeringtotal of 75,000 ten year options under its 2006 Plan to the non-employee members of its board of directors and certain key employees to purchase the Company’s common stock at exercise prices equal the market value of the Company’s common stock on the date of grant. The option exercise prices ranged from $21.84 to $24.59 and the options vest in equal installments on the first, second and third anniversary of the grant date. The weighted-average fair value of the options granted during the three months ended March 31, 2007 totaled $10.05 per share.

The Company granted 35,000 shares of restricted stock to each of Craig A. Norris, Chief Operating Officer, and Fred D. Furman, Executive Vice President and General Counsel as part of their long-term incentive award for fiscal year 2006 during the three months ended March 31, 2007. Messrs. Norris’ and Furman’s award of restricted stock will vest in equal installments on June 19, 2007, 2008 and 2009. In addition, the Company granted 2,000 shares of restricted stock to each non-employee member of the Company’s board of directors as part of their compensation for service on the Company’s board for the fiscal year 2007. These restricted stock awards will vest in three equal annual installments on the first, second and third anniversaries of the date of grant. The weighted-average fair value of the restricted stock awards granted during the three months ended March 31, 2007 totaled $24.77 per share.

During the three months ended March 31, 2007, the Company issued 1,824 shares of its common stock in connection with whichthe exercise of employee stock options under the Company’s Stock Option and Incentive Plan, and 1,000 shares of its common stock in connection with the exercise of employee stock options under the Company’s 2003 Stock Option Plan.

On February 1, 2007, the Company’s board of directors approved a stock repurchase program for up to one million shares of its common stock. The Company may purchase shares of its common stock from time to time on the open market or in privately negotiated transactions, depending on the market conditions and the Company’s capital requirements. As of March 31, 2007, the Company sold 2,000,000spent approximately $10.4 million to purchase 442,500 shares at an offering price of $32.00 per share, which includedits common stock on the full exercise of the underwriter’s over-allotment option. The Company received net proceeds of approximately $60.3 million after deducting the underwriting discounts of $3.7 million, but before deducting other offering costs of approximately $770,000. open market.

At December 31, 20052006 and September 30, 2006,March 31, 2007, there were 9,822,48612,171,127 and 12,163,57212,173,951 shares of the Company’s common stock outstanding, respectively, (including 146,905 treasury shares)shares at December 31, 2006 and 589,405 at March 31, 2007) and no shares of preferred stock outstanding.

18

The following table reflects changes in common stock, and additional paid-in capital and treasury stock for the ninethree months ended September 30, 2006:March 31, 2007:

8.7. Earnings Per Share

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

For the three and nine months ended September 30, 2006,March 31, 2007, employee stock options to purchase 405,920 and 128,34724,768 shares of common stock, respectively, 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 stock for the period and, therefore, the effect of these options would be antidilutive.

9.8. Income Taxes

The Company’s effective income tax rate for the interim periods was based on management’s estimate of the Company’s effective tax rate for the applicable year and differs from the federal statutory income rate primarily due to nondeductible permanent differences and state income taxes.

10.9. 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.

19

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 various 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.

Under the earn out provision of the purchase agreement related to the purchase of Maple Star Nevada in 2005, the Company was obligated to pay, in the third fiscal quarter of 2006, an additional amount up to $2.0 million. On September 25, 2006, the Company received a dispute notice from the seller disputing the amount of the earn out payment of approximately $971,000 made by the Company to the seller on

September 6, 2006. As of the date of the filing of this report on Form 10-Q for the quarterly periodquarter ended September 30, 2006,March 31, 2007, the dispute has not been resolved. If the seller prevails under the dispute resolution provision of the purchase agreement, the Company may be obligated to pay the difference between the amount paid and the maximum earn out amount of $2.0 million in the fourth fiscal quarter of 2006.2007. The contingent consideration will be paid in cash and the Company will record the fair value of the consideration paid as an additional cost to acquire Maple Star Nevada.

In connection withUnder the purchase agreement related to the acquisition of Transitional Family Services, Inc. and AlphaCare Resources, Inc. (collectively “AlphaCare”) in 2005, the Company may bewas obligated to pay to the sellers, in the second fiscal quarter of 2007, an additional specified amount underif certain conditions set forth in an earn out provision pursuant to a formula specifiedcontained in the purchase agreement were satisfied. The Company has determined that it is based upon certain factors, including the EBITDA of certain programs of AlphaCare. Ifnot required to make any payments under 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.provision.

In accordance with certain provisions in the purchase agreement related to the acquisition of FBS,Family Based Strategies, Inc. (“FBS”) in 2006, 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, theAny additional consideration if any, will be paid in cash and the Company will record the additional consideration paid as an additional cost to acquire FBS.

The Company may be obligated to pay to the former members of W.D. Management, L.L.C. (“WD ManagementManagement”) in each of 2007 and 2008, 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 WD Management. If the conditions for payment under the earn out provision isare met in 2007, the contingent consideration will be paid in cash, and if the conditions for payment under the earn out provision isare met in 2008, 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. When and if the earn out provision is triggered or when and paid,if the Company makes any payment under the earn out provision, the Company will record any excess of the fair value of the consideration paid, issued or issuable over the contingent liability recorded as an additional cost to acquire WD Management. The Company expects to pay additional consideration of between $7.5 and $8.0 million in 2007 under the earn out provision.

11.10. Transactions with Related Parties

Effective March 1, 2006, the Company amended its management services agreement with Family Preservation Community Services, Inc., a not-for-profit affiliate, to increase the management fee to reimburse the Company for the compensation costs for its 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 non-executive chairman of the board of Qualifacts Systems, Inc (“Qualifacts”). Qualifacts is a specialized healthcare information

20

technology provider that entered into a software license, maintenance and servicing agreement with the Company. This agreement became effective on March 1, 2002 and was to continue for five years. 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. Qualifacts provided the Company services and the Company incurred expenses in the amount of approximately $57,000$19,000 and $64,000$53,000 for the ninethree months ended September 30, 2005March 31, 2006 and 2006,2007, respectively, under the agreement.

On February 3, 2006,The Company, as part of its commitment to give back to the boardlocal communities in which it operates, has provided a loan to a Tucson, Arizona based not-for-profit organization that supports and promotes public awareness 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.

Due to issues related to contractual limitations in reimbursement methodologies in Florida, the Company agreed to reduce its management fee by 1% beginning January 1, 2006 under its management services agreement with Camelot Community Care, Inc.

Upon the Company’s acquisition of Maple Services, LLC in August 2005, Mr.art and humanities. Fletcher Jay McCusker, the Company’s chief executive officer Mr. Deitch, the Company’s chief financial officer, and Mr. Norris, the Company’s chief operating officer, became memberschairman of the board of directors, became a member 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., which, while not-for-profit organizations, are not federally tax exempt organizations and are required to file federal income tax returns. These entities are governed by their respective boards of directors and the state laws under which they are incorporated. As such, the Company believes that while certain executive officers of the Company hold positions on the respective boards of directors of these managed entities, the IRS rules under Section 501(c)(3) of the Internal Revenue Code regarding tax exempt not-for-profit organizations are not applicable to these entities. 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 $884,000 for the nine months ended September 30, 2006, including incentive bonuses of $144,000 granted by theentity’s board of directors in March 2007. The loan of Maple Star Oregon, Inc.$100,000 was granted in 2006 to the Company for the nine months ended September 30, 2006, which were included in management fee receivable at September 30, 2006.

In connection with the acquisition of Pottsville Behavioral Counseling Group, Inc., which is now known as Providence Community Services, Inc., and the establishment ofnot-for-profit entity under a management agreement with The ReDCo Group (“ReDCo”) in May 2004, the Company loaned $875,000 to ReDCo to fund certain long-term obligations of ReDCo in exchange for ademand promissory note for the same amount. The note assumesthat bears interest equal the prime rate in effect from time to a fluctuating interest rate per annum based on a weighted-average oftime as quoted in 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, 2004Wall Street Journal plus 1% with the principal and any accrued and unpaid interest due upon maturity, which was 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 $20,000 and $32,000 was earned for the nine months ended September 30, 2005 and 2006, 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, 2005 and September 30, 2006, the balance of the note was $875,000 and is reflected in the accompanying consolidated balance sheets as “Notes receivable from unconsolidated affiliates”.demand.

The Company is 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 $1,100 per flight hour. For the ninethree months ended September 30, 2005March 31, 2006 and 2006,2007, the Company reimbursed Las Montanas Aviation, LLC approximately $40,000$0 and $120,000,$45,000, respectively, for use of the airplane for business travel purposes. Of

11. Subsequent Events

Effective April 12, 2007, the totalCompany’s reinsurance policy with respect to its general and professional liability reinsurance program was renewed under substantially the same terms as the prior year policy. In addition, the Company added $2.0 million to its existing umbrella liability insurance policy resulting in coverage in the amount paid to Las Montanas Aviation, LLC duringof $3.0 million per occurrence and $3.0 million in the nine months ended September 30, 2006, approximately $109,000 was recorded as deferred offering costs related toaggregate in excess of the follow-on offeringpolicy limits of the Company’s common stock completed in April 2006.general and professional liability policy.

On May 1, 2007, the Company became the sole member of Maple Star Oregon, Inc., a non-tax exempt not-for-profit organization managed by the Company.

21

12. Subsequent Events

On October 5, 2006, the Company entered into an agreement with Maximus, Inc. (“Maximus”) to purchase all of the assets of the Correctional Services Business of Maximus (“Correctional Services”). The business provides misdemeanant private probation supervision services in Florida, Georgia, South Carolina, Tennessee and Washington. The purchase price consisted of cash of $3.0 million and the assumption of deferred compensation liability limited to $250,000 and contingent liabilities related to the purchased assets, assigned contracts and the subcontract agreement that was entered into simultaneously with this asset purchase agreement. The acquisition closed on October 5, 2006 and was retroactively effective as of September 30, 2006 except for those locations where payer consent or provider certification is required as set forth in the agreement. From September 30, 2006 until all payer consents or provider certifications are obtained, the Company will provide services to those locations where payer consent or provider certification was not obtained as of October 5, 2006 under a subcontract with Maximus. The purchase price was funded from proceeds from the Company’s follow-on offering of its common stock completed in April 2006. This acquisition provides an entry into the state of Washington and further expands the Company’s human services delivery platform and will enable the Company to introduce private probation services into its existing markets where privatized probation services are funded.

In connection with the acquisition of A to Z, the Company was 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 based upon the future financial performance of A to Z. On October 31, 2006, the Company entered into a settlement agreement with a seller of A to Z to release the Company from its obligation to make any additional purchase price payments to that seller under the earn out provision of the purchase agreement in exchange for $1.2 million in cash (less approximately $300,000 for the sale by the Company to the seller of certain accounts receivable of A to Z), the payment of which was made by the Company to the seller on November 3, 2006. The settlement amount was added to the cost of acquiring A to Z. As a result of the settlement agreements reached on July 7, 2006 (described in Note 5) and October 31, 2006 with the seller, the Company has no further obligations to the seller under the earn out provision of the purchase agreement.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion should be read in conjunction with our consolidated financial statements and accompanying notes for the three and nine months ended September 30, 2006March 31, 2007 as well as our consolidated financial statements and accompanying notes and management’s discussion and analysis of financial condition and results of operations included in our Form 10-K for the year ended December 31, 2005.2006.

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 increasedgrown both organically by increasing our capacity to provide services in previously underserved geographic areas through the development of new programs and by consummating strategic acquisitions. acquisitions to enter new states and to gain expertise in new service areas.

As part of thisour growth strategy we have entered into the in-home tutoring, workforce development and private probation services markets and expanded our presence in existing markets through several acquisitions which were completed during the nine months ended September 30, 2006 discussed below.in 2006. As of September 30, 2006,March 31, 2007, we provided services directly and through the entities we manage to over 45,00075,000 clients from 254319 locations in 3437 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.

22

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 or assigned 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.

This was the case in October 2006 in North Carolina where we were awarded approximately 4,000 clients under North Carolina’s accelerating privatization initiatives for its mental health, developmental disabilities and substance abuse services. In order to accommodate this rapid roll-out, we expect to spend approximately $250,000 to $350,000 in the fourth quarter of 2006 to obtain office space and hire and train the necessary personnel to provide services. With respect to some of the large contracts we are awarded, we may be 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 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.

OnEffective April 17, 2006, we completed an underwritten follow-on offering of our common stock. Additional information regarding the underwritten follow-on offering of our common stock is included in the liquidity and capital resources discussion below.

We renegotiated certain terms of12, 2007, our reinsurance policy, with respect to our general and professional liability reinsurance program, effective May 23, 2006.renewed under substantially the same terms as the prior year’s policy. In addition, we added $2.0 million to our existing umbrella liability insurance policy resulting in coverage in the amount of $3.0 million per occurrence and $3.0 million in the aggregate in excess of the policy limits of our general and professional liability policy. Additional information regarding our reinsurance programs is included in the liquidity and capital resources discussion below.

Our working capital requirements are primarily funded by cash from operations and borrowings from our credit facility with CIT Healthcare LLC, or CIT, which provides funding for general corporate purposes and acquisitions.

Critical accounting estimates

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.

As of September 30, 2006, except for the implementation of the fair value recognition provisions of Statement of Financial Accounting Standards No. 123R, “Share-Based Payment”, or SFAS 123R, on January 1, 2006,March 31, 2007, there has been no change in our accounting policies or the underlying assumptions or estimates made by us to fairly present our financial position, results of operations and cash flows for the periods covered by this report.

Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS 123R, which requires companies to measure and recognize compensation expense for all share based payments at fair

23

value. With respect to stock option awards, the fair value is estimated on the date of grant using the Black-Scholes-Merton option-pricing formula and amortized over the option’s vesting periods. The Black-Scholes-Merton option-pricing formula requires us to make assumptions for the expected dividend yield, stock price volatility, life of options and risk-free interest rate. We adopted the requirements of SFAS 123R using the modified prospective transition method in which compensation costs are recognized beginning with the effective date based on the requirements of SFAS 123R for all awards granted to employees prior to the effective date of SFAS 123R that remain unvested on the effective date. Other than certain options previously issued at amounts below fair market value for accounting and reporting purposes in 2003 and the expense associated with the acceleration of vesting of all outstanding stock options in 2005, no other stock-based compensation cost has been reflected in our net income prior to the adoption of SFAS 123R. Financial results for prior periods have not been restated.

We calculate the tax effects of stock-based compensation under SFAS 123R using the long-form transition method to establish the beginning balance of the additional paid-in capital pool, or APIC pool, related to the tax effects of employee stock-based compensation and to determine the subsequent impact on the APIC pool and the consolidated statements of cash flows of the tax effects of employee stock-based compensation awards that are outstanding upon adoption of SFAS 123R.

Prior to January 1, 2006, we followed the intrinsic value method of accounting for stock-based compensation plans and presented all benefits of tax deductions resulting from the exercise of stock-based awards as operating cash flows in the statement of cash flows. Under SFAS 123R, the benefits of tax deductions in excess of the compensation costs recognized for those options are classified as financing cash flows. For the nine months ended September 30, 2005 and 2006, the amount of excess tax benefits resulting from the exercise of stock options was approximately $516,000 and $1.8 million, respectively. These amounts are reflected as cash flows from operating activities for the nine months ended September 30, 2005 and financing activities for the nine months ended September 30, 2006 in our consolidated statements of cash flows.

On December 6, 2005, our board of directors approved the acceleration of the vesting dates of all unvested stock options outstanding as of December 29, 2005. The purpose of accelerating the vesting of outstanding unvested options was to enable us to avoid recognizing approximately $3.8 million in associated stock-based compensation expense in future periods, of which approximately $2.0 million would have been recognized in 2006, as a result of the adoption of SFAS 123R. As a result of the acceleration of vesting of these options, stock-based compensation expense of approximately $549,000 was recognized in 2005. In determining the amount of stock-based compensation expense related to the acceleration of vesting of these options, we assumed an expected forfeiture rate for non-employee directors, significant consultants and executive officers as a group of 10% based on historical trends. Similarly, we assumed an expected forfeiture rate of 18% for other employees based on historical trends.

On May 25, 2006, our stockholders approved The Providence Service Corporation 2006 Long-Term Incentive Plan, or 2006 Plan. The 2006 Plan allows us the flexibility to issue up to 800,000 shares of our common stock pursuant to awards of stock options, stock appreciation rights, restricted stock, unrestricted stock, stock units including restricted stock units and performance awards to employees, directors, consultants, advisors and others who are in a position to make contributions to our success and to encourage such persons to take into account our long-term interests and the interests of our stockholders through ownership of our common stock or securities with value tied to our common stock.

As of September 30, 2006, there was approximately $1.6 million of unrecognized compensation cost related to non-vested stock-based compensation arrangements granted under the 2006 Plan. The cost is expected to be recognized over a weighted-average period of 2.7 years. The total fair value of shares vested during the nine months ended September 30, 2005 and 2006 was approximately $2.0 million and $0, respectively.

For further discussion of our critical accounting policies see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report on Form 10-K for the year ended December 31, 2005.2006.

24

Acquisitions

Since December 31, 2005,2006, we have completed the following acquisitions:acquisition:

On FebruaryEffective January 1, 2006,2007, 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 $900,000 in debt excluding a $250,000 bridge loan owing to us by A to Z at the date of acquisition. This acquisition expands our home based social services to include educational tutoring.

On February 27, 2006, we acquired allassets of the equity interest in Family Based Strategies,Behavioral Health Rehabilitation Services business of Raystown Development Services, Inc., or FBS, a North CarolinaRaystown. The business provides in-home counseling and school 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. This portion of the purchase price will be paid upon the final determination of FBS’ working capital. The purchase price also included the payoff of certain debt of FBS in the amount of approximately $180,000 that was paid by us on the date of acquisition. 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 New Jersey.

On April 25, 2006, we acquired all of the equity interest in W.D. Management, L.L.C., or WD Management, a Missouri based management company that provides management services in Missouri. The purchase price included $1.0 million in cash, in addition to which we may be obligated to pay to the former members of WD Management in each of 2007 and 2008, 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 WD Management. This acquisition was retroactively effective as of April 1, 2006 and expands our management of workforce development services.

On August 4, 2006, we acquired substantially all of the assets of Innovative Employment Solutions, or IES, a division of Ross Education, LLC. IES is a Michigan based provider of workforce development services. IES also provides workforce development services in Pennsylvania, West Virginia and New York.Pennsylvania. The purchase price consisted of cash of $9.0 million$500,000, of which included $1.2 million for excess working capital received at closing under a working capital adjustment provision of$100,000 was placed in to escrow to cover possible indemnity obligations by the seller. The purchase agreement (less approximately $1.3 million placed into escrow as security against indemnification obligations, working capital adjustments and payment of the purchase price).price was primarily funded from our operating cash. This acquisition was retroactively effective as of AugustJanuary 1, 2006 and expands our existing workforce development service continuum.

On October 5, 2006, we entered into an agreement with Maximus, Inc., or Maximus, to purchase all of the assets of the Correctional Services Business of Maximus, referred to as Correctional Services. The business provides misdemeanant private probation supervision services in Florida, Georgia, South Carolina, Tennessee and Washington. The purchase price consisted of cash of $3.0 million and the assumption of deferred compensation liability limited to $250,000 and contingent liabilities related to the purchased assets, assigned contract and the subcontract agreement described below that was entered into simultaneously with this asset purchase agreement. The acquisition closed on October 5, 2006 and was retroactively effective as of September 30, 2006 except for those locations where payer consent or provider certification is required as set forth in the agreement. From September 30, 2006 until all payer consents or provider certifications are obtained, we will provide services to those locations where payer consent or provider certification was not obtained as of October 5, 2006 under a subcontract with Maximus. This acquisition provides an entry into the state of Washington2007 and further expands our humanhome and community based services delivery platform and will enable us to introduce private probation services into our existing markets where privatized probation services are funded.

The cash portion of the purchase price of the A to Z and FBS acquisitions was funded from our credit facility with CIT. The purchase price of the WD Management, IES and Correctional Services acquisitions was funded from operating cash, proceeds from the issuance of our common stock pursuant to stock option exercises and proceeds from the follow-on offering of our common stock completed in April 2006.Pennsylvania.

25

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

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:

Three months ended September 30, 2006March 31, 2007 compared to three months ended September 30, 2005March 31, 2006

Revenues

Home and community based services. The acquisition of Raystown in January 2007, A to Z In-Home Tutoring, LLC, or A to Z, and Family Based Strategies, Inc, or FBS, in February 2006, andInnovative Employment Solutions, or IES, in August 2006 and the Correctional Services Business of Maximus, Inc., or Correctional Services, in October 2006 added, on a cumulativean aggregate basis, approximately $3.3$6.4 million to home and community based services revenue for the three months ended September 30, 2006.March 31, 2007 as compared to the same prior year period. We added over 3,600nearly 25,000 clients as a result of these acquisitions and expanded our home and community based services to include educational tutoring and workforce development as well as entered several new markets. In addition,

Excluding the acquisition of (i) Maple Star Nevada, (ii) Transitional Family Services, Inc., AlphaCare Resources, Inc., collectively referred to as AlphaCare, and (iii) Drawbridges Counseling Services, LLC and Oasis Comprehensive Foster Care Services LLC, collectively referred to as Drawbridges, which were all completed in 2005,

26

added, on a cumulative basis, approximately $2.0 million to home and community based services revenue for the three months ended September 30, 2006 as compared to the same prior year period.

We recognized approximately $323,000 of home and community based services revenue, based upon our service encounter value and allowable administrative expenses, in excess of the annual funding allocation amount under our annual block purchase contract with The Community Partnership of Southern Arizona, or CPSA, for the three months ended September 30, 2006 which we expect to collect through supplemental payments. This contract provides that at the discretion of CPSA, supplemental or additional payments may be distributed in addition to the annual funding allocation. Historically, we have received supplemental payments under this contract. Due to the discretionary nature of supplemental payments and despite the fact that we have been awarded such payments historically, historical supplemental payments are not necessarily indicative of the supplemental payments that we may receive in the future.

Excluding the acquisitions of A to Z, FBS, IESRaystown and the acquisitions completed in 2005,2006, our home and community based services provided additional revenue of approximately $3.2$9.5 million for the three months ended September 30, 2006,March 31, 2007, as compared to the same period one year ago due to client volume increases in new and existing locations. We experienced a net increase of over 1,300approximately 6,000 new home and community based clients during the three months ended September 30, 2006March 31, 2007 as compared to the same three month period in 2005,2006, with increases at our existing and new locations. Partially offsetting the increase in home and community based services revenue for the three months ended September 30, 2006 was a decrease in our District of Columbia market where we have experienced a decrease in the services we provide in this market.

In the District of Columbia, eligibility requirements for social services clients have been tightened to stratify services into intensity levels with rates that vary by level and to stabilize the number of eligible clients. The tightened eligibility requirements have led to a reduction in the number of clients eligible for higher level services for which we are paid at higher rates and reduced the total population of eligible clients in this market resulting in a decrease in our home and community based services revenue of approximately $583,000 for the three months ended September 30, 2006 as compared to the same three month period one year ago. In response to the tightened eligibility requirements of the government entities that fund the services we provide in the District of Columbia market, we are focusing on cross-selling activities to enhance the current continuum of social services we provide. In addition, we are seeking to acquire or subcontract with strategic entities that currently compete with us in this market for the same services. While we expect our cross-selling activities and possible strategic acquisitions will result in future growth in our business in the District of Columbia, there can be no assurances that growth in our home and community based services revenue in this market will materialize.

Foster care services. The acquisitions of Maple Star Nevada and Oasis Comprehensive Foster Care Services LLC in 2005 resulted in an increase in foster care services revenue of approximately $348,000 for the three months ended September 30, 2006 as compared to the same period one year ago. We continue to cross-sell our services which we anticipate will increase our foster care revenue. We are increasing our efforts to recruit additional homes in many of our markets which we expect will also increase our foster care service offerings.

Management fees. Revenue for entities we manage but do not consolidate for financial reporting purposes (managed entity revenue) increased to $48.0$53.3 million for the three months ended September 30, 2006March 31, 2007 as compared to $39.6$40.6 million for the same prior year period. The combined effects of business growth and the addition of twoa management agreementsagreement acquired in connection with the acquisition of Maple Services, LLC in 2005 andW.D. Management, L.L.C., or WD Management, in April 2006 added approximately $1.1$1.6 million in additional management fees revenue for the three months ended September 30, 2006March 31, 2007 as compared to the three months ended September 30, 2005. In September 2005, we entered into several short-term consulting agreements which added approximately $467,000 to management fees revenue for the three months ended September 30, 2005. No such amounts were recorded for the three months ended September 30, 2006 resulting in a decrease in management fees revenue for the current three month period when compared to the same period one year ago.

27

Further, we earned an additional $407,000 for the three months ended September 30, 2005 under our reinsurance and self-funded health insurance programs in which certain of the entities we manage participated.March 31, 2006. Effective July 1, 2006, the managed entities that previously participated in our self-funded health insurance programs obtained separate health insurance policies which resulted in a decreasepartially offset the increase in management fees revenue for the three months ended September 30, 2006 whenMarch 31, 2007 as compared to the three months ended September 30, 2005.March 31, 2006 by approximately $440,000. In addition, no consulting fee revenue was earned for the three months ended March 31, 2007, which further offset the increase in management fees revenue for the first three months of 2007 by approximately $610,000 as compared to the same period one ago.

Operating expenses

Client service expense.Client service expense included the following for the three months ended September 30, 2005March 31, 2006 and 2006:2007:

Payroll and related costscosts.. 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 who possess higher degrees of education, experience and licensures. As we enter new markets, we expect payroll and related costs to continue to increase. Our payroll and related costs increased for the three months ended September 30, 2006,March 31, 2007, as compared to the same prior year period, as we added new direct care providers, administrative staff and other employees to support our growth. In addition, we added over 600400 new employees in connection with the acquisition of Maple Star Nevada, AlphaCare and Drawbridges beginningRaystown in August 2005,January 2007, A to Z and FBS in February 2006, and IES in August 2006 and Correctional Services in October 2006 which resulted in an increase in payroll and related costs of approximately $2.5$4.1 million in the aggregate for the three months ended September 30, 2006March 31, 2007 as compared to the three months ended September 30, 2005.March 31, 2006.

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 or decrease our capacity in response to budgetary constraints and changes to the eligibility requirements of the government entities that provide funding and referrals for the services we provide. Alternatively, we may lag behind in client referrals as we may have difficulty recruiting employees to service 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 55.0%56.3% for the three months ended September 30, 2005March 31, 2006 to 56.5%58.8% for the three months ended September 30, 2006.March 31, 2007.

Purchased servicesservices.. Increases in foster parent payments and the number of referrals requiring pharmacy servicesout-of-home placement under our annual block purchase contract accounted for the increase in purchased services for the three months ended September 30, 2006March 31, 2007 as compared to the same period one year ago. 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. As a percentage of revenue, purchased services decreased from 11.4%10.3% for the three months ended September 30, 2005March 31, 2006 to 10.2%7.9% for the three months ended September 30, 2006March 31, 2007 primarily due to our revenue growth rate and a decrease in the number of referrals requiring out-of-home placementpharmacy and support services under our annual block purchase contract during the three months ended September 30, 2006.March 31, 2007.

28

Other operating expensesexpenses.. As a result of our organic growth during the last twelve months ended September 30, 2006,March 31, 2007, we added several new locations that contributed to an increase in other operating expenses for the three months ended September 30, 2006March 31, 2007 when compared to the three months ended September 30, 2005.March 31, 2006. In addition, client related expenses have increased approximately $1.1 million for the three months ended March 31, 2007 as compared the same period one year ago under new contracts in California and as a result of the addition of workforce development services in Pennsylvania. The acquisitions of Maple Star Nevada, AlphaCare and Drawbridges beginningRaystown in August 2005,January 2007, A to Z and FBS in February 2006, and IES in August 2006 and Correctional Services in October 2006 added approximately $863,000$1.0 million to other operating expenses for the three months ended September 30, 2006.March 31, 2007. As a percentage of revenue other operating expenses increased from 7.9%7.8% to 10.6%10.4% from period to period primarily due to the addition of new locations resulting from our organic growth.growth and additional client related expenses.

Stock-based compensationcompensation.. Stock-based compensation of approximately $48,000$172,000 for the three months ended September 30, 2006,March 31, 2007, represents the amortization of the fair value of stock options and stock grants awarded to executive officers, directors and employees in June 2006 and January 2007 under our 2006 Long-Term Incentive Plan. No stock-based compensation was recorded for the three months ended September 30, 2005,March 31, 2006, as we followedall of the intrinsic value method to account for stock-basedequity awards granted to employeesoutstanding at that time which did not require us to record stock-based compensation for awards granted at exercise prices equal to the market value of our common stock on the date of grant.were fully vested.

General and administrative expense.

The addition of corporate staff to adequately support our growth and provide services under our management agreements and higher rates of pay for employees accounted for an increase of approximately $1.2 million$830,000 of corporate administrative expenses for the three months ended September 30, 2006March 31, 2007 as compared to the same prior year period. Also contributing to the increase in general and administrative expense were stock-based compensation and expenses related to bidding on new contracts, contributions made to educational not-for-profit organizations as well as costs associated with meetings of our board of directors.contracts. In addition, as a result of our growth during the twelve months ended September 30, 2006,March 31, 2007, rent and facilities management increased $441,000$847,000 for the three months ended September 30, 2006March 31, 2007 mostly due to our acquisition activities. Further, based upon our judgment using historical data and our experience, we determined that an adjustment to decrease the reserve for our general and professional liability by approximately $390,000 was appropriate to more accurately reflect our estimate of professional liability at September 30, 2006. As a percentage of revenue, general and administrative expense remained relatively constant at approximately 11.7%decreased from 12.8% to 12.1% from period to period.

Depreciation and amortization.

The increase in depreciation and amortization from period to period primarily resulted from the amortization of the fair value of the acquired management agreements with Maple Services, LLC andagreement related to WD Management. Also contributing to the increase in depreciation and amortization was the amortization of

29

customer relationships related to the acquisitions of Maple Star Nevada, AlphaCare and Drawbridges beginning in August 2005, A to Z and FBS in February 2006, and IES in August 2006 and Correctional Services in October 2006, 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 increased from 1.6% to 1.9%1.7% from period to period due to increased amortization of management agreements and customer relationships related to our acquisition activity.

Non-operating (income) expense

Interest expense. Beginning in June 2005 through December 2005 and in February 2006, we acquired several businesses which we primarily funded through borrowings under our acquisition line of credit with CIT. On April 18, 2006, we prepaid approximately $15.8 million of the principal and accrued interest then outstanding related to our credit facility with CIT out of the net proceeds from the follow-on offering of our common stock that was completed on April 17, 2006. As a result, interest expense for the three months ended September 30, 2005March 31, 2006 was higher than that for the three months ended September 30, 2006March 31, 2007 due to a higher level of debt for the three months ended September 30, 2005March 31, 2006 as compared to the same current year period.

Interest income. The increase in interest income for the three months ended September 30, 2006March 31, 2007 as compared to the same prior year period resulted from interest earned on the net proceeds from the follow-on offering of our common stock completed in April 2006 which were deposited into an interest bearing account.

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 40.4%. Our estimated annual effective income tax rate differs from the federal statutory rate primarily due to nondeductible permanent differences and state income taxes.

Nine months ended September 30, 2006 compared to nine months ended September 30, 2005

Revenues

Home and community based services. The acquisition of A to Z and FBS in February 2006 and IES in August 2006 added, on a cumulative basis, approximately $5.9 million to home and community based services revenue for the nine months ended September 30, 2006. In addition, the acquisition of Children’s Behavioral Health, Inc, or CBH, Maple Star Nevada, AlphaCare, and Drawbridges added, on a cumulative basis, approximately $11.1 million to home and community based services revenue for the nine months ended September 30, 2006 as compared to the same prior year period. We also recognized approximately $2.5 million of home and community based services revenue, based upon our service encounter value and allowable administrative expenses, in excess of the annual funding allocation amount under our annual block purchase contract with CPSA, for the nine months ended September 30, 2006. Excluding the acquisitions of A to Z, FBS, IES and the acquisitions completed in 2005, our home and community based services provided additional revenue of approximately $5.9 million for the nine months ended September 30, 2006, as compared to the same period one year ago due to client volume increases in new and existing locations. Partially offsetting the increase in home and community based services revenue for the nine months ended September 30, 2006 was a decrease in our District of Columbia market of approximately $1.9 million described above.