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BUSINESS OVERVIEW

Overview

We are a leading independent information storage architect with operations throughout the United States. We work with customers to analyze, design, implement, and support information storage infrastructures that store, manage, and protect business critical information. Our areas of expertise include:

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Backup and Recovery—Datalink backup and recovery solutions mitigate risk by helping companies protect and quickly recover information.

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Consolidation and Virtualization—Designed to simplify management and improve productivity. Datalink consolidation and virtualization solutions help improve efficiencies of data storage infrastructures and the staff that manage them.

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Databases and Business Applications—Datalink storage, backup, and recovery solutions are designed to achieve stringent data availability requirements found in high performance database and business application environments.

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Archive and Compliance—Aligned with increasing compliance requirements, Datalink solutions help companies simplify the retention, protection, and discovery of information.

We offer a comprehensive suite of services spanning analysis, design, implementation and support. Our highly skilled technical services and practice management teams test and compare data storage technologies available from the leading manufacturers and software developers. Once a product is approved for our solution sets, our technical services team has the flexibility to choose from the best of these storage technologies to solve our customers' growing data storage needs. In addition, our support staff ensures the continued success of our data storage solutions for each customer. We believe these value-added services and our adherence to the highest quality standards have resulted in superior levels of customer satisfaction.

The Data Storage Industry

Information technology (IT) departments are faced with a daunting challenge of rapidly expanding amounts of data to manage. Coupled with this growth are increasing demands for availability of this data for day-to-day business and to meet regulatory requirements. At the same time, IT headcount is expected to remain relatively flat over the next several years. As a result, we expect customers will continue to look for alternatives to dramatically simplify management of storage infrastructures and increase productivity of existing IT teams.

To address the increased need for efficiency, we anticipate that organizations will consolidate and virtualize their server environments. We expect this will result in increased demand and requirements for shared storage infrastructures tuned to virtualized server environments. With a unified virtualization strategy, organizations will improve management and utilization, as well as reduce costs.

We expect that disk-based data protection, SAN/NAS convergence, storage management software, and storage services will grow rapidly over the next several years. We anticipate that, together, these areas will continue to grow faster than the rest of the storage industry. Organizations recognize the importance and value of data as a strategic and competitive asset. Employees, customers and suppliers demand uninterrupted access to mission-critical data 24 hours a day, 7 days a week. As a result, the ability to efficiently store, manage, and protect this data will continue as one of the most important aspects of business-critical decision-making, increasing the need for high-performance, scalable and highly available solutions.

In light of the importance of data to businesses, we believe that organizations will continue to dedicate a significant percentage of their information technology budgets to data storage. We believe that capital investment priorities will include:

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Enhanced data protection and recovery capabilities.


Increased need for high throughput performance, greater frequency of backups, quick restoration of data and stringent data availability requirements are key factors we expect will continue to drive the migration to disk-based protection solutions. Many of our customers have deployed disk-based backup and recovery solutions. With the convergence of key technologies, such as data deduplication, WAN optimization, and advanced heterogeneous replication and snapshot software, we expect the benefits customers receive from disk-based backup will increase, resulting in increased demand.

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Continued migration to networked storage infrastructures using virtualization technologies.

A comprehensive virtualization strategy should encompass both server and storage environments. Without this integrated approach, the full benefits of virtualization cannot be realized. We expect organizations will seek the professional services of a provider, like Datalink, to assess their environment, conduct a gap analysis, as well as design and deploy storage solutions tuned to their virtualized server environment. This approach will help organizations increase the quality of service and decrease the total cost of ownership.

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Retention and retrieval of data to address Email, regulatory, compliance and litigation support issues.

Long-term data retention has become the norm with recent industry regulations such as the Sarbanes-Oxley Act, HIPAA (Health Insurance Portability and Accountability Act) and SEC section 17a-4 (electronic communication preservation) mandating the retention of documents for many years. The consequences can be great if a company does not have the proper retention of documents for compliance, including stiff monetary penalties.

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Acceptance and growing need for storage services.

We expect three factors to drive IT organizations to increasingly outsource storage-related services (consulting, implementation and support). They include the growing strategic importance of data storage, growing complexity of networked storage environments and increasing scope of spending on storage.

The Datalink Opportunity

The increased need for data storage and the development of sophisticated, enterprise-class information data storage systems have created a demand for independent data storage solution providers, such as Datalink. Both potential customers and data storage device manufacturers are looking to independent storage solutions providers such as Datalink primarily for the following reasons:

Pressures on Customers. We believe organizations will increasingly look outside their in-house technical staff to independent information storage architects, such as Datalink, for specialized expertise. Networked storage architecture design is complex. Advanced functionalities, such as disk-based backup and recovery and virtualization, further increase the level of complexity. Although organization-wide data storage solutions, such as SANs, are designed to ease data management functions, these systems are difficult to understand and implement because they integrate diverse operating systems, hardware and software. In addition, there continues to be a steady influx of new products and technologies introduced to the market. In-house information technology departments prefer to focus their efforts on mission- critical applications. Accordingly, they often turn to outside storage experts that are able to research, design, implement and support networked storage solutions.

Pressures on Manufacturers. We believe manufacturers increasingly rely on channel partners such as us for two principal reasons:

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Sophisticated disk-based backup and recovery solutions require the integration of highly specialized products made by a variety of manufacturers. A typical enhanced data recovery architecture, for instance, can utilize components such as software, tape libraries, and disk systems, each from a different manufacturer. High-end data storage manufacturers generally focus on only a portion of the overall enhanced data recovery system, leaving companies like us to integrate comprehensive networked data storage solutions from the best available products and technologies.

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Gross profit margins have been under pressure for many storage companies. Because of the high cost of maintaining a national sales and marketing organization, high-end data storage manufacturers have focused their resources on their research and development functions. This strategy requires them to leverage their sales and marketing functions by partnering with companies such as Datalink.

We believe we are uniquely positioned to capitalize on this significant opportunity for the following reasons:

Expertise. We have been implementing sophisticated data storage solutions for over twenty years. This experience has given us significant expertise in understanding and applying data storage technologies and has allowed us to earn and retain the trust and confidence of our customers and suppliers. We invest in and train resources to differentiate our company, adapt to the ever-changing needs of our customers and capitalize on opportunities.

Independence. Unlike many of our competitors, we are independent of any manufacturer or particular technology. Our customers are increasingly using open systems computing architectures, which can combine products from multiple manufacturers. Our customers value our independence and rely on us to choose the best available hardware and software and tailor it to their individual needs.

The Datalink Solution

We combine our technical expertise, the best products from leading manufacturers and comprehensive services to meet each customer's specific needs. Our services include:

Analysis

At the beginning of an engagement, we place considerable emphasis on formulating a needs analysis based on each customer's business initiatives, operating environment and current and anticipated data storage requirements. While our focus is on each customer's unique situation, we bring to each engagement our extensive product knowledge and the experience we have gained from providing data storage solutions for over twenty years to customers in numerous industries.

Datalink assessment services provide customers with objective guidance on developing data storage strategies that optimize their resources, leverage their existing environments and facilitate cost-effective growth for the future. These services provide an independent viewpoint to align people, processes and technologies with business objectives. These services help organizations maximize current investments, outline recommendations for future purchases and provide assurance that storage infrastructures are efficient, reliable and scalable.

Design

Once we have completed our initial analysis, we begin the design phase of the project. Our professional services teams work together to design a system that meets the customer's data storage needs and budget. Our independence permits us to choose from a wide range of technologies in order to fuse together the appropriate hardware, software and services for each project.

Datalink designs storage infrastructures based on each customer's developed detailed business requirements. The engagement begins with a definition of the project's objectives, scope and key milestones. The Datalink team then prepares an outline of the schedule and deliverables. Following a thorough analysis, the team prepares a comprehensive blueprint of the storage solution, including a detailed design schematic, key implementation milestones and recommendations for handling potential configuration issues to ensure a smooth transition to the new storage environment.

Implementation

Once we design and test a system, we formulate a detailed project implementation plan with our customers to meet their financial and operating objectives and minimize disruption to their operations. We oversee the timely delivery of hardware and software products to the customer's location. We then coordinate the installation with our technical services team, or personnel from the equipment manufacturer, and complete the installation at the customer's site using industry best practices.

Support

We provide our customers advanced technical support from a team of customer support and field engineers. Our extensive experience in data storage systems enables our staff to deliver expert configuration and usage assistance, technical advice and prompt incident detection and resolution. The support team also acts as our primary interface with manufacturers' technical support organizations.

Datalink support services offer additional flexible levels of service to help organizations maximize the return on their storage technology investments. We believe that our customer support program is one of very few customer service plans that provide support across multiple storage product lines and manufacturers.

We provide our analysis, design and support services to customers through either a stand-alone services engagement or as a part of an overall project that includes a storage solution and services.

Our Strategy

Our strategy is to improve our position as a leading, independent information storage architect and to develop a customer-focused, high performance company with sustainable profitable growth. To achieve these objectives, we intend to build upon our record of successfully addressing the evolving enterprise-class information storage management needs of our customers. Key elements of our strategy include:

Increase Sales Team Productivity

Although we believe that Datalink's sales productivity is high, we believe it can be enhanced. We continue to accelerate the learning and productivity curve of our newer sales professionals and enhance the skills of seasoned executives through implementation of techniques and best practices learned from our top producers.

Scale Existing Locations

We intend to focus on our existing geographic locations to increase market share, leverage fixed expenses and provide higher quality service levels. Datalink will drive this growth by hiring experienced, quality account executives and storage engineers to gain sales productivity and field engineering utilization.

Expand Customer Support Revenues

We have significantly increased our customer support capabilities and performance over the last several years and will continue to make this a focus. Our customers appreciate our quality support initiatives, which we believe will continue to be a key differentiator and growth driver for Datalink.

Enhance Our Professional Services Business

There is significant opportunity to sell more of our storage services expertise to customers. By improving our assessment, storage audit and implementation service methodologies and sales tools, we plan to enhance our solution selling capabilities and continue to drive gross margins to higher levels.

Pursue Acquisitions

We believe there is an opportunity to strengthen our resources and presence in key geographies through the acquisition of select competitors. On January 31, 2007, we acquired Midrange Computer Solutions Inc. (MCSI), a storage consulting, solutions and service provider based in Chicago, Illinois. The acquisition of MCSI increased our revenue base by approximately one-third, expanding the number of enterprise accounts we serve and extending our presence geographically in the Northeast, Midwest, and California. We will continue to look for other acquisition opportunities.

Suppliers and Products

As an independent information storage architect, we do not manufacture data storage products. Instead, we continually evaluate and test new and emerging technologies from leading manufacturers to ensure that our solutions incorporate state-of-the-art, high performance, cost-effective technologies. This enables us to maintain our technological leadership, identify new and innovative products and applications and objectively help our customers align their data storage solutions with their business needs.

We have strong, established relationships with the major enterprise-class information storage hardware and software suppliers. Our expertise in open system environments includes UNIX, Microsoft Windows, Linux and in-depth knowledge of all major hardware platforms manufactured by industry leaders, including Hewlett-Packard Company, International Business Machines Corp. and Sun Microsystems, Inc. This expertise has earned us preferred status with many of our principal suppliers. Preferred status often enables us to participate in our suppliers' new product development, evaluation, introduction and marketing programs. These collaborations enable us to identify and market innovative new hardware and software products and exchange critical information in order to maximize customer satisfaction.

Customers

Our customers trust us with their most demanding data storage projects. Customer engagements range from specialized professional assessment and design services, to complex organization-wide SAN implementations. We serve customers throughout the United States in a diverse group of data intensive industries. Our broad industry experience enables us to understand application and business issues specific to each customer and to design and implement appropriate networked storage solutions. We enjoy strong relationships with our customers, which are reflected by our significant repeat business. Spanning a broad array of industries, our customers include CBS SportsLine.com, AT&T Inc., Harris Corporation, NAVTEQ Corporation, St. Jude Medical, Inc., The Nielsen Company, Inc., and Blue Cross Blue Shield of Minnesota.

Sales and Marketing

We market and sell our products and services throughout the United States primarily through a direct sales force. In addition to our Minneapolis headquarters, as of December 31, 2007, we have 20 field sales offices in order to efficiently serve our customers' needs.

Our field account executives and account associates work closely with our technical services team in evaluating the enterprise-class information storage needs of existing and prospective customers and in designing high quality, cost effective solutions. To ensure quality service, we assign each customer a specific field account executive and account associate. We believe that the average longevity of service of our sales force, and their close collaboration with our technical services team, are key factors to earning and retaining the trust and confidence of our customers. We believe this differentiates us from many other storage solution providers.

In addition to the efforts of our field account executives, inside account associates, and technical services team we engage in a variety of other marketing activities designed to attract new business and retain customer loyalty. We regularly execute integrated, demand creation campaigns, gain exposure through online and print trade publications, hold webcasts and informational seminars and publish a quarterly newsletter.

Competition

Datalink primarily competes with the direct sales forces of storage OEM's. Besides Datalink's current technology partners, these OEM competitors include Hewlett-Packard Company and Dell Computer Corporation. In addition, we compete with channel partners of storage OEM's. These include Forsythe Technology, Inc., Trace--3, Inc., Midwave Corporation, and Sirius Computer Solutions, Inc.

Employees

As of December 31, 2007, we had a total of 199 full-time employees. We have no employment agreements with any of our employees, except for Mr. Barnum, our Chief Financial Officer and Mr. Beyer, our Senior Vice President of Field Operations. In November 2004, we entered into change of control severance agreements with Mr. Westling, our President and Chief Executive Officer, and Ms. West, our Vice President of Human Resources, and each of Messrs. Barnum and Beyer under their respective employment agreements. None of our employees are unionized or subject to a collective bargaining agreement. We have experienced no work stoppages and believe that our employee relations are good.

CEO BACKGROUND

Between 1985 and 1997, Mr. Lidsky was employed by Norstan, Inc, most recently as Executive Vice President of Strategy and Business Development.
Margaret A. Loftus , age 63, was elected as a director in June 1998. Since 2005, Ms. Loftus has served as an independent consultant. Between 1989 and 2005, Ms. Loftus was an owner of Loftus Brown-Wescott, Inc., a business consulting firm, which she co-founded in 1989. Between 1976 and 1989, she was employed by Cray Research, Inc., most recently as Vice President of Software. Ms. Loftus also serves on the Board of Directors for Analysts International Corporation and several private technology companies.
J. Patrick O'Halloran, age 51, was elected as a director in August 2006. Since January 2005, Mr. O'Halloran has served as Chief Executive Officer for Entiera. Between 1983 and 2004, Mr. O'Halloran served in a range of senior, international management positions at Accenture Ltd., most recently as Partner in charge of Accenture's Customer Insight organization.
James E. Ousley , age 62, was elected as a director in June 1998 and in May 2007 was elected as our Lead Director. Between 2002 and 2004, Mr. Ousley was President and Chief Executive Officer of Vytek Wireless Inc., which was acquired by Calamp, Inc. From 1999 to 2001, he served as President and Chairman of Syntegra (USA), a division of British Telecommunications plc. From 1991 to 1999, Mr. Ousley was President and Chief Executive Officer of Control Data Systems (CDS), which was acquired by British Telecommunications in August 1999. From 1968 to 1991, he held various sales and executive management positions with Control Data Corporation. Mr. Ousley also serves on the Board of Directors for Actidentity Inc., Bell Microproducts Inc. and Savvis, Inc.
Robert M. Price , age 77, was elected as a director in June 1998 and served as our Chairman of the Board between June 1998 and December 2005. Mr. Price has been President of PSV, Inc., since 1990. Between 1961 and 1990, he served in various executive positions, including as Chairman and Chief Executive Officer, with Control Data Corporation. From 1991 to 2005, Mr. Price was a Senior Advisor and Professor at the Fuqua School of Business at Duke University, and is now Adjunct Professor of the Pratt School of Engineering at Duke University. Mr. Price is Mr. Meland's father-in-law. Mr. Price also serves on the Board of Directors of Public Service Company of New Mexico, Affinity Technology Group, Inc. and National Center for Social Entrepreneurs.
Charles B. Westling , age 49, became our President and Chief Executive Officer in December 2005 and became a director in January 2006. He originally joined us in 2002 and prior to becoming our President and Chief Executive Officer, held the offices of Vice President—Corporate and Business Development, Vice President—Market Development, and President and Chief Operating Officer. Between 2000 and 2001, he was the Executive Vice President of Business Development of Agiliti, Inc. Mr. Westling served as Senior Managing Director and Director of Corporate Finance for John G. Kinnard and Company, Incorporated from 1997 to 1999. From 1990 to 1997, Mr. Westling was a member of the corporate finance department at Dain Bosworth Incorporated, serving most recently as a managing director and head of technology investment banking. Mr. Westling received his B.A. in economics from Carleton College and earned a Master of Management degree from the J.L. Kellogg Graduate School of Management at Northwestern University.
MANAGEMENT DISCUSSION FROM LATEST 10K

OVERVIEW

We are an independent architect of enterprise-class information storage infrastructures. We derive our revenues principally from designing, installing and supporting data storage systems. Our solutions can include hardware products, such as disk arrays, tape systems and interconnection components and storage management software products. The market for data storage products and services is large. IDC estimates that digital information will occupy more than six times its current quantity, or 988 billion gigabytes, by 2010. As of December 31, 2007, we have 21 locations throughout the United States with the highest concentration of revenues in the central states.

We sell support service contracts to most of our customers. When customers purchase support services through us, customers receive the benefit of integrated system wide support. We have a qualified, independent support desk that takes calls from customers, diagnoses the issues they are facing and either solves the problem or coordinates with Datalink and/or vendor technical staff to meet the customer's needs. Our support service agreements with our customers include an underlying agreement with the product manufacturer. The manufacturer provides on-site support assistance if necessary. We defer revenues and direct costs resulting from these contracts, and amortize these revenues and expenses into operations, over the term of the contracts, which are generally twelve months.

The enterprise-class information storage market is rapidly evolving and highly competitive. Our competition includes other independent storage system integrators, high end value added resellers, distributors, consultants and the internal sales force of our suppliers. Our ability to hire and retain qualified outside sales representatives and engineers with enterprise-class information storage experience is critical to effectively competing in the marketplace and achieving our growth strategies.

In the past, we have experienced fluctuations in the timing of orders from our customers, and we expect to continue to experience these fluctuations in the future. These fluctuations have resulted from, among other things, the time required to design, test and evaluate our data storage solutions before customers deploy them, the size of customer orders, the complexity of our customers' network environments, necessary system configuration to deploy our solutions and new product introductions by suppliers. Completion of our installation and configuration services may also delay recognition of revenues. Economic conditions and competition also affect our customers' decisions to place orders with us. As a result, our net sales may fluctuate from quarter to quarter.

We view the current data storage market as providing significant opportunity for growth. Currently, Datalink's market share is a small part of the overall market. However, the providers of the data storage industry's products and technologies are increasing their utilization of indirect sales approaches to broaden their reach and optimize their margins. Increasingly, they are turning to companies such as Datalink to sell their products. While these trends provide opportunity for Datalink, we must improve our business model to generate sustainable, profitable growth. Our model requires highly skilled sales and technical staff which results in substantial fixed costs for us. We believe the best way to improve our company and create long-term shareholder value is to focus on building scaleable capabilities and a leverageable cost structure. Our current strategies are focused on:

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Increasing productivity of our sales, technical and customer support teams in our existing locations.

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Deepening our presence in existing enterprise accounts and penetrating new enterprise accounts.

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Targeting high growth market segments and deploying new technologies.

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Growing our customer support revenue and market share. We believe that our customer support services offerings are becoming increasingly attractive to companies looking for system-wide integrated support.

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Increasing our professional services revenues. We believe there is an opportunity to sell more of our data storage services such as implementation services, storage environment assessments and on-site data storage management and architecture services.

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Exploring potential acquisitions that we believe can strengthen our resources and capabilities in key geographic locations.

To pursue these strategies, we are:

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Improving our training, tools and recruiting efforts for sales and engineering teams to increase productivity.

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Hiring additional customer support staff and enhancing the customer support staff's communications and call management capabilities.

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Developing more effective delivery capabilities for professional services and solutions.

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Meeting regularly with potential acquisition candidates.

All of these plans have various challenges and risks associated with them, including that:

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We may not increase our productivity and may lose, or not successfully recruit and retain key sales, technical or other personnel.

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Competition is intense and may adversely impact our profit margin. Customers have many options for data storage products and services.

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Economic conditions may adversely impact our business. Customers may delay purchasing decisions or seek to spend less.

In January 2007, we entered into an agreement and plan of merger with Midrange Computer Systems Inc. (MCSI), a storage consulting, solutions and service provider based in Chicago, Illinois. We believe the acquisition has strengthened our presence in existing regional markets and expanded our reach into a number of key new regional markets. We paid a purchase price of approximately $14.3 million for MCSI, consisting of $5.0 million cash and 1,163,384 shares of our common stock. Our results of operations for 2007 reflect the addition of MCSI for eleven months.

Results of Operations

Our sales for 2007 increased $31.8 million or 21.8% to $177.8 million for 2007 as compared to 2006. Our gross margin increased $7.2 million or 18.9% to $45.3 million for 2007 as compared to 2006. Our earnings from operations decreased $4.4 million from $5.6 million in 2006 to $1.2 million in 2007. The following table shows, for the periods indicated, certain selected financial data expressed as a percentage of net sales.

Comparison of Years Ended December 31, 2007, 2006 and 2005

Net Sales. Our product sales increased 8.6% in 2007 from 2006 to $111.2 million, and increased 25.5% in 2006 from 2005 to $102.4 million. Our service sales, which includes customer support, consulting and installation services, increased 52.7% in 2007 from 2006 to $66.6 million, and increased 22.7% in 2006 from 2005 to $43.6 million.

The increase in our product sales in 2007 as compared to 2006 is primarily due to the acquisition of MCSI in January 2007. The increase in our product sales in 2006 as compared to 2005 reflects a greater number of customers funding large projects, particularly for enhanced data recovery technology solutions. We had an increase in customers representing more than $1 million in annual revenues from 20 in 2005 to 24 in 2006 to 31 in 2007. Product sales growth decreased from 25.5% in 2006 to 8.6% in 2007 continuing to reflect what we believe to be a slow down in IT and storage spending with some of our larger customers, as they have become more cautious about the economy and their individual growth prospects. This has created longer sales cycles with a number of large project delays. We do not know whether this spending slow down among our customers will continue.

The increase in our service revenues for 2007 over 2006 reflects an increase in our customer support contract revenues and consulting service revenues. For 2007 customer support contract revenues increased $21.4 million or 61.7% over 2006 and consulting service revenues increased $1.3 million or 82.3%. The majority of our increase in customer support contract revenues in 2007 was due to the acquisition of MCSI. The increase in our service revenues for 2006 over 2005 reflects an increase in our customer support contract revenues and our installation and configuration service revenues. Customer support contract revenues increased $8.3 million or 31.4%, consulting service revenues decreased $1.3 million or 53.1% and installation and configuration service revenues increased $1.1 million or 16.3%. With the growth in our product revenues, we continue to successfully sell our installation and configuration services and customer support contracts. The decrease in our consulting revenues between 2005 and 2006 reflects the completion of a long term professional services contract at the end of 2005.

We derived approximately 13.9% of our sales from our customer, AT&T Inc., during 2006. We cannot provide assurance that this customer will account for a substantial portion of our future sales. We had no customers that comprised more than 10% of our sales in 2005 or 2007.

Gross Profit. Our total gross profit as a percentage of net sales was 25.5% in 2007 decreasing from 26.1% in 2006 and 26.2% in 2005.

Product gross profit as a percentage of product sales decreased to 24.1% in 2007 as compared to 24.4% in 2006 which increased as compared to 23.8% in 2005. Our product gross profit as a percentage of product sales is impacted by the mix and type of projects we complete for our customers. Our product gross profit as a percentage of product sales decreased for 2007 over 2006 due to the additional MCSI revenues which historically had lower product margins. Our efforts to successfully integrate the MCSI sales force, by leveraging product and service offerings across our vendors, has gradually improved the gross margins realized by the MCSI sales force. The MCSI sales force has not yet achieved the product gross profit margins that we previously experienced and we cannot assure they will reach those targets. The percentage improvement in 2006 over 2005 reflects the increase in enhanced data recovery technology solution purchases made by our customers for which we achieved a higher gross profit. We have various programs in place with our vendors that provide economic incentives for achieving various sales performance targets. Achieving these targets contributed favorably to our product gross profit by $2.0 million, $1.5 million and $829,000 in 2007, 2006 and 2005, respectively. These vendor incentive programs constantly change and we negotiate them separately with each vendor. While we expect the incentive programs to continue, the vendors could modify or discontinue them, which would unfavorably impact our product gross profit margins.

Service gross profit as a percentage of service sales decreased to 27.7% in 2007 as compared to 30.0% in 2006 and 31.5% in 2005. The percentage decrease in 2007 as compared to 2006 is primarily due to a $664,000 reduction in revenues and corresponding margins for the MCSI acquisition to reflect the fair value of maintenance contracts we acquired. The percentage decrease in 2006 as compared to 2005 reflects the completion of a long term professional services contract at the end of 2005 which carried a higher gross profit percentage.

Sales and Marketing. Sales and marketing expenses include wages and commissions paid to sales and marketing personnel, travel costs and advertising, promotion and hiring expenses. Sales and marketing expenses totaled $22.1 million, or 12.4% of net sales for 2007 as compared to $16.0 million, or 10.9% of net sales for 2006 and $15.1 million, or 12.9% of net sales for 2005. The increase in sales and marketing expense in absolute dollars for 2007 over 2006 is primarily a result of higher commission expense of $1.6 million and compensation expense of $3.7 million. The increase in commission expense is due to our increase in revenues for the year. The increase in compensation expense is due to our acquisition of MCSI which increased our sales and marketing headcount by approximately 45%. The increase in sales and marketing expense in absolute dollars for 2006 over 2005 is primarily a result of higher commission expense of $1.5 million related to our increased 2006 revenues. The increase in sales and marketing expense as a percentage of net sales from 2007 to 2006 reflects primarily the increase in sales and marketing headcount as a result of our MCSI acquisition, and investments in sales management. The decrease in sales and marketing expense as a percentage of net sales from 2006 to 2005 reflects better leverage of our fixed costs as revenues increased in 2006. As we continue to selectively hire additional outside sales representatives, our sales and marketing expenses may increase without a commensurate increase in sales.

General and Administrative. General and administrative expenses include wages for administrative personnel, professional fees, depreciation, communication expenses and rent and related facility expenses. General and administrative expenses increased to $11.7 million, or 6.6% of net sales for 2007 compared to $10.4 million, or 7.2% of net sales for 2006 and $9.9 million, or 8.5% in 2005. The increase in general and administrative expenses in absolute dollars for 2007 as compared to 2006 is primarily due to an increase in facility expenses of $496,000 with the acquisition of MCSI in January 2007, an increase in audit fees and outside consulting fees for Sarbanes-Oxley compliance of $213,000, an increase in compensation expense of $200,000 and an increase in depreciation expense of $120,000. The increase in general and administrative expenses in absolute dollars for 2006 as compared to 2005 is primarily due to an increase of $294,000 in facilities expenses for new regional office lease agreements entered into during the second and third quarters of 2005, an increase of $135,000 for board compensation expense and an increase of $50,000 for sales and use tax expense for several state audits. Our general and administrative expenses were lower as a percentage of net sales for 2007 as compared to 2006, and for 2006 as compared to 2005, primarily due to more controlled spending coupled with an increase in revenues.

Engineering. Engineering expenses include employee wages and travel, hiring and training expenses for our field and customer support engineers and technicians. We allocate engineering costs associated with installation and configuration services and with consulting services to our cost of service sales. Engineering expenses increased to $9.2 million, or 5.2% of net sales in 2007 compared to $6.1 million, or 4.2% of net sales in 2006 and $5.1 million, or 4.4% of net sales in 2005. The increase in engineering expenses in absolute dollars for 2007 over 2006 is due primarily to an increase in compensation expense of $3.6 million related to our MCSI acquisition. The MCSI acquisition increased our engineering headcount approximately 26%. The increase in engineering expenses in absolute dollars for 2006 as compared to 2005 is due primarily to a $908,000 increase in compensation expense related to a 30% increase in headcount coupled with higher health insurance expenses. The increase in engineering expenses as a percentage of sales for 2007 as compared to 2006 is primarily the result of investments in regional management. The decrease in engineering expenses as a percentage of sales for 2006 as compared to 2005 is primarily the result of more controlled spending coupled with an increase in revenues.

Integration Costs. We had integration expenses of $442,000 in 2007 related to the January 31, 2007 acquisition of MCSI. Integration expenses include salaries and benefits of MCSI employees who assisted with the initial integration but whom we ultimately did not retain, together with retention bonuses and severance payments.

Sublease Arrangements. In December 2004, we agreed to sublease approximately 55,000 of the 104,000 square feet we then occupied as our corporate headquarters in Chanhassen, Minnesota. The initial sublease term is co-terminal with our lease and is for 85 months starting in April 2005 and ending in April 2012. The sublessee will pay us rent ranging from approximately $55,000 per month at the beginning of the term to approximately $60,000 per month by the end of the term. We also negotiated with our landlord to sell the 2.5 acre lot adjoining our facility for $200,000. In the first quarter of 2005, we incurred a one-time, non-cash charge of $3.5 million related to the sublease and lot sale. We obtained cost savings of approximately $950,000 in 2007, 2006 and 2005 as a result of the sublease agreement and expect to achieve comparable savings in future years during the sublease term.

Intangible Amortization. We had expenses related to the amortization of finite-lived intangible assets of $727,000, $0 and $224,000 in 2007, 2006 and 2005, respectively. Amortization of intangible assets increased to $727,000 in 2007 from $0 in 2006. The increase in finite-lived intangible assets and subsequent amortization is due to our acquisition of MCSI on January 31, 2007. The finite lived intangibles we acquired, consisting of customer relationships and backlog, have estimated lives of six years and two months, respectively, and we are amortizing them using the straight line method. Amortization of finite-lived intangible assets decreased to $0 in 2006 from $224,000 in 2005. At the end of 2005, we fully amortized all intangible assets primarily related to our acquisition in November 2000 of the data storage and services business of OpenSystems. For 2007, 2006 and 2005, we determined that our goodwill was not impaired.

Operating Earnings (Loss). We realized operating earnings of $1.2 million in 2007 and $5.6 million in 2006 and incurred an operating loss of $3.2 million in 2005. The decrease in our operating earnings in 2007 as compared to 2006 is due to our lower gross margin and increased operating expenses in 2007 primarily as a result of our acquisition of MCSI. Our operating earnings in 2006 increased over our operating loss in 2005 primarily as a result of higher revenues and gross margins partially offset by higher operating expenses. Excluding the sublease charge of $3.5 million in the first quarter of 2005, we generated operating earnings of $284,000 in 2005.

Income Taxes. We had income tax expense of $864,000 in 2007 as a result of our estimated effective tax rate of 42%. We had an income tax benefit of $2.2 million in 2006. We had no income tax benefit or expense in 2005. Prior to fiscal 2006, we recorded a full valuation allowance against our deferred tax assets due to the uncertainty of the realization and timing of the benefits from those deferred tax assets as we had not achieved a sufficient level of sustained profitability. During 2006, we utilized approximately $4.8 million of our net operating loss carryforwards. Furthermore, we concluded that we had attained a sufficient level of sustained profitability to reverse the remaining $2.8 million valuation allowance. We utilized approximately $1.9 million, $4.8 million and $200,000 of our federal net operating loss carryforwards in 2007, 2006 and 2005, respectively. For 2007 and 2006, respectively, we recorded approximately $104,000 and $392,000 to equity for tax benefits associated with the exercises of stock options. In future periods of taxable earnings, we expect to report an income tax provision using an effective tax rate of approximately 42%.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

RESULTS OF OPERATIONS



On January 30, 2007 we entered into an agreement and plan of merger with Midrange Computer Systems Inc. (MCSI), a storage consulting solutions and services provider. Our results of operations for the three months ended March 31, 2007 reflect the addition of MCSI for two months.

Net Sales . Our total net sales increased by $6.8 million, or 16.7%, to $47.7 million for the three months ended March 31, 2008, from $40.9 million for the comparable quarter in 2007. Our product sales increased $960,000, or 3.5%, to $28.5 million for the three months ended March 31, 2008 from $27.6 million for the comparable quarter in 2007. Our service sales increased $5.9 million, or 43.9%, to $19.2 million for the three months ended March 31, 2008 from $13.3 million for the comparable quarter in 2007.



We had a modest increase in our product sales for the three month period ended March 31, 2008, as compared to the same period in 2007. Our product revenues continue to reflect our customers’ closer scrutiny of expenditures as they focus more attention on the impact or potential impact that macro economic conditions will have on the growth and profitability of their business. This resulted in a lull in bookings activity during the first half of the quarter. We saw a pick up in orders beginning in late February that continued throughout March, and we ended the quarter with a backlog of over $30 million.



Our service sales increase for the three month period ended March 31, 2008 as compared to the same periods in 2007 was due to an increase in customer support contracts of $5.2 million. With the growth in our product revenues, we continue to successfully sell our installation and configuration services and customer support contracts.



We had no single customer account for greater than 10% of our revenues for the three months ended March 31, 2008. We derived 12% of our revenues for the three months ended March 31, 2007, from AT&T Inc.

Net Sales . Our total net sales increased by $6.8 million, or 16.7%, to $47.7 million for the three months ended March 31, 2008, from $40.9 million for the comparable quarter in 2007. Our product sales increased $960,000, or 3.5%, to $28.5 million for the three months ended March 31, 2008 from $27.6 million for the comparable quarter in 2007. Our service sales increased $5.9 million, or 43.9%, to $19.2 million for the three months ended March 31, 2008 from $13.3 million for the comparable quarter in 2007.



We had a modest increase in our product sales for the three month period ended March 31, 2008, as compared to the same period in 2007. Our product revenues continue to reflect our customers’ closer scrutiny of expenditures as they focus more attention on the impact or potential impact that macro economic conditions will have on the growth and profitability of their business. This resulted in a lull in bookings activity during the first half of the quarter. We saw a pick up in orders beginning in late February that continued throughout March, and we ended the quarter with a backlog of over $30 million.



Our service sales increase for the three month period ended March 31, 2008 as compared to the same periods in 2007 was due to an increase in customer support contracts of $5.2 million. With the growth in our product revenues, we continue to successfully sell our installation and configuration services and customer support contracts.



We had no single customer account for greater than 10% of our revenues for the three months ended March 31, 2008. We derived 12% of our revenues for the three months ended March 31, 2007, from AT&T Inc.

our estimated tax rate of 40%. In future periods of taxable earnings, we expect to continue reporting an income tax provision using an effective tax rate of approximately 41%.



LIQUIDITY AND CAPITAL RESOURCES



Net cash provided by operating activities was $1.4 million for the three months ended March 31, 2008 as compared to net cash provided by operating activities of $2.8 million for the three months ended March 31, 2007. Significant items which impacted our operating cash flows as of March 31, 2008 were:



• Net earnings of $505,000.

• A $622,000 net increase in deferred customer support contracts. While we amortize the revenues from these contracts over the life of the contract, the customer almost always pays for the contracts at the beginning of the contract period which favorably impacts our cash flows.

• A net increase in cash of approximately $1.4 million for accounts receivable, inventory and accounts payable. This was primarily due to a decrease in inventories related to a higher balance of inventories in transit at December 31, 2007.

• A decrease in cash of $1.7 million related to a decrease in variable compensation and sales and use tax accruals since December 31, 2007.



Net cash provided by investing activities was $2.4 million for the three months ended March 31, 2008. This cash was primarily provided by the sale of a short-term investment. We are planning for $500,000 of capital expenditures for the remainder of 2008 related primarily to computer and communication system upgrades or other management information system enhancements.



Net cash used in financing activities was $21,000 for the three months ended March 31, 2008, from tax withholding payments reimbursed by restricted stock. Net cash provided by financing activities was $7,000 for the three months ended March 31, 2007, from the exercise of stock options offset by tax withholding payments reimbursed by restricted stock.



We have elected not to pursue a credit facility at this time. With our current cash position, we believe we have the liquidity to meet our operating needs for the foreseeable future. We have no outstanding debt, and if the need should arise to borrow funds, we believe that we could obtain a secured facility.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES



The preparation of financial statements requires us to make estimates and assumptions that affect reported earnings. We evaluate these estimates and assumptions on an on-going basis based on historical experience and on other factors that we believe are reasonable. Estimates and assumptions include, but are not limited to, the areas of customer receivables, establishment of vendor specific objective evidence of fair value for customer contracts with multiple elements, inventories, income taxes, self-insurance reserves and commitments and contingencies.



Our significant accounting policies and estimates are summarized in our annual financial statements. Some of our accounting policies require management to exercise significant judgment in selecting the appropriate assumptions for calculating financial estimates. Such judgments are subject to an inherent degree of uncertainty. These judgments are based on our historical experience, known trends in our industry, terms of existing contracts and other information from outside sources, as appropriate. We believe these estimates and assumptions are reasonable based on the facts and circumstances as of March 31, 2008. However, actual results may differ from these estimates under different assumptions and circumstances.

We believe that the following represent the areas where we use more critical estimates and assumptions in the preparation of our financial statements:



Revenue Recognition. We realize revenue from the design, installation and support of data storage solutions, which may include hardware, software and services. We recognize revenue when we have met our obligations for installation or other services and collectability is reasonably assured.



Product Sales . We sell software and hardware products on both a “free-standing” basis without any services and as data storage solutions bundled with our installation and configuration services (“bundled arrangements”).



Product Sales Without Service . If we sell a software or hardware product and do not provide any installation or configuration services with it, we recognize the product revenues upon shipment.



Product Sales With Service . If we sell a bundled arrangement, then we defer recognizing any revenues on it until we finish our installation and/or configuration work. We account for the hardware, software and service elements of our bundled arrangements by applying the provisions of Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended by SOP 98-4 and SOP 98-9.



Pursuant to the provisions of SOP 97-2, we apply contract accounting to our bundled arrangements. In accordance with SOP 81-1, “Accounting for Performance of Construction Type and Certain Production Type Contracts,” we apply the completed contract method. Factors we have considered in applying the completed contract method accounting include (i) the relatively short duration of our contracts, (ii) the difficulty of estimating our revenues on a percentage-of-completion method and (iii) our use of acceptance provisions on larger bundled arrangements.



Service Sales . In addition to installation and configuration services that are part of our bundled arrangements described above, our service sales include customer support contracts and consulting services. On our balance sheet, deferred revenue relates to service sales for which our customer has paid us or has been invoiced but for which we have not yet performed the applicable services.



Customer Support Contracts . We sell service contracts to most of our customers. These contracts are support service agreements. We have an internal support desk that provides integrated customer support services, including configuration and usage assistance, technical advice and prompt incident detection and resolution. Our technical staff first assists a customer in identifying the source of system problems and in determining whether there is defective hardware or software. If our customer requires on-site maintenance or repair services, we arrange for a service call pursuant to underlying third-party support service agreements we have with our hardware and software vendors.



When we sell a service contract as part of a bundled arrangement, we use vendor specific objective evidence to allocate revenue to the service contract element. In all cases, we defer revenues and direct costs resulting from our service contracts and amortize them into operations over the term of the contracts, which are generally twelve months. We are contractually obligated to provide or arrange to provide these underlying support services to our customers in the unlikely event that the hardware or software vendor, or its designee, fails to perform according to the terms of its contact.



Consulting Services . Some of our customers engage us to analyze their existing storage architectures and offer our recommendations. Other customers engage us to assist them on-site with extended data storage projects, to support their data storage environments and to help with long-term data storage design challenges. For these types of consulting services that do not include the sale of hardware or software products, we recognize revenues as we perform these services.



Gross Reporting of Revenues. We report our revenues from the sale of hardware and software products on a gross, rather than a net, basis. In reporting our revenues on a gross basis, we considered that:



• We are the primary obligor to our customers. We are responsible for fulfillment, including the acceptability of the products and services to our customers.

• We have the risk of loss for inventory and credit.

• We establish the prices for our products and services with our customers.

• We are responsible for the installation and configuration services ordered by our customers.



Inventory . We periodically review, estimate and adjust our reserves for obsolete or unmarketable inventory equal to the difference between the inventory cost and the estimated market value based upon assumptions about future demand and market conditions. Results could be materially different if demand for our products decreased because of economic or competitive conditions, length of industry downturn, or if products become obsolete because of technical advancements in the industry.

Valuation of Goodwill . We test goodwill for impairment annually or more frequently if changes in circumstance or the occurrence of events suggests an impairment exists. The test for impairment requires us to make several estimates about fair value, most of which are based on total market capitalization as compared to the carrying value of our net assets. If our total market capitalization is at or below the carrying value of our net assets, it may prompt us to engage a third party valuation firm to perform a valuation of us to further assess whether our goodwill is impaired pursuant to SFAS 142. We consider our goodwill impairment test estimates critical due to the amount of goodwill recorded on our balance sheet and the judgment required in determining fair value amounts.



Valuation of Long-Lived Assets, Including Finite-Lived Intangibles . We evaluate long-lived assets and intangible assets with finite lives for impairment, as well as the related amortization periods, to determine whether adjustments to these amounts or useful lives are required based on current events and circumstances. We base the evaluation on our projection of the undiscounted future operating cash flows of the underlying assets. To the extent such projections indicate that future undiscounted cash flows are not sufficient to recover the carrying amounts of related assets, we record a charge to reduce the carrying amount to its estimated fair value. The test for impairment requires us to make several estimates about fair value, most of which are based on projected future cash flows. We consider the estimates associated with the asset impairment tests critical due to the judgments required in determining fair value amounts, including projected future cash flows. Changes in these estimates may result in the recognition of an impairment loss.



Income Taxes . We utilize the asset and liability method of accounting for income taxes. We recognize deferred tax liabilities or assets for the expected future tax consequences of temporary differences between the book and tax bases of assets and liabilities. We regularly assess the likelihood that we will recover our deferred tax assets from future taxable income We consider projected future taxable income and ongoing tax planning strategies in assessing the need for a valuation allowance.



Stock-Based Compensation . We adopted the provisions of FASB No. 123R, Share Based Payment on January 1, 2006. SFAS 123(R) requires us to measure and recognize in our statements of operations the expense associated with all share-based payment awards made to employees and directors based on estimated fair values. SFAS 123(R) requires the use of an option pricing model to determine the fair value of share-based payment awards. Our stock price, as well as assumptions regarding a number of highly complex and subjective variables, will affect our determination of fair value. We base recognition of compensation expense for our performance-based, non-vested shares on management’s estimate of the probable outcome of the performance condition. Management reassesses the probability of meeting these performance conditions on a quarterly basis. Changes in management’s estimate of meeting these performance conditions may result in significant fluctuations in compensation expense from period to period.

CONF CALL

Charles B. Westling

I’d like to welcome everyone to this afternoon’s conference call. With me today are Greg Barnum, our Vice President of Finance and Chief Financial Officer and Scott Robinson, our Chief Technology Officer. Let me first turn the call over to Greg to discuss the second quarter results and then I will provide some additional perspectives on Q2 and our outlook for the third quarter and the rest of the year.

Gregory T. Barnum

Before we start with Q2, let me first cover the Safe Harbor on forward-looking statements. The Private Securities Litigation Reform Act of 1995 provides a Safe Harbor for certain forward-looking statements. In this conference call we will be discussing our views regarding future events and financial performance. These forward-looking statements are subject to certain risks and uncertainties. Actual future results and trends may differ materially from historical results or those anticipated depending on a variety of factors. Please refer to our filings with the SEC for a full discussion of our company’s risk factors.

Also, let me remind everyone that when we talk about the second quarter and six months of 2008, it includes three months and six months respectively of the results of operations of MCSI which we acquired on January 31, 2007. When we refer to 2007 second quarter and six months this includes three months and five months respectively of MCSI.

Turning to the quarter, on a GAAP basis second quarter revenues were $49.7 million which is up 23% from revenues of $40.3 million in the second quarter of 2007 and a sequential increase of 4% from $47.7 million in the first quarter of 2008. Revenue for the six months ended June 30th were $97.4 ]]>Fri, 18 Jul 2008 12:56:35 GMThttp://www.dailystocks.com/forum/showtopic.php?tid/748/http://www.dailystocks.com/forum/showtopic.php?tid/748/
Dailystocks.com only deals with facts, not biased journalism. What is a better way than to go to the SEC Filings? It's not exciting reading, but it makes you money. We cut and paste the important information from SEC filings for you to get started on your research on a specific company.


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BUSINESS OVERVIEW

OVERVIEW

Pediatrix is a leading provider of physician services including newborn, maternal-fetal, pediatric subspecialty, and anesthesia care. At December 31, 2007, our national network was composed of 1,072 affiliated physicians, including 788 physicians who provide neonatal clinical care in 32 states and Puerto Rico, primarily within hospital-based neonatal intensive care units (“NICUs”), to babies born prematurely or with medical complications. We have 109 affiliated physicians who provide maternal-fetal medical care to expectant mothers experiencing complicated pregnancies in many areas where our affiliated neonatal physicians practice. Our network includes other pediatric subspecialists, including 69 physicians providing pediatric cardiology care, 37 physicians providing pediatric intensive care and 16 physicians providing hospital based pediatric care. In addition, we have 53 physicians who provide anesthesia care to patients in connection with surgical and other medical procedures.

In December 2007, we signed a definitive agreement to sell our newborn metabolic screening laboratory business in a cash transaction. The closing of the sale is subject to customary conditions. In accordance with Statement of Financial Accounting Standards No. 144 (“FAS 144”), “Accounting for the Impairment or Disposal of Long-Lived Assets,” the assets and liabilities related to the laboratory business have been classified as held for sale at December 31, 2007 and its business operations are considered discontinued operations. The sale of the laboratory is intended to allow us to focus more resources to support the continued expansion of our clinical and administrative competencies within physician services.

Pediatrix Medical Group, Inc. was incorporated in Florida in 1979. Our principal executive offices are located at 1301 Concord Terrace, Sunrise, Florida 33323, and our telephone number is (954) 384-0175.

Our Physician Specialties

The following discussion describes our physician specialties and the care that we provide:


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Neonatal Care . We provide clinical care to babies born prematurely or with complications within specific units at hospitals, primarily NICUs, through a team of experienced neonatal physician subspecialists (called “neonatologists”), neonatal nurse practitioners and other pediatric clinicians. Neonatologists are board-certified or eligible-to-apply-for-cer tification as a neonatologist who have extensive education and training for the care of babies born prematurely or with complications that require complex medical treatment. Neonatal nurse practitioners are registered nurses who have advanced training and education in managing the healthcare needs of newborns, infants and their families.


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Maternal-fetal Care . We provide outpatient and inpatient clinical care to expectant mothers experiencing complicated pregnancies and their unborn babies through our affiliated maternal-fetal medicine subspecialists and other clinicians, such as maternal-fetal nurse practitioners, certified nurse mid-wives, ultrasonographers and genetic counselors. Maternal-fetal medicine subspecialists are board-certified or eligible-to-apply-for-cer tification obstetricians who have extensive education and training for the treatment of high-risk expectant mothers and their fetuses. Our affiliated maternal-fetal

medicine subspecialists practice in certain metropolitan areas where we have affiliated neonatologists to provide coordinated care for women with complicated pregnancies and whose babies are often admitted to a NICU upon delivery.


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Pediatric Cardiology Care . We provide inpatient and outpatient pediatric cardiology care of the fetus, infant, child, and adolescent patient with congenital heart defects and acquired heart disease as well as adults with congenital heart defects through our affiliated pediatric cardiologist subspecialists and other clinicians such as pediatric nurse practitioners, echocardiographers and other diagnostic technicians, and exercise physiologists. Pediatric cardiologists are board-certified pediatricians who have additional education and training in congenital heart defects and pediatric acquired heart disorders.


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Other Pediatric Subspecialty Care . Our network includes pediatric intensivists, who are hospital-based pediatricians with additional education and training in caring for critically ill or injured children and adolescents, and pediatric hospitalists, who are hospital-based pediatricians specializing in inpatient care and management of acutely ill children. Our affiliated physicians also provide clinical services in other areas of hospitals, particularly in the labor and delivery area, nursery and pediatric department, where immediate accessibility to specialized care may be critical.


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Anesthesia Care . We provide anesthesia care through a team of experienced physician anesthesiologists and certified registered nurse anesthetists (called “CRNAs”). Anesthesiologists are board certified or eligible-to-apply-for-cer tification physicians who have extensive education and training for the relief of pain and care of the surgical patient before, during and after surgery, primarily at hospitals. They also provide medical care and consultations in many other settings and situations in addition to the operating room.

As part of our ongoing commitment to improving patient care through evidence-based medicine, we also conduct clinical research, monitor clinical outcomes and implement clinical quality initiatives with a view to improving patient outcomes, shortening the length of hospital stays and reducing long-term health system costs. We believe that referring and collaborating physicians, hospitals, third-party payors and patients all benefit from our clinical research, education and quality initiatives.

Demand for Our Services

Neonatal Medicine . Of the approximately 4.3 million births in the United States annually, we estimate that approximately 12 percent require NICU admissions. Research continues to be conducted by numerous institutions to identify potential causes of premature birth and medical complications that often require NICU admissions. Some common contributing factors include the presence of hypertension or diabetes in the mother, lack of prenatal care, complications during pregnancy, drug and alcohol abuse and smoking or poor nutritional habits during pregnancy. Babies admitted to NICUs typically have an illness or condition that requires the care of a neonatologist. Babies who are born prematurely or have a low birth weight often require neonatal intensive care services because of increased risk for medical complications. We believe obstetricians generally prefer to perform deliveries at hospitals that provide a full complement of labor and delivery services, including a NICU staffed by board-certified or eligible-to-apply-for-cer tification neonatologists. Because obstetrics is a significant source of hospital admissions, hospital administrators have responded to these demands by establishing NICUs and contracting with independent neonatology group practices to staff and manage these units. As a result, NICUs within the United States tend to be concentrated in hospitals with a higher volume of births. There are approximately 4,000 board-certified neonatologists in the United States who practice at approximately 1,500 hospital-based NICUs.

Maternal-fetal Medicine . Expectant mothers with pregnancy complications often seek or are referred by their obstetricians to maternal-fetal medicine subspecialists. These subspecialists provide inpatient and outpatient care to women with conditions such as diabetes, hypertension, sickle cell disease, multiple gestation, recurrent miscarriage, family history of genetic diseases, suspected fetal birth defects, and other complications during their pregnancies. We believe that improved maternal-fetal care has a positive impact on neonatal outcomes. Data on neonatal outcomes demonstrate that, in general, the likelihood of mortality or an adverse condition or outcome (referred to as “morbidity”) is reduced the longer a baby remains in the womb. There are approximately 1,200 maternal-fetal medicine subspecialists providing care in the United States.

Pediatric Cardiology Medicine . Pediatric cardiologists provide inpatient and outpatient cardiology care of the fetus, infant, child, and adolescent with congenital heart defects and acquired heart disease as well as adults with congenital heart defects. We estimate that approximately one in every 120 babies is born with some form of heart defect. With advancements in care, there are approximately one million adults in the United States today living with congenital heart disease.

Other Pediatric Subspecialty Medicine . Other areas of pediatric subspecialty medicine are closely associated with maternal-fetal-newborn medical care. For example, pediatric intensivists are subspecialists who care for critically ill or injured children and adolescents in pediatric intensive care units (called “PICUs”). There are approximately 1,200 board-certified pediatric intensivists in the United States who practice at approximately 300 hospital-based PICUs. In addition, pediatric hospitalists are pediatricians who provide care in many hospital areas, including labor and delivery and the newborn nursery.

Anesthesia Medicine . An estimated 45 million inpatient procedures and 31.5 million ambulatory procedures are performed annually in the United States. Anesthesiologists generally provide or participate in the administration of anesthetics in these procedures. According to the US Census Bureau, the population continues to expand and the fastest growing segment of the population consists of individuals over the age of 65. The growth in population and the over age 65 segment thereof has resulted in an increase in demand for surgical services and a correlating increase in demand for anesthesia services. The growth of ambulatory surgical centers and expansion of office-based procedures has also contributed to the demand for anesthesia services. There are approximately 43,000 anesthesiologists practicing in the United States.

Hospital-Based Care . Hospitals generally must provide cost-effective, quality care in order to enhance their reputations within their communities and desirability to patients, referring and collaborating physicians and third-party payors. In an effort to improve outcomes and manage costs, hospitals typically employ or contract with physician subspecialists to provide specialized care in many hospital-based units or settings. Hospitals traditionally staffed these units or settings through affiliations with local physician groups or independent practitioners. However, management of these units and settings present significant operational challenges, including variable admissions rates, increased operating costs, complex reimbursement systems and other administrative burdens. As a result, hospitals contract with physician organizations that have the clinical quality initiatives, information and reimbursement systems and management expertise required to effectively and efficiently operate these units and settings in the current healthcare environment. Demand for hospital-based physician services, including neonatology and anesthesiology, is determined by a national market in which qualified physicians with advanced training compete for hospital contracts.

Practice Administration . Administrative demands and cost containment pressures from a number of sources, principally commercial and government payors, make it increasingly difficult for physicians and hospitals to effectively manage patient care, remain current on the latest procedures and efficiently administer non-clinical activities. As a result, we believe that physicians and hospitals remain receptive to being affiliated with larger organizations that reduce administrative burdens, achieve economies of scale and provide value-added clinical research, education and quality initiatives. By relieving many of the burdens associated with the management of a subspecialty group practice, we believe that our practice administration services permit our affiliated physicians to focus on providing quality patient care and thereby contribute to improving patient outcomes, ensuring appropriate length of hospital stays and reducing long-term health system costs. In addition, our national network of affiliated physician practices, although modeled around a traditional group practice structure, is managed by a non-clinical professional management team with proven abilities to achieve significant operating efficiencies in providing administrative support systems, interacting with physicians, hospitals and third-party payors, managing information systems and technologies, and complying with laws and regulations.

Our Business Strategy

Our business objective is to enhance our position as a leading provider of physician services. The key elements of our strategy to achieve our objective are:


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Build upon core competencies . We have developed significant administrative expertise relating to neonatal, maternal-fetal and other pediatric subspecialty physician services. We have also facilitated the development of a clinical approach to the practice of medicine among our affiliated physicians that includes research, education and quality initiatives intended to advance the practice of neonatology, improve the quality of care provided to acutely ill newborns and reduce long-term health system costs. We are in the process of developing similar expertise in maternal-fetal medicine and pediatric cardiology and intend to explore ways to do the same for anesthesia medicine as we expand our presence in this specialty.


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Promote same-unit growth . We seek opportunities for increasing revenues from our hospital and office-based operations. For example, our affiliated hospital-based neonatal, maternal-fetal and other pediatric physicians are well situated to, and, in some cases, provide physician services in other departments, such as newborn nurseries, or in situations where immediate accessibility to specialized obstetric and pediatric care may be critical. In addition, we market our capabilities to obstetricians, pediatricians and family physicians to attract referrals to our hospital-based units and our office based practices as well. We also market the services of our affiliated physicians to other hospitals to attract neonatology transport admissions. We intend to seek similar opportunities with our affiliated anesthesiologists.


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Acquire physician practice groups . We continue to seek to expand our operations by acquiring established neonatal, maternal-fetal medicine and pediatric cardiology groups and other complementary pediatric subspecialty physician groups, such as pediatric intensivists and pediatric hospitalists. During 2007, we added ten physician groups to our national network through acquisitions consisting of five neonatal practices, one maternal-fetal medicine practice, one radiology practice and two pediatric cardiology practices as well as the acquisition of our first anesthesia practice. We believe that there are opportunities to apply our administrative expertise to this practice area and accordingly intend to explore other opportunities to acquire anesthesia practices during 2008.


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Strengthen relationships with our partners . By managing many of the operational challenges associated with a subspecialty practice, encouraging clinical research, education and quality initiatives, and promoting timely intervention by our physicians, we believe that our business model is focused on improving the quality of care delivered to patients, promoting the appropriate length of their hospital stays and reducing long-term health system costs. We believe that referring and collaborating physicians, hospitals, third-party payors and patients all benefit to the extent that we are successful in implementing our business model. We will continue to seek opportunities to strengthen relationships with our partners.

OUR PHYSICIAN SERVICES

Neonatal Care

We provide neonatal care to babies born prematurely or with complications within specific hospital units, primarily NICUs, through our network of 788 affiliated neonatal physicians and other related clinical professionals who staff and manage clinical activities at more than 257 NICUs in 32 states and Puerto Rico. We partner with our hospital clients in an effort to enhance the quality of care delivered to premature and sick babies. Some of the nation’s largest and most prestigious hospitals, both not-for-profit and for-profit institutions, retain us to staff and manage their NICUs. Our affiliated neonatologists generally provide 24-hours-a-day, seven-days-a-week coverage in NICUs, support the local referring physician community and are available for consultation in other hospital departments. Our hospital partners benefit from our experience in managing complex intensive care units. Our neonatal physicians interact with colleagues across the country through an internal communications system to draw upon their collective expertise in managing challenging patient care issues. Our neonatal physicians also work collaboratively with maternal-fetal medicine subspecialists to coordinate care of mothers experiencing complicated pregnancies and their fetuses. We also employ or contract with neonatal nurse practitioners, who work with our affiliated physicians in providing medical care.

Maternal-fetal Care

We provide outpatient and inpatient maternal-fetal care to expectant mothers with complicated pregnancies and their fetuses through our network of 109 affiliated physicians who provide maternal-fetal medical care as well as other related clinical professionals. Our affiliated neonatologists practice with maternal-fetal medicine subspecialists to provide coordinated care for women with complicated pregnancies whose babies are often admitted to the NICU upon delivery. We believe continuity of treatment from mother and developing fetus during the pregnancy to the newborn upon delivery has improved the clinical outcomes of our patients.

Pediatric Cardiology Care

Our pediatric cardiology practice consists of 69 affiliated physicians and other related clinical professionals who provide specialized cardiac care to the fetus, pediatric patients with congenital and acquired heart disorders, as well as adults with congenital heart defects, through scheduled office visits, hospital rounds and immediate consultation in emergency situations.

Other Pediatric Subspecialty Care

Our network includes other pediatric subspecialists such as pediatric intensivists and pediatric hospitalists. In addition, our affiliated physicians also seek to provide support services in other areas of hospitals, particularly in the labor and delivery area, nursery and pediatric department, where immediate accessibility to specialized care may be critical. Our experience and expertise in maternal-fetal-neonatal medicine has led to our involvement in these other areas.


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Pediatric Intensive Care . We have 37 affiliated physicians who provide clinical care for critically ill or injured children and adolescents. They staff and manage PICUs at 17 hospitals.


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Pediatric Hospitalists . We have 16 affiliated hospital-based physicians who provide clinical care to acutely ill children at 13 hospitals.


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Other Newborn and Pediatric Care . Because our affiliated physicians and advanced nurse practitioners generally provide hospital-based coverage, they are situated to provide highly specialized care to address medical needs that may arise during a baby’s hospitalization. For example, as part of our ongoing efforts to support and partner with hospitals and the local referring physician community, our affiliated neonatologists, pediatric hospitalists and advanced nurse practitioners provide in-hospital nursery care to newborns through our newborn nursery program. This program is made available for babies during their hospital stay, which in the case of healthy babies typically comprises two days of evaluation and observation, following which they are referred, and their hospital records are provided, to their pediatricians or family practitioners for follow-up care.


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Newborn Hearing Screening Program . Our affiliated physicians also oversee the Company’s newborn hearing screening program. Since we launched this program in 1994, we believe that we have become the largest provider of newborn hearing screening services in the United States. In 2007, we screened approximately 355,000 babies for potential hearing loss at more than 159 hospitals across the nation. Over 40 states either require newborns to be screened for potential hearing loss before being discharged from the hospital or require that parents be offered the opportunity to submit their newborns to hearing screens. We contract or coordinate with hospitals to provide hearing screening services.

Anesthesia Care

We provide anesthesia care at hospitals, ambulatory surgery centers, and office based practices with our 53 affiliated anesthesiologists. We also employ CRNAs, who work with our affiliated physicians in providing anesthesia care. Our anesthesiologists generally work as part of a team that includes surgeons and nurses that assist them. They support the surgeons by providing medical care before, during and after surgery so that surgeons may concentrate on the applicable surgery. Our anesthesiologists provide this care by evaluating the patient and consulting with the surgical team before surgery, providing pain control and support of life functions during surgery, supervising care after surgery and discharging the patient from the recovery unit. They also support the hospital’s emergency room by providing services as appropriate to patients requiring immediate care. In addition, our physicians provide anesthesia care at ambulatory surgical centers and office based practices for procedures performed that require some level of anesthesia.

OUR CLINICAL RESEARCH AND EDUCATION

As part of our patient focus and ongoing commitment to improving patient care through evidenced-based medicine, we engage in clinical research, continuous quality improvement, and education initiatives. We discover, understand, and teach healthcare practices that enhance the abilities of clinicians to deliver quality care, thereby contributing to better patient outcomes and reduced long-term health system costs. We invest in these initiatives for our patients, clinicians, referring and collaborating physicians, hospital partners and third-party payors. We believe that these initiatives help us, among other things, to attract new and retain existing clinicians, improve clinical operations and enhance practice communication.


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Clinical Research . We conduct clinical research to discover ways to improve care for our patients. We share our discoveries throughout the medical community through submissions to peer-reviewed literature. In the past three years, our clinicians have contributed to more than 100 published research papers, rivaling many academic institutions.


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We have successfully completed five clinical trials. In 2007, the results of a major multi-center trial, A Randomized Controlled Trial Evaluating the Effect of Two Different Doses of Amino Acids on Growth and Serum Amino Acids in Premature Neonates were published in the medical journal, Pediatrics . This trial evaluated the use of protein administration and growth in the preterm infant. Epidemiology of Respiratory Failure in Near-Term Neonates commenced in February 2001 and resulted in a paper published in the Journal of Perinatology in April 2005. Comparison of Infasurf (Calfactant) and Survanta (Beractant) in the Prevention and Treatment of Respiratory Distress Syndrome commenced in March 2001 with a grant from Forest Laboratories and resulted in a paper published in Pediatrics in August 2005. Glutamine Supplementation in Safely Reducing Hospital-Acquired Sepsis in Very Low Birth Weight Infants commenced in April 2000 and resulted in a paper published in the Journal of Pediatrics in June 2003. A study on Optimal Management of Monoamniotic Twins was published in the American Journal of Obstetrics & Gynecology in December 2003.


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Seven additional multi-institutional clinical trials are in progress. Two of the trials are focused on improving care for the infant: Demographic, Metabolic, and Genomic Description of Neonates with Severe Hyperbilirubinemia and Utility of Genetic Testing in Detection of Late-Onset Hearing Loss. The other five trials focus on the high-risk mother to reduce the rate of prematurity and/or complications in pregnancy or delivery: A Randomized Double-Blinded Study Comparing the Impact of One Versus Two Doses of Antenatal Steroids on Neonatal Outcomes; Removal versus Retention of Cerclage in Preterm Premature Rupture of Membranes; 17 A-Hydroxyprogesterone Caproate for Reduction of Neonatal Mortality Due to Preterm Birth in Twin or Triplet Pregnancies; Amniotic Fluid Tandem Mass Spectrometry for Pregnancies Complicated by Nonimmune Hydrops and Severe Symmetrical Intrauterine Growth Restriction; and Development of non-invasive tests to detect intra-amniotic infection and predict pre-term birth in women presenting with pre-term labor.

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Continuous Quality Improvement . As part of our dedication to improving quality across our affiliated practices, we provide our clinicians with powerful information resources. Our physicians have access to accumulated data and robust software tools that enable them to compare their practices, across a variety of activity and outcome metrics, to our national practice network. From these comparisons, our physicians can identify areas for improvement, and then systematically monitor, study, learn, and implement change. We believe that our initiatives in continuous quality improvement have contributed to better patient care. For example, one of our initiatives has led to a nationwide, online collaborative effort among 80 hospitals to reduce the leading cause of infant blindness among premature newborns. We are also working on similar efforts to optimize antibiotic usage, weight gain among very low birth weight infants, the use of breast milk, and the occurrences of red blood cell transfusions in premature infants. In addition, continuous quality improvement initiatives are underway for our other physician specialties. Some of our prior continuous quality initiatives have resulted in published research papers.




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Continuing Medical Education . We also make extensive physician continuing medical education and continuing nursing education resources available to our affiliated clinicians in an effort to ensure that they have access to current treatment methodologies. As an accredited provider for clinicians generally, we offer live continuing medical education through, what we believe is one of the premier conferences in neonatal medicine— NEO: The Conference for Neonatology , which we launched in 2007. In addition to live educational opportunities, we also offer online education through “Pediatrix University—A University Without Walls R ,” an interactive educational website.

We believe that these initiatives have been enhanced by our integrated national presence together with our management information systems, which are an integral component of our clinical research and education activities. See “Our Information Systems.”

OUR PRACTICE ADMINISTRATION

We provide multiple administrative services to support the practice of medicine by our affiliated physicians and improve operating efficiencies of our affiliated practice groups.


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Unit Management . We appoint a senior physician practicing medicine in each NICU, PICU, maternal-fetal, pediatric cardiology and anesthesia practice and other subspecialty practice that we manage to act as our medical director for that unit or practice. Each medical director is responsible for the overall management of his or her unit or practice, including staffing and scheduling, quality of care, professional discipline, utilization review, coordinating physician recruitment, and monitoring our financial success within the unit or practice. Medical directors also serve as a liaison with hospital administration, other physicians and the community. Each medical director reports to a physician who is part of the Company’s management team and is either board-certified or eligible-to-apply-for-cer tification in his or her respective specialty.


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Staffing and Scheduling . We assist with staffing and scheduling physicians and advanced practice nurses within the units and practices that we manage. For example, each NICU is staffed by at least one specialist on site or available on call. For our affiliated anesthesia physicians and CRNAs, we employ an operational system that assists with their staffing and scheduling. We are responsible for the salaries and benefits paid and provided to our affiliated physicians and practitioners. In addition, we employ, compensate and manage all non-medical personnel for our affiliated physician groups.


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Recruiting and Credentialing . We have significant experience in locating, qualifying, recruiting and retaining experienced neonatologists, maternal-fetal medicine subspecialists, pediatric cardiologists, pediatricians and other pediatric subspecialists. We maintain an extensive nationwide database of maternal-fetal, neonatal and other pediatric subspecialty physicians and are beginning to develop such a database for anesthesiologists. Our medical directors and physician management play a central role in the recruiting and interviewing process before candidates are introduced to other practice group physicians and hospital administrators. We check the credentials, licenses and references of all

prospective affiliated physician candidates. In addition to our database of physicians, we recruit nationally through trade advertising, referrals from our affiliated physicians and attendance at conferences.


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Billing, Collection and Reimbursement . We assume responsibility for contracting with third-party payors for all of our affiliated physicians. We are responsible for billing, collection and reimbursement for services rendered by our affiliated neonatal, maternal-fetal and pediatric subspecialty physicians. Presently, we contract with a third-party billing company to process billing, collection and reimbursement for our affiliated anesthesiologists. We are in the process of evaluating various systems that will allow us to provide these services directly. In all instances, however, we do not assume responsibility for charges relating to services provided by hospitals or other physicians with whom we collaborate. Such charges are separately billed and collected by the hospitals or other physicians. We provide our affiliated physicians with a training curriculum that emphasizes detailed documentation of and proper coding protocol for all procedures performed and services provided, and we provide comprehensive internal auditing processes, all of which are designed to achieve appropriate coding, billing and collection of revenues for physician services. Our billing and collection operations are conducted from our corporate offices, as well as our regional business offices located across the United States and in Puerto Rico .


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Risk Management and Other Services . We maintain a risk management program focused on reducing risk and improving outcomes through evidence-based medicine, including diligent patient evaluation, documentation and access to research, education and best demonstrated processes. We maintain professional liability coverage for our national group of affiliated healthcare professionals. Through our risk management and medical affairs staff, we conduct risk management programs for loss prevention and early intervention in order to prevent or minimize professional liability claims. In addition, we provide a multi-faceted compliance program that is designed to assist our affiliated practice groups in complying with increasingly complex laws and regulations. We also provide management information systems, facilities management, marketing support and other services to our affiliated physicians and affiliated practice groups.

CEO BACKGROUND

Roger J. Medel, M.D. has been a Director of Pediatrix since he co-founded the Company in 1979. Dr. Medel served as Pediatrix’s President until May 2000 and as Chief Executive Officer until December 2002. In March 2003, Dr. Medel reassumed the position of President, serving in that position until May 2004, and Chief Executive Officer, a position in which he continues to serve today. Dr. Medel is a member of the Board of Trustees of the University of Miami and a member of the Board of Directors of MBF Healthcare Acquisition Corp. Dr. Medel participates as a member of several medical and professional organizations.

Cesar L. Alvarez was elected as Chairman of the Board of Directors in May 2004 and has been a Director since March 1997. Mr. Alvarez has served since 1997 as the Chief Executive Officer of the international law firm of Greenberg Traurig, P.A. Mr. Alvarez also serves on the Board of Directors of Atlantis Plastics, Inc. and Watsco, Inc.

Waldemar A. Carlo, M.D. was elected as a Director in June 1999. Dr. Carlo has served as Professor of Pediatrics and Director of the Division of Neonatology at the University of Alabama School of Medicine since 1991. Dr. Carlo also has served as Director of Newborn Nurseries at the University of Alabama Medical Center and the Children’s Hospital of Alabama since 1991. Dr. Carlo participates as a member of several medical and professional organizations. He has received numerous research awards and grants and has lectured extensively, both nationally and internationally.

Michael B. Fernandez was elected as a Director in October 1995. Mr. Fernandez has served as Chairman and is and has been a Managing Director of MBF Healthcare Partners, L.P., a private equity firm focused on investing in healthcare service companies, since February 2005 and has been Chairman and Chief Executive Officer of MBF Healthcare Acquisition Corp. since June 2006. He is also the Chairman of Navarro Discount Pharmacies, LLC. Mr. Fernandez previously served as Chairman and Chief Executive Officer of CarePlus Health Plans Inc., a managed care HMO, from January 2003 until February 2005, and as Chairman and Chief Executive Officer of Physicians Healthcare Plans, Inc., a Florida-based HMO, from 1992 until December 2002. Presently, Mr. Fernandez also serves on the Board of Directors of various private entities, including Healthcare Atlantic, Inc., a holding company that operates various health care entities.

Roger K. Freeman, M.D. was elected as a Director in May 2002. Dr. Freeman is a maternal-fetal medicine physician. In 1975, he founded Perinatal Associates of Southern California, a physician practice group that has been affiliated with Pediatrix since we acquired Magella Healthcare Corporation (“Magella”) in May 2001. In September 1999, Dr. Freeman retired from the private practice of medicine. Dr. Freeman has served on many national and local OB/GYN and maternal-fetal organizations. He is currently a member of the Long Beach Memorial Medical Center Foundation Board and serves on the Board of Directors of Todd Cancer Institute at Long Beach Memorial Hospital. Dr. Freeman has authored numerous articles and three books.

Paul G. Gabos was elected as a Director in November 2002. Mr. Gabos has served as Chief Financial Officer of Lincare Holdings Inc. since June 1997 and previously served as Vice President — Administration for Lincare. Prior to joining Lincare in 1993, Mr. Gabos worked for Coopers & Lybrand and for Dean Witter Reynolds, Inc.

Pascal J. Goldschmidt, M.D. was elected as a Director in March 2006. Dr. Goldschmidt has been the Senior Vice President for Medical Affairs and Dean of the University of Miami Leonard M. Miller School of Medicine since April 2006. Previously, Dr. Goldschmidt was a faculty member with the Department of Medicine at Duke University Medical Center where he served as Chairman from 2003 to 2006 and as Chief of the Division of Cardiology from 2000 to 2003.

Manuel Kadre was elected as a Director in May 2007. Mr. Kadre has served since 1995 as Vice President and General Counsel of the de la Cruz Companies, which distributes Eagle Brands beverages in South Florida and bottles Coca-Cola products in markets throughout the Caribbean. Mr. Kadre also serves on the Board of Directors of Equity Media Holdings Corporation and on the Board of Trustees of the University of Miami and Miami Children’s Hospital.

Enrique J. Sosa, Ph.D. was elected as a Director in May 2004. Mr. Sosa is currently a Director of FMC Corporation and Northern Trust Corporation. Mr. Sosa, who is presently retired, served as President of BP Amoco Chemicals from January 1999 to April 1999. From 1995 to 1998, he was Executive Vice President of Amoco Corporation. Prior to joining Amoco, Mr. Sosa served as Senior Vice President of The Dow Chemical Company, President of Dow North America and a member of its Board of Directors. Mr. Sosa has previously served on the Board of Directors of Electronic Data Systems Corporation, Dow Corning Corporation and Destec Energy, Inc. He also served as a member of the Executive Committee of the American Plastics Council, a member of the Executive Committee of the American section of the Society of Chemical Industry, and a member of the American Chemical Council.

Joseph M. Calabro joined Pediatrix in January 1996 as Chief Information Officer. In January 2000, Mr. Calabro was appointed Executive Vice President, Management, in May 2000, he was appointed Chief Operating Officer and in May 2004, he was appointed President. Prior to joining Pediatrix, Mr. Calabro served as Director of Information Technology for the Ambulatory Surgery Group of Columbia/HCA. He served in various operational and technology positions for various healthcare companies from 1987 to 1994.

Thomas W. Hawkins joined Pediatrix in May 2003 and became Senior Vice President, General Counsel and Secretary in June 2003. From January 2000 to April 2003, he was a partner with New River Capital Partners, L.P., a private equity firm. Mr. Hawkins previously served as Senior Vice President, Corporate Development at AutoNation, Inc., from June 1996 to December 1999. From 1994 to 1996, Mr. Hawkins was Executive Vice President — Administration of Blockbuster Entertainment Group, a division of Viacom, Inc. He served as General Counsel at Blockbuster Entertainment Corporation prior to its merger with Viacom, Inc. in 1994.

Karl B. Wagner joined Pediatrix in May 1997 and was appointed Chief Financial Officer and Treasurer in August 1998. Prior to his appointment, Mr. Wagner served as Pediatrix’s Controller. Prior to joining Pediatrix, Mr. Wagner was Chief Financial Officer for the East Region of Columbia/HCA’s Ambulatory Surgery Group from January 1995 until May 1997. From July 1993 through January 1995, Mr. Wagner was Assistant Controller of Medical Care International, Inc., a subsidiary of Medical Care America, Inc.

MANAGEMENT DISCUSSION FROM LATEST 10K

OVERVIEW

Pediatrix is a leading provider of physician services including newborn, maternal-fetal, pediatric subspecialty, and anesthesia care. At December 31, 2007, our national network was composed of 1,072 affiliated physicians, including 788 physicians who provide neonatal clinical care in 32 states and Puerto Rico, primarily within hospital-based neonatal intensive care units (“NICUs”), to babies born prematurely or with medical complications. We have 109 affiliated physicians who provide maternal-fetal medical care to expectant mothers experiencing complicated pregnancies in many areas where our affiliated neonatal physicians practice. Our network includes other pediatric subspecialists, including 69 physicians providing pediatric cardiology care, 37 physicians providing pediatric intensive care and 16 physicians providing hospital based pediatric care. In addition, we have 53 physicians who provide anesthesia care to patients in connection with surgical and other medical procedures.

In December 2007, we signed a definitive agreement to sell our newborn metabolic screening laboratory business in a cash transaction. The closing of the sale is subject to customary conditions. In accordance with FAS 144, the assets and liabilities related to the laboratory business have been classified as held for sale at December 31, 2007 and its business operations are reported separately as discontinued operations, net of income taxes. The sale of the laboratory is intended to allow us to focus more resources to support the continued expansion of our clinical and administrative competencies within physician services.

In September, 2007, we completed the acquisition of Fairfax Anesthesiology Associates, a physician group that consists of 53 anesthesiologists and 60 certified registered nurse anesthetists who provide anesthesia services in northern Virginia. This acquisition represents our initial expansion of services into anesthesia care. We believe that there are opportunities to apply our administrative expertise to this practice area and accordingly we intend to explore other opportunities to acquire anesthesia practices during 2008.

We completed the acquisition of ten physician group practices during the year ended December 31, 2007. These acquisitions consist of five neonatal practices, two cardiology practices, one maternal-fetal practice, one ultrasound radiology practice and one anesthesiology practice as discussed above. Based on past results, we expect that we can improve the results of these practices through improved managed care contracting, improved collections, identification of growth initiatives, as well as, operating and cost savings based upon the significant infrastructure we have developed.

In August 2007, our Board of Directors authorized a $100 million share repurchase program to repurchase shares of the Company’s common stock in open market transactions subject to price, general economic and market conditions and trading restrictions. In November 2007, we completed the share repurchase program having bought approximately 1.6 million shares for approximately $100 million. In December 2007, our Board of Directors authorized an additional $100 million share repurchase program. As of December 31, 2007, no repurchases had been made under the additional program.

In July 2007, the Audit Committee of our Board of Directors concluded a comprehensive review of our historical practices related to the granting of stock options. Based on this review, the Audit Committee and management concluded that incorrect measurement dates were used for certain stock option grants in prior periods. Our results of operations for the years ended December 31, 2007 and 2006 include professional fees incurred in connection with the review. In addition, our results of operations for the year ended December 31, 2007, reflect costs to cover Internal Revenue Code Section 409A (“409A”) tax obligations on behalf of employees and other payments to employees as a result of stock option measurement date revisions.

In September 2006, we completed a final settlement agreement with the Department of Justice and a relator who initiated a “qui tam” complaint against the Company relating to our billing practices for services reimbursed by Medicaid, the Federal Employees Health Benefit program, and the United States Department of Defense’s TRICARE program for military dependents and retirees (“Federal Settlement Agreement”). In February 2007, we completed separate state settlement agreements with each state Medicaid program involved in the settlement (the “State Settlement Agreements”). Under the terms of the Federal Settlement Agreement and State Settlement Agreements, the Company paid $25.1 million to the federal government and participating state Medicaid programs in connection with our billing for neonatal services provided from January 1996 through December 1999.

Effective January 1, 2006, we adopted FAS 123(R). This statement requires us to expense stock-based awards to our employees using a fair-value-based measurement method. Our results of operations for the years ended December 31, 2007 and 2006 include stock-based compensation expense related to stock options and restricted stock awarded under our stock incentive plans (the “Stock Incentive Plans”) and employee stock purchases under our stock purchase plans (the “Stock Purchase Plans”) in accordance with FAS 123(R). For the year ended December 31, 2005, we recorded stock-based compensation expense using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and its related interpretations (“APB 25”) for restricted stock first awarded on July 14, 2005, and for stock options determined to have been issued at grant prices below market value on the measurement date.

Geographic Coverage and Payor Mix

During 2007, 2006 and 2005, approximately 56%, 56% and 59%, respectively, of our net patient service revenue was generated by operations in our five largest states, Arizona, California, Florida, Texas and Washington. Over those same periods, our operations in Texas accounted for approximately 28%, 28% and 30% of our net patient service revenue. Adverse changes or conditions affecting states in which our operations are concentrated, such as healthcare reforms, changes in laws and regulations, reduced Medicaid reimbursements or government investigations, may have a material adverse effect on our business, financial condition, results of operations and cash flows.

We bill payors for professional services provided by our affiliated physicians to our patients based upon rates for specific services provided. Our billed charges are substantially the same for all parties in a particular geographic area regardless of the party responsible for paying the bill for our services. We determine our net patient service revenue based upon the difference between our gross fees for services and our estimated ultimate collections from payors. Net patient service revenue differs from gross fees due to (i) government sponsored healthcare program reimbursements at government-established rates, (ii) managed care payments at contracted rates, (iii) various reimbursement plans and negotiated reimbursements from other third-parties and (iv) discounted and uncollectible accounts of private-pay patients.

Our payor mix is comprised of government (principally Medicaid), contracted managed care, other third-parties and private-pay patients. We benefit from the fact that most of the medical services provided in the NICU are classified as emergency services, a category typically classified as a covered service by managed care payors. In addition, we benefit when patients are covered by Medicaid, despite Medicaid’s lower reimbursement rates as compared with other payors, because typically these patients would not otherwise be able to pay for services due to lack of insurance coverage.

Quarterly Results

We have historically experienced and expect to continue to experience quarterly fluctuations in net patient service revenue and net income. These fluctuations are primarily due to the following factors:


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A significant number of our employees and our associated professional contractors, primarily physicians, exceed the level of taxable wages for social security during the first and second quarters of the year. As a result, we incur a significantly higher payroll tax burden and our net income is lower during those quarters.


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There is a lower number of calendar days in the first and second quarters of the year as compared to the remainder of the year. Because we provide services in NICUs on a 24-hour basis, 365 days a year, any reduction in service days will have a corresponding reduction in net patient service revenue.

We have significant fixed operating costs, including physician costs, and, as a result, are highly dependent on patient volume and capacity utilization of our affiliated professional contractors to sustain profitability. Additionally, quarterly results may be affected by the timing of acquisitions and fluctuations in patient volume. As a result, the operating results for any quarter are not necessarily indicative of results for any future period or for the full year. Our quarterly results are presented in further detail in Note 17 to the Consolidated Financial Statements in this Form 10-K.

Application of Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires estimates and assumptions that affect the reporting of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities. Note 2 to our Consolidated Financial Statements provides a summary of our significant accounting policies, which are all in accordance with generally accepted accounting policies in the United States. Certain of our accounting policies are critical to understanding our Consolidated Financial Statements because their application requires management to make assumptions about future results and depends to a large extent on management’s judgment, because past results have fluctuated and are expected to continue to do so in the future.

We believe that the application of the accounting policies described in the following paragraphs are highly dependent on critical estimates and assumptions that are inherently uncertain and highly susceptible to change. For all of these policies, we caution that future events rarely develop exactly as estimated, and the best estimates routinely require adjustment. On an ongoing basis, we evaluate our estimates and assumptions, including those discussed below.

RESULTS OF OPERATIONS

Year Ended December 31, 2007 as Compared to Year Ended December 31, 2006

Our net patient service revenue increased $112.9 million, or 14.0%, to $917.6 million for the year ended December 31, 2007, as compared to $804.7 million for the same period in 2006. Of this $112.9 million increase, $42.2 million, or 37.4%, was attributable to revenue generated from acquisitions completed after December 31, 2005. Same-unit net patient service revenue increased $70.7 million, or 9.3%, for the year ended December 31, 2007. The change in same-unit net patient service revenue was primarily the result of increased revenue of $36.9 million from higher patient service volumes across our subspecialties and a net increase in revenue of approximately $33.8 million related to pricing and reimbursement factors. Increased revenue of $36.9 million from higher patient service volumes includes $22.0 million from a 4.2% increase in neonatal intensive care unit patient days and $14.9 million from volume growth in maternal-fetal, pediatric cardiology and other services, including hearing screens and newborn nursery services. The net increase in revenue of $33.8 million related to pricing and reimbursement factors is due to: (i) improved managed care contracting; (ii) increased reimbursement for physician services from the Texas Medicaid program beginning in September 2007; (iii) increased revenue related to hospital contract administrative fees due to expanded services in existing practices; and (iv) the flow through of revenue from modest price increases. Same units are those units at which we provided services for the entire current period and the entire comparable period.

Practice salaries and benefits increased $67.1 million, or 14.4%, to $533.3 million for the year ended December 31, 2007, as compared to $466.2 million for the same period in 2006. The increase was primarily attributable to: (i) costs associated with new physicians and other staff of $48.9 million to support acquisition-related growth and volume growth at existing units; (ii) an increase in incentive compensation of $15.2 million as a result of operational improvements at the physician-practice level and an increase in the number of practices participating in our incentive compensation program; and (iii) costs of $3.0 million to cover 409A tax obligations on behalf of practice employees and other payments to practice employees as a result of stock option measurement date revisions.

Practice supplies and other operating expenses increased $4.8 million, or 16.5%, to $34.1 million for the year ended December 31, 2007, as compared to $29.2 million for the same period in 2006. This increase was primarily attributable to supply and maintenance costs and other costs to support acquisition-related growth and volume growth at existing units.

General and administrative expenses include all billing and collection functions and all other salaries, benefits, supplies and operating expenses not specifically related to the day-to-day operations of our physician group practices. General and administrative expenses increased $13.0 million, or 12.2%, to $119.8 million for the year ended December 31, 2007, as compared to $106.8 million for the same period in 2006. This $13.0 million increase was due to: (i) a $7.6 million increase in salaries and benefits and other general and administrative expenses related to the continued growth of the Company; (ii) costs of $3.4 million to cover 409A tax obligations on behalf of employees and other payments to employees as a result of stock option measurement date revisions; (iii) a reduction in expense in the 2006 period associated with a $1.6 million gain on the sale of the Company’s aircraft; and (iv) professional fees related to our stock option review of $400,000.

Depreciation and amortization expense increased by approximately $1.5 million, or 18.7%, to $9.6 million for the year ended December 31, 2007, as compared to $8.1 million for the same period in 2006. This increase was attributable to the amortization of intangible assets related to acquisitions and the depreciation of fixed asset additions.

Income from operations increased $26.5 million, or 13.6%, to $220.9 million for the year ended December 31, 2007, as compared with $194.4 million for the same period in 2006. Our operating margin decreased to 24.1% for the year ended December 31, 2007, as compared to 24.2% for the same period in 2006. The net decrease in our operating margin is primarily attributable to (i) $6.4 million of costs to cover 409A tax obligations on behalf of employees and other payments to employees as a result of stock option measurement date revisions; (ii) a reduction in expense in the 2006 period associated with a $1.6 million gain on the sale of the Company’s aircraft; (iii) a $400,000 increase in professional fees related to our stock option review; and (iv) an offsetting reduction in costs due to improved management of general and administrative expenses.

We recorded net investment income of $6.1 million for the year ended December 31, 2007, as compared to net investment income of $2.8 million for the same period in 2006. The increase in net investment income is due to an increase in funds available to invest and a higher return on outstanding investment balances for the year ended December 31, 2007, as compared to the prior year period. Interest expense for the years ended December 31, 2007 and 2006, consisted of interest charges, commitment fees and amortized debt costs associated with our revolving credit facility (“Line of Credit”).

Our effective income tax rate was 38.32% for the year ended December 31, 2007, as compared to 38.08% for the same period in 2006. The net increase in our effective tax rate is primarily due to an increase in our provision for uncertain tax positions as a result of the adoption of FIN 48 and increased taxes as a result of tax law changes in the State of Texas, partially offset by the recognition of tax benefits on uncertain tax positions as a result of the expiration of the statute of limitations on certain filed tax returns. We anticipate our effective tax rate will be approximately 39.25% for 2008, excluding any adjustments related to reductions in liabilities for uncertain tax positions.

Income from discontinued operations, net of income taxes for the years ended December 31, 2007 and 2006 represents the financial results of our newborn metabolic screening laboratory business. In December 2007, we signed a definitive agreement to sell this business in a cash transaction. The closing of the sale is subject to customary conditions. In accordance with FAS 144, the financial results of our newborn metabolic screening laboratory business are reported separately as income from discontinued operations, net of income taxes, for all periods presented. See Note 15 to our Consolidated Financial Statements in this Form 10-K.

Net income increased 14.7% to $142.7 million for year ended December 31, 2007, as compared to $124.5 million for the same period in 2006. Net income for the year ended December 31, 2007, reflects the after-tax impact of approximately $3.9 million for costs to cover 409A tax obligations on behalf of employees and other payments to employees as a result of stock option measurement date revisions, and the after-tax impact of approximately $250,000 for increased professional fees related to our stock option review. Net income for the year ended December 31, 2006, reflects the after-tax impact of approximately $1.0 million related to the gain on sale of the Company’s aircraft.

Diluted net income per common and common equivalent share was $2.86 on weighted average shares outstanding of 49.9 million for the year ended December 31, 2007, as compared to $2.52 on weighted average shares outstanding of 49.4 million for the same period in 2006. The net increase in weighted average shares outstanding was primarily due to the exercise of employee stock options, the vesting of restricted stock and the issuance of shares under our employee stock purchase plans (“Stock Purchase Plans”) partially offset by the weighted average impact of shares repurchased through December 31, 2007 under the $100 million share repurchase program approved by our Board of Directors in August 2007 and completed in November 2007.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Results of Operations

Three Months Ended March 31, 2008 as Compared to Three Months Ended March 31, 2007

Our net patient service revenue increased $34.7 million, or 16.4%, to $245.6 million for the three months ended March 31, 2008, as compared to $210.9 million for the same period in 2007. Of this $34.7 million increase, $18.5 million, or 53.3%, was attributable to revenue generated from acquisitions completed after December 31, 2006. Same-unit net patient service revenue increased $16.2 million, or 7.8%, for the three months ended March 31, 2008. The change in same-unit net patient service revenue was the result of increased revenue of approximately $9.5 million related to pricing and reimbursement factors and approximately $6.7 million from higher patient service volumes across our subspecialties. The net increase in revenue of $9.5 million related to pricing and reimbursement factors is due to: (i) increased reimbursement for physician services from the Texas Medicaid program beginning in September 2007; (ii) improved managed care contracting; and (iii) increased revenue related to hospital contract administrative fees due to expanded services in existing practices; partially offset by (iv) a decrease in revenue caused by a slight increase in the percentage of our patients being enrolled in government-sponsored programs. Payments received from government-sponsored programs are substantially less than payments received from commercial insurance payors for equivalent services. Increased revenue of $6.7 million from higher patient service volumes includes $2.8 million from a 1.9% increase in neonatal intensive care unit patient days and $3.9 million from volume growth in maternal fetal, pediatric cardiology and other services, including hearing screens and newborn nursery services. Excluding the additional calendar day in February for the 2008 leap year, the increase in neonatal intensive care unit patient days was .7%. Same units