**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**Form 10-Q**
| **x**      |   | **Quarterly report pursuant to Section 13 or 15(d)  of the Securities Exchange Act of 1934**  |
|------------|--------|-----------------------------------------------------------------------------------------------|
| ** ** |   | ** **                                                                                    |
| ** ** |   | **For the quarterly period ended June 30, 2007**                                              |
| ** ** |   | ** **                                                                                    |
| ** ** |   | **or**                                                                                        |
| ** ** |   | ** **                                                                                    |
| **o**      |   | **Transition report pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934** |
| ** ** |   | ** **                                                                                    |
| ** ** |   | **Commission  file number: 1-32203**                                                          |

 

**Prospect Medical Holdings,Inc.**

(Exact name of registrant as specified in itscharter)
| **Delaware**                                               |   | **33-0564370**       |
|------------------------------------------------------------|--------|----------------------|
| (State or other  jurisdiction of                           |   | (I.R.S. Employer     |
| incorporation or  organization)                            |   | Identification  No.) |
| ** **                                                 |   | ** **           |
| **400  Corporate Pointe, Suite 525**                       |   | ** **           |
| **Culver  City, California**                               |   | **90230**            |
| (Address of  principal executive offices)                  |   | (Zip Code)           |
|                                                       |   |                 |
| **(310)  338-8677**                                        |
| (Registrant’s telephone number, including  area code) |

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.  Yes o   No x

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act. (Check one):
| Large accelerated  filer  o |   | Accelerated  filer  o |   | Non-accelerated  filer  x |
|---------------------------------------|--------|---------------------------------|--------|-------------------------------------|

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act):

Yes  o   No  x

The number of shares of the issuer’s Common Stock, parvalue $0.01 per share, outstanding as of August 15, 2007 was 11,370,234.

 

----

**PROSPECTMEDICAL HOLDINGS, INC.**

**Index**
|                  | ** ** | **Part I – Financial  Information**                                                                                                  |       |       |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
|             | ** ** | ** **                                                                                                                                |       |       |
| **Item 1.**      |       | **Financial Statements**                                                                                                                  |       |       |
| ** **       |       | ** **                                                                                                                                |       |       |
|             |       | **Condensed  Consolidated Balance Sheets as of June 30, 2007 (unaudited) and September 30,  2006**                                        |       |       |
|             |       | ** **                                                                                                                                |       |       |
|             |       | **Condensed  Consolidated Statements of Operations for the three-month and nine-month  periods ended June 30, 2007 and 2006 (unaudited)** |       |       |
|             |       | ** **                                                                                                                                |       |       |
|             |       | **Condensed  Consolidated Statements of Cash Flows for the nine-month periods ended June  30, 2007 and 2006 (unaudited)**                 |       |       |
|             |       | ** **                                                                                                                                |       |       |
|             |       | **Notes to  Condensed Consolidated Financial Statements (unaudited)**                                                                     |       |       |
|             |       |                                                                                                                                      |       |       |
| **Item 2.**      | ** ** | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations**                                           |       |       |
| ** **       | ** ** | ** **                                                                                                                                |       |       |
| **Item 3.**      | ** ** | **Quantitative  and Qualitative Disclosures About Market Risk**                                                                           |       |       |
| ** **       | ** ** | ** **                                                                                                                                |       |       |
| **Item 4.**      | ** ** | **Controls and  Procedures**                                                                                                              |       |       |
| ** **       | ** ** | ** **                                                                                                                                |       |       |
|             | ** ** | **Part II - Other  Information**                                                                                                          | ** ** | ** ** |
|             | ** ** | ** **                                                                                                                                | ** ** | ** ** |
| **Item 1.**      | ** ** | **Legal Proceedings**                                                                                                                     |       |       |
| ** **       | ** ** | ** **                                                                                                                                |       |       |
| **Item 1A.**     | ** ** | **Risk Factors**                                                                                                                          |       |       |
| ** **       | ** ** | ** **                                                                                                                                |       |       |
| **Item 2.**      | ** ** | **Unregistered  Sales of Equity Securities and Use of Proceeds**                                                                          |       |       |
| ** **       | ** ** | ** **                                                                                                                                |       |       |
| **Item 3.**      | ** ** | **Defaults Upon  Senior Securities**                                                                                                      |       |       |
| ** **       |       |                                                                                                                                      |       |       |
| **Item 4.**      | ** ** | **Submission of  Matters to a Vote of Security Holders**                                                                                  |       |       |
| ** **       |       |                                                                                                                                      |       |       |
| **Item 5.**      | ** ** | **Other information**                                                                                                                     |       |       |
| ** **       |       |                                                                                                                                      |       |       |
| **Item 6.** | ** ** | **Exhibits**                                                                                                                              |       |       |
|             |       |                                                                                                                                      |       |       |
| **Signatures**   |       |                                                                                                                                      |       |       |

 

2

----

**PART I - FINANCIAL INFORMATION**

**Item 1.Financial Statements.**

**PROSPECTMEDICAL HOLDINGS, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**
| ** **                                                                                                                                                                                               | ** ** | **June 30** | ** **  | **September 30** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|-------------|-----------------------|------------|
| ** **                                                                                                                                                                                               | ** ** | **2007**         | ** **  | **2006**              | ** ** |
| ** **                                                                                                                                                                                               | ** ** | **(Unaudited)**  | ** **  | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                                               | ** ** | ** **       | ** **  | ** **            | ** ** |
| **Current assets**                                                                                                                                                                                       | ** ** | ** **       | ** **  | ** **            | ** ** |
| Cash and cash  equivalents                                                                                                                                                                               |       | $                | 16,924,337  |                  | $          | 16,623,407 |   |
| Investments, primarily  restricted certificates of deposit                                                                                                                                               |       | 1,092,971        |        | 836,244               |       |
| Risk pool receivables                                                                                                                                                                                    |       | 1,770,159        |        | 1,418,973             |       |
| Other receivables, net  of allowances of $600,000 and $509,000 at June 30, 2007 and September 30,  2006                                                                                                  |       | 6,052,257        |        | 1,916,883             |       |
| Notes receivable,  current portion                                                                                                                                                                       |       | 62,063           |        | 176,265               |       |
| Prepaid expenses and  other                                                                                                                                                                              |       | 955,537          |        | 645,466               |       |
| Refundable income taxes                                                                                                                                                                                  |       | 3,030,455        |        | 2,493,035             |       |
| Deferred income taxes,  net                                                                                                                                                                              |       | 345,478          |        | 657,678               |       |
| Total current  assets                                                                                                                                                                                    |       | 30,233,257       |        | 24,767,951            |       |
|                                                                                                                                                                                                     |       |             |        |                  |       |
| Property,  improvements and equipment:                                                                                                                                                                   |       |             |        |                  |       |
| Land                                                                                                                                                                                                     |       | 40,620           |        | 40,620                |       |
| Leasehold  improvements                                                                                                                                                                                  |       | 1,111,035        |        | 984,934               |       |
| Equipment                                                                                                                                                                                                |       | 4,205,223        |        | 3,478,435             |       |
| Furniture and  fixtures                                                                                                                                                                                  |       | 998,482          |        | 782,087               |       |
|                                                                                                                                                                                                     |       | 6,355,360        |        | 5,286,076             |       |
| Less accumulated  depreciation and amortization                                                                                                                                                          |       | (4,440,767       | )           | (3,999,863            | )          |
| Property,  improvements and equipment, net                                                                                                                                                               |       | 1,914,593        |        | 1,286,213             |       |
|                                                                                                                                                                                                     |       |             |        |                  |       |
| Notes receivable, long  term portion                                                                                                                                                                     |       | 503,595          |        | 413,577               |       |
| Deposits and other  assets                                                                                                                                                                               |       | 961,846          |        | 613,087               |       |
| Goodwill                                                                                                                                                                                                 |       | 75,768,401       |        | 37,838,169            |       |
| Other intangible  assets, net                                                                                                                                                                            |       | 13,770,874       |        | 1,738,475             |       |
| Total assets                                                                                                                                                                                             |       | $                | 123,152,566 |                  | $          | 66,657,472 |   |
| ** **                                                                                                                                                                                               | ** ** | ** **       | ** **  | ** **            | ** ** |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                                                                                                                                           | ** ** | ** **       | ** **  | ** **            | ** ** |
| **Current liabilities:**                                                                                                                                                                                 | ** ** | ** **       | ** **  | ** **            | ** ** |
| Accrued medical claims  and other health care costs payable                                                                                                                                              |       | $                | 20,628,526  |                  | $          | 11,400,000 |   |
| Accounts payable and  other accrued liabilities                                                                                                                                                          |       | 5,737,399        |        | 8,191,849             |       |
| Current maturities of  long-term debt                                                                                                                                                                    |       | 6,125,000        |        | 5,300,000             |       |
| Total current  liabilities                                                                                                                                                                               |       | 32,490,925       |        | 24,891,849            |       |
|                                                                                                                                                                                                     |       |             |        |                  |       |
| Long-term debt, less  current maturities                                                                                                                                                                 |       | 41,375,000       |        | 6,700,000             |       |
| Deferred income taxes                                                                                                                                                                                    |       | 5,616,707        |        | 1,145,573             |       |
| Other long-term  liabilities                                                                                                                                                                             |       | 231,368          |        | 34,712                |       |
| Total  liabilities                                                                                                                                                                                       |       | 79,714,000       |        | 32,772,134            |       |
| **Minority interest**                                                                                                                                                                                    |       | 76,529           |        | 81,881                |       |
| ** **                                                                                                                                                                                               | ** ** | ** **       | ** **  | ** **            | ** ** |
| **Shareholders’ equity:**                                                                                                                                                                           | ** ** | ** **       | ** **  | ** **            | ** ** |
|                                                                                                                                                                                                     |       |             |        |                  |       |
| Common stock, $0.01 par  value; 40,000,000 shares authorized; 9,483,229 (including 40,197 shares held  in treasury) and 7,186,977 shares issued and outstanding at June 30, 2007 and  September 30, 2006 |       | 94,832           |        | 71,869                |       |
| Additional paid-in  capital                                                                                                                                                                              |       | 30,105,048       |        | 20,345,805            |       |
| Retained earnings                                                                                                                                                                                        |       | 13,162,157       |        | 13,385,783            |       |
| Total  shareholders’ equity                                                                                                                                                                         |       | 43,362,037       |        | 33,803,457            |       |
|                                                                                                                                                                                                     |       |             |        |                  |       |
| Total liabilities and  shareholders’ equity                                                                                                                                                         |       | $                | 123,152,566 |                  | $          | 66,657,472 |   |

 

See accompanying notes.

3

----

**PROSPECTMEDICAL HOLDINGS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

**(Unaudited)**
| ** **                                          | ** ** | **Three months ended June 30** | ** ** | **Nine months ended June 30** | ** ** |
|-----------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                          | ** ** | **2007**                                           | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                |       |                                               |       |                                              |       |   |   |   |   |
| Revenues                                            |       | $                                                  | 40,751,862 |                                              | $          | 34,818,020 |   | $ | 108,906,846 |   | $ | 102,854,925 |   |
| Cost of Revenues                                    |       | 31,890,916                                         |       | 25,408,055                                        |       | 84,097,298 |   | 73,857,934 |   |
|                                                |       |                                               |       |                                              |       |   |   |   |   |
| Gross margin                                        |       | 8,860,946                                          |       | 9,409,965                                         |       | 24,809,548 |   | 28,996,991 |   |
|                                                |       |                                               |       |                                              |       |   |   |   |   |
| Non-medical  expenses:                              |       |                                               |       |                                              |       |   |   |   |   |
| General and administrative                          |       | 8,566,868                                          |       | 7,286,083                                         |       | 25,725,367 |   | 22,878,291 |   |
| Depreciation and amortization                       |       | 616,393                                            |       | 338,140                                           |       | 1,399,419 |   | 995,729 |   |
| Total  non-medical expenses                         |       | 9,183,261                                          |       | 7,624,223                                         |       | 27,124,786 |   | 23,874,020 |   |
|                                                |       |                                               |       |                                              |       |   |   |   |   |
| Operating income  from unconsolidated joint venture |       | 1,551,088                                          |       | 321,125                                           |       | 2,314,666 |   | 998,019 |   |
|                                                |       |                                               |       |                                              |       |   |   |   |   |
| Operating income  (loss)                            |       | 1,228,773                                          |       | 2,106,867                                         |       | (572 | ) | 6,120,990 |   |
| ** **                                          | ** ** | ** **                                         | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Other (income)  expense:                            |       |                                               |       |                                              |       |   |   |   |   |
| Investment income                                   |       | (329,712                                           | )          | (219,589                                          | )          | (793,573 | ) | (658,778 | ) |
| Interest expense                                    |       | 637,140                                            |       | 269,884                                           |       | 1,138,718 |   | 815,625 |   |
| Total other expense,  net                           |       | 307,428                                            |       | 50,295                                            |       | 345,145 |   | 156,847 |   |
|                                                |       |                                               |       |                                              |       |   |   |   |   |
| Income (loss)  before income taxes                  |       | 921,345                                            |       | 2,056,572                                         |       | (345,717 | ) | 5,964,143 |   |
| Provision (benefit)  for income taxes (benefits)    |       | 382,165                                            |       | 743,949                                           |       | (129,173 | ) | 2,313,524 |   |
|                                                |       |                                               |       |                                              |       |   |   |   |   |
| Net income (loss)  before minority interest         |       | 539,180                                            |       | 1,312,623                                         |       | (216,544 | ) | 3,650,619 |   |
|                                                |       |                                               |       |                                              |       |   |   |   |   |
| Minority  interest                                  |       | 5,210                                              |       | 8,632                                             |       | 7,082 |   | 14,616 |   |
|                                                |       |                                               |       |                                              |       |   |   |   |   |
| Net income  (loss)                                  |       | $                                                  | 533,970    |                                              | $          | 1,303,991 |   | $ | (223,626 | ) | $ | 3,636,003 |   |
|                                                |       |                                               |       |                                              |       |   |   |   |   |
| Net income per  common share:                       |       |                                               |       |                                              |       |   |   |   |   |
| Basic                                               |       | $                                                  | 0.06       |                                              | $          | 0.19 |   | $ | (0.03 | ) | $ | 0.53 |   |
| Diluted                                             |       | $                                                  | 0.06       |                                              | $          | 0.16 |   | $ | (0.03 | ) | $ | 0.45 |   |
| Weighted average  shares outstanding:               |       |                                               |       |                                              |       |   |   |   |   |
| Basic                                               |       | 8,394,827                                          |       | 6,969,440                                         |       | 7,786,145 |   | 6,851,751 |   |
| Diluted                                             |       | 9,018,948                                          |       | 8,141,421                                         |       | 7,786,145 |   | 8,044,146 |   |

 

See accompanying notes.

4

----

**PROSPECTMEDICAL HOLDINGS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFCASH FLOWS**

**(Unaudited)**
| ** **                                                                                | ** ** | **Nine Months ended June 30** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                | ** ** | **2007**                                          | ** ** | **2006** | ** ** |
| **Operating  activities**                                                                 | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Net income (loss)                                                                         |       | $                                                 | (223,626   | ) | $ | 3,636,003 |   |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities: |       |                                              |       |   |   |
| Depreciation and amortization                                                             |       | 1,399,419                                         |       | 995,729 |   |
| Provision for bad debts                                                                   |       | 90,647                                            |       | 85,366 |   |
| Loss on disposal of assets                                                                |       | —                                            |       | 1,692 |   |
| Stock based compensation                                                                  |       | 462,356                                           |       | — |   |
| Deferred income taxes, net                                                                |       | 556,381                                           |       | 184,501 |   |
| Changes in operating assets and liabilities:                                              |       |                                              |       |   |   |
| Risk pool receivables                                                                     |       | 244,357                                           |       | (735,120 | ) |
| Other receivables                                                                         |       | (833,645                                          | )          | 1,045,836 |   |
| Prepaid expenses and other                                                                |       | (217,821                                          | )          | 42,254 |   |
| Refundable income taxes                                                                   |       | 679,114                                           |       | (2,643,588 | ) |
| Excess tax benefits from options exercised                                                |       | (318,465                                          | )          | (459,341 | ) |
| Deposits and other assets                                                                 |       | (393,572                                          | )          | (52,194 | ) |
| Accrued medical claims and other health care costs  payable                               |       | 2,914,990                                         |       | (1,212,191 | ) |
| Accounts payable and other accrued liabilities                                            |       | (3,139,853                                        | )          | 343,152 |   |
| Net cash provided by operating activities                                                 |       | 1,220,282                                         |       | 1,232,099 |   |
|                                                                                      |       |                                              |       |   |   |
| **Investing  activities**                                                                 | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Purchases of property, improvements and equipment                                         |       | (693,312                                          | )          | (466,833 | ) |
| Collections on note receivable                                                            |       | 24,183                                            |       | 26,307 |   |
| Cash paid for acquisitions, net of cash received                                          |       | (36,137,282                                       | )          | (6,596,080 | ) |
| Decrease in restricted certificates of deposit                                            |       | 201,894                                           |       | 294,364 |   |
| Capitalized expenses related to acquisitions                                              |       | (1,178,419                                        | )          | — |   |
| Other investing activities                                                                |       | (5,352                                            | )          | 14,616 |   |
| Net cash used in investing activities                                                     |       | (37,788,288                                       | )          | (6,727,626 | ) |
|                                                                                      |       |                                              |       |   |   |
| **Financing  activities**                                                                 | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Borrowings from term loan                                                                 |       | 48,000,000                                        |       | 4,000,000 |   |
| Borrowings on line of credit                                                              |       | —                                            |       | 2,000,000 |   |
| Repayments on credit line                                                                 |       | (2,500,000                                        | )          | (2,000,000 | ) |
| Reduction of note payable                                                                 |       | (10,000,000                                       | )          | (1,966,667 | ) |
| Cash paid for deferred financing costs                                                    |       | (990,914                                          | )          | — |   |
| Proceeds from issuance of common stock, net                                               |       | 2,041,385                                         |       | 929,140 |   |
| Tax benefit from options exercised                                                        |       | 318,465                                           |       | 459,341 |   |
| Net cash provided by financing activities                                                 |       | 36,868,936                                        |       | 3,421,814 |   |
|                                                                                      |       |                                              |       |   |   |
| Net increase (decrease) in cash and cash equivalents                                      |       | 300,930                                           |       | (2,073,713 | ) |
|                                                                                      |       |                                              |       |   |   |
| Cash and cash equivalents at beginning of period                                          |       | 16,623,407                                        |       | 16,949,304 |   |
|                                                                                      |       |                                              |       |   |   |
| Cash and cash equivalents at end of period                                                |       | $                                                 | 16,924,337 |   | $ | 14,875,591 |   |
| ** **                                                                                | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| **Supplemental  cash flow information**                                                   | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Cash paid during the period for:                                                          |       |                                              |       |   |   |
| Income taxes                                                                              |       | —                                            |       | $ | 4,071,000 |   |
| Interest                                                                                  |       | $                                                 | 501,579    |   | $ | 802,248 |   |
|                                                                                      |       |                                              |       |   |   |
| Details of  businesses acquired:                                                          |       |                                              |       |   |   |
| Fair value of assets acquired                                                             |       | $                                                 | 60,032,035 |   | $ | 9,364,744 |   |
| Liabilities assumed or created                                                            |       | (11,573,414                                       | )          | (1,329,556 | ) |
| Total net assets acquired                                                                 |       | 48,458,621                                        |       | 8,035,188 |   |
| Less cash acquired                                                                        |       | (5,361,339                                        | )          | (1,439,108 | ) |
| Less stock consideration                                                                  |       | (6,960,000                                        | )          | — |   |
| Net cash paid for acquisitions                                                            |       | $                                                 | 36,137,282 |   | $ | 6,596,080 |   |

 

5

----

**PROSPECT MEDICAL HOLDINGS, INC.**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**June 30, 2007**

**(Unaudited)**

**1. Reporting Entity**

Prospect Medical Holdings, Inc. (Prospect or the Company),a Delaware corporation, was incorporated on May 12, 1993. The Company is ahealth care management services organization that develops integrated deliverysystems, and provides medical management systems and services to affiliatedmedical organizations. The affiliated medical organizations employ and/orcontract with physicians and professional medical corporations, and contractwith managed care payors. Prospect manages the provision of prepaid health careservices for its affiliated medical organizations in Southern California.

**2. Basis of Presentation**

The unaudited condensed consolidated interim financialstatements have been prepared under the assumption that users of the interimfinancial data have either read or have access to our audited consolidatedfinancial statements for the latest fiscal year ended September 30, 2006.Accordingly, certain footnote disclosures that would substantially duplicatethe disclosures contained in the September 30, 2006 audited financialstatements have been omitted. These unaudited condensed consolidated interimfinancial statements should be read in conjunction with our September 30, 2006audited financial statements.

The unaudited condensed consolidated financialstatements include the accounts of the Company and all majority ownedsubsidiaries and controlled entities under Emerging Issues Task Force (EITF)No. 97-2, “*Application of FASB Statement No. 94 and APBOpinion No. 16 to Physician Practice Management Entities and Certain OtherEntities with Contractual Management Arrangements.”* In the opinionof management, all adjustments considered necessary for a fair presentation ofthe results as of the date of, and for the interim periods presented, whichconsist solely of normal recurring adjustments, have been included. Allsignificant inter-company balances and transactions have been eliminated inconsolidation. The consolidated results of operations for the current interimperiod are not necessarily indicative of the results that may be expected forthe entire year ending September 30, 2007.

Revenues are comprised of the following amounts:
|                 | ** ** | **Three months ended June 30** | ** ** | **Nine months ended June 30** | ** ** |
|-----------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **      | ** ** | **2007**                                           | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
| Capitation      |       | $                                                  | 39,083,312 |                                              | $          | 33,170,653 |   | $ | 105,630,649 |   | $ | 99,442,631 |   |
| Fee for service |       | 583,717                                            |       | 472,181                                           |       | 1,483,596 |   | 1,595,946 |   |
| Management fees |       | 161,633                                            |       | 296,123                                           |       | 618,802 |   | 927,890 |   |
| Other           |       | 923,200                                            |       | 879,063                                           |       | 1,173,799 |   | 888,458 |   |
| Total revenues  |       | $                                                  | 40,751,862 |                                              | $          | 34,818,020 |   | $ | 108,906,846 |   | $ | 102,854,925 |   |

 

Certain prior yearamounts have been reclassified to conform to current period presentation.

The operating results forthe three and nine months ended June 30, 2007 include the results of the ProMedEntities acquired on June 1, 2007 (see Note 7).

**3. Stock Based Compensation**

Our equity incentive programs include stock optionsand restricted stock which vest based on continuous service. On January 1,2006, we adopted SFAS No. 123 (revised), *Share-BasedPayment*(SFAS No. 123R), which requires measurement andrecognition of compensation expense for all share-based awards made toemployees and directors.  Under SFASNo. 123R, the fair value of share-based awards is estimated at grant dateusing an option pricing model, and the portion that is ultimately expected tovest is recognized as compensation cost over the requisite service period.Werecord compensation expense ratably over the service period from the date ofgrant. Since share-based compensation under SFAS No. 123R is recognizedonly for those awards that are ultimately expected to vest, we have applied anestimated forfeiture rate to unvested awards for the purpose of calculatingcompensation cost. These estimates will be revised, if necessary, in futureperiods if actual forfeitures differ from the estimates. Changes in forfeitureestimates impact compensation cost in the period in which the change inestimate occurs. We use the Black-Scholes option-pricing model to estimate thefair value of share-based awards. The determination of fair value using theBlack-Scholes option-pricing model is affected by our stock price as well asassumptions regarding a number of complex and subjective variables, includingexpected stock price volatility, risk-free interest rate, expected dividendsand projected employee stock option exercise behaviors.

6

----

**4. Earnings Per Share**

The denominators for thecomputation of basic and diluted earnings (loss) per share are calculated asfollows:
|                                                                          | ** ** | **For the three months  ended June 30** | ** ** | **For the nine month  ended June 30** | ** ** |
|--------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                               | ** ** | **2007**                                                         | ** ** | **2006**                                                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Basic earnings per common share:                                         |       |                                                             |       |                                                           |       |   |   |   |   |
| Numerator – net income (loss)                                       |       | $                                                                | 533,970    |                                                           | $          | 1,303,991 |   | $ | (223,626 | ) | $ | 3,636,003 |   |
|                                                                     |       |                                                             |       |                                                           |       |   |   |   |   |
| Denominator – weighted average number of common  shares outstanding |       | 8,394,827                                                        |       | 6,969,440                                                      |       | 7,786,145 |   | 6,851,751 |   |
|                                                                     |       |                                                             |       |                                                           |       |   |   |   |   |
| Basic earnings  (loss) per common share                                  |       | $                                                                | 0.06       |                                                           | $          | 0.19 |   | $ | (0.03 | ) | $ | 0.53 |   |
|                                                                     |       |                                                             |       |                                                           |       |   |   |   |   |
| Diluted earnings per common share:                                       |       |                                                             |       |                                                           |       |   |   |   |   |
| Numerator – net income (loss)                                       |       | $                                                                | 533,970    |                                                           | $          | 1,303,991 |   | $ | (223,626 | ) | $ | 3,636,003 |   |
|                                                                     |       |                                                             |       |                                                           |       |   |   |   |   |
| Denominator:                                                             |       |                                                             |       |                                                           |       |   |   |   |   |
| Weighted average  number of common shares outstanding                    |       | 8,394,827                                                        |       | 6,969,440                                                      |       | 7,786,145 |   | 6,851,751 |   |
| Diluted stock options, warrants and preferred shares                     |       | 624,121                                                          |       | 1,171,981                                                      |       | — |   | 1,192,395 |   |
|                                                                     |       | $                                                                | 9,018,948  |                                                           | $          | 8,141,421 |   | $ | 7,786,145 |   | $ | 8,044,146 |   |
|                                                                     |       |                                                             |       |                                                           |       |   |   |   |   |
| Diluted earnings (loss)  per common share                                |       | $                                                                | 0.06       |                                                           | $          | 0.16 |   | $ | (0.03 | ) | $ | 0.45 |   |

 

Optionsand warrants are excluded from diluted EPS for periods with net losses sincetheir inclusion would be anti-dilutive.

**5. Related Party Transactions**

We have an employmentagreement with our Chief Executive Officer, Jacob Y. Terner that runs throughAugust 1, 2008. The agreement provides that if we terminateDr. Terner’s employment without cause, we will be required to pay him$12,500 for each month of past service as our Chief Executive Officer,commencing as of July 31, 1996. The Company’s maximum contingentobligation under this termination provision was frozen at $1,237,500.

Prospect Medical Group, Inc.(PMG), which is wholly owned by Dr. Terner, and whose accounts areconsolidated in these financial statements under EITF 97-2, maintains anintercompany account receivable due from Prospect Medical Holdings, Inc.The intercompany receivable was created in connection with intercompanytransactions, including those related to previous acquisitions. In the eventthat PMG is required by the health maintenance organizations (HMO’s) orregulatory agencies to maintain a positive tangible net equity and positiveworking capital, Dr. Terner had previously agreed to personally guaranteethe intercompany account receivable due from Prospect MedicalHoldings, Inc. up to a level sufficient to enable PMG to attain positivetangible net equity and working capital.

On June 1, 2003, inconsideration for Dr. Terner’s personal guarantee and pledge, theCompensation Committee of the Board of Directors granted to Dr. Terner asix-year, non-qualified stock option to purchase 800,000 shares of common stockat $3.00 per share. During its term, Dr. Terner’s personal guarantee wassupported through the pledge of certain of his personal assets. Dr. Terneragreed to maintain his personal guarantee and collateral in effect until PMGhad positive tangible net equity. This personal guarantee arrangement wasterminated by the Board of Directors effective January 19, 2005.

7

----

**6. Long Term Debt**

Long-term debt at June30, 2007 and September 30, 2006, respectively, consists of the following:
|                            | ** ** | **June 30,** | ** ** | **September 30,** | ** ** |
|----------------------------|------------|-------------------|------------|------------------------|------------|
| ** **                 | ** ** | **2007**          | ** ** | **2006**               | ** ** |
| Term loan                  |       | $                 | 47,500,000 |                   | $          | 9,500,000 |   |
| Revolving credit  facility |       |              |       | 2,500,000              |       |
|                       |       | $                 | 47,500,000 |                   | $          | 12,000,000 |   |
| Less current  maturities   |       | (6,125,000        | )          | (5,300,000             | )          |
|                       |       | $                 | 41,375,000 |                   | $     | 6,700,000 |   |

 

On September 27, 2004,the Company entered into a senior secured credit facility with ResidentialFunding Corporation (RFC), comprised of a $5,000,000 revolving credit facilityand a $10,000,000 term loan. On September 28, 2004, the Company borrowed$10,000,000 on the RFC term loan and paid off its existing term loan andrevolving credit facility with another lender.

The RFC revolving creditfacility commitment was for three years, with interest at prime plus 0.5% perannum and an unused line fee of 0.25% per annum. The Company could borrow, makerepayments, and re-borrow under the revolving credit facility until January 31,2008. The RFC term loan was amortized over a five-year period with principalpayments of $166,667 per month, plus interest payable monthly on the outstandingbalance at prime plus 2.0% per annum. The remaining balance of the term loan wasdue and payable in full on January 31, 2008. The Company was subject to certainfinancial covenants under the loan agreement, including a maximum seniordebt/EBITDA ratio, minimum fixed charge coverage ratio, minimum consolidatednet worth, minimum liquidity and a limit on capital expenditures. The Company wasalso restricted, without consent, from using the net proceeds of any sale ofequity securities except to pay down indebtedness under the loan agreement.

In November 2005, inconnection with the acquisition of Genesis Healthcare of Southern California,RFC provided us with additional term loan debt financing of $4,000,000, onterms identical to the existing term loan. This additional term loan wasinitially due on September 30, 2007 and required monthly principal payments of$66,667 until that time.

All amounts owning to RFC($7,842,000 plus $209,000 of prepayment penalties) were repaid on June 1, 2007,from proceeds of a new 3-year senior secured credit facility entered into withBank of America, in connection with the purchase of the ProMed Entities. TheBank of America facility totaled $53,000,000, and comprised of a $48,000,000 variablerate term loan, and a $5,000,000 (undrawn) revolver. The Bank of America termloan required monthly principal payments beginning at $500,000 and increasing to$1,000,000 by December 31, 2009 with a balloon payment of $24,950,000 onMay 31, 2010.

The term loan bearsinterest at a base rate selected by the Company plus a margin. For Base Rate Loans(higher of the federal funds rate plus 0.05% or lender’s prime rate), themargin is 0.75%. For Eurodollar Rate loans (LIBOR), the margin is 3.75%. Themargin may increase or decrease based on the consolidated senior leverageratios. The Company is subject to certain financial covenants, includingmaximum senior leverage ratio, minimum adjusted EBITDA, minimum net worth,minimum fixed charge coverage ratio, and minimum membership, each determined ona consolidated basis. The Company incurred financing costs of $753,000, whichhas been deferred and will be amortized over the life of the credit facilityusing the effective interest method. The Company is in compliance with allcovenants as of June 30, 2007.

Prospect Medical is alsorequired by the lender to enter into an interest rate swap to hedge changes ininterest rates. Concurrent with the acquisition of the ProMed Entities andrelated financing, the Company entered into a $48 million interest rate swap,which effectively converts the variable interest rate under the credit facilityto a fixed rate of 5.3% plus the applicable margin per year throughout the termof the loan. The Company did not elect hedge accounting for the interest rateswap and accounts for it as a derivative with changes in fair value recordedthrough earnings. The fair value of the instrument as of June 30, 2007 and therelated change in fair value is not significant.

All amounts outstandingunder the $53,000,000 Bank of America credit facility ($48,000,000), wererepaid on August 8, 2007 with proceeds from a $155,000,000 syndicated seniorsecured credit facility arranged by Bank of America with identical terms inconnection with the acquisition of Alta Healthcare System, Inc. – see Notes 7and 9. The Company is also required to enter into an interest rate swapcovering at least 50% of the loan balance within 60 days of the closing ofthe $155 million credit facility.

**7. Acquisitions**

Genesis HealthCare ofSouthern California

OnNovember 1, 2005 Prospect Medical Group, Inc., acquired theoutstanding common stock of Genesis HealthCare of Southern California (Genesis)for $8,000,000 in cash. The purchase price was funded using $4,000,000 of theCompany’s existing cash and a

8

----

$4,000,000 term loan fromRFC.  Revenues and expenses for this acquisitionhave been included in our consolidated results starting November 1, 2005. Thefollowing table summarizes the estimated fair values of the assets acquired andliabilities assumed, as of the date of acquisition:

|                           | ** ** | **Genesis** | ** ** |
|---------------------------|------------|-------------|------------|
| Current assets            |       | $           | 1,520,539  |   |
| Goodwill                  |       | 6,398,652   |       |
| Identifiable  intangibles |       | 1,378,800   |       |
| Other assets  acquired    |       | 31,565      |       |
| Total assets              |       | $           | 9,329,556  |   |
| Less liabilities  assumed |       | 1,329,556   |       |
| Net assets acquired       |       | $           | 8,000,000  |   |

 

Intangibles include tradename of $194,800, a covenantnot-to-compete of $199,200 and $984,800 for customer relations, which are beingamortized on a straightline basis over 18 months to four years. The Company madea Section 338 election, and expects $7,777,452 of total goodwill andintangibles to be deductible for tax purposes. Under the acquisition agreement,differences between the estimated claims and tax liabilities recorded on theclosing date and the ultimate payment amounts will be paid to or received fromthe seller.  As of June 30, 2007 werecorded a liability to the seller approximately $120,000 relates to this provision.The agreement also guaranteed certain minimum risk pool collections for the2005 calendar year, which were met. The seller also provides customaryindemnification of up to $1.5 million for eligible non-medical and non-taxclaims submitted within a two year period. The indemnification amount isreduced ratably over 24 months. In conjunction with the acquisition, we enteredinto an employment agreement with the sole selling shareholder of Genesis and 2of its employees.

ProMed Entities

On June 1, 2007,the Company acquired the outstanding common stock of the ProMed Entities,comprised of ProMed Health Services Company and its wholly-owned subsidiary, ProMedHealthCare Administrators, Inc., Pomona Valley Medical Group, Inc. and UplandMedical Group, Inc., for total consideration of $48,000,000 (plus transactioncosts of $459,000), comprised of cash in the amount of $41,040,000 and1,543,237 shares of common stock valued, at $4.51 per share or $6,960,000.The per share value of $4.51 was based on the average of the closing prices for5 trading days before and after the acquisition announcement date of May 22,2007 (May 15, 2007 through May 30, 2007). The agreements alsoprovides for $2,400,000 of the cash consideration be held in an escrow accountas the exclusive recourse to the Company for any losses or claims reportedwithin two years against the seller. 25% will be released on the firstanniversary and the balance and after 2 years, less claims applied oramounts reserved for pending claims. The cash portion of the purchase price wasfunded using proceeds from the new $53,000,000 Bank of America senior securedcredit facility described in Note 6. Revenues and expenses for this acquisition have been included in ourconsolidated results starting June 1, 2007. The Company has engaged an outsidevaluation firm to assist with the determination of the fair value and economiclives of the assets acquired at June 1, 2007. Pending completion of this valuationstudy, the following table summarizes the preliminary estimated fair values ofthe assets acquired and liabilities assumed, as of the date of acquisition.

|                                                                         | ** ** | **ProMed** | ** ** |
|-------------------------------------------------------------------------|------------|------------|------------|
| Current assets                                                          |       | $          | 10,294,762 |   |
| Goodwill                                                                |       | 37,210,454 |       |
| Identifiable  intangibles                                               |       | 12,000,000 |       |
| Other assets  acquired                                                  |       | 526,819    |       |
| Total assets                                                            |       | $          | 60,032,035 |   |
| Less liabilities  assumed                                               |       | 7,247,325  |       |
| Deferred tax  liabilities for non-deductible intangible assets acquired |       | 4,326,089  |       |
| Total  liabilities assumed                                              |       | 11,573,414 |       |
| Net assets acquired,  including transaction costs                       |       | $          | 48,458,621 |   |

 

The preliminary estimated fair value of theidentifiable intangibles which consists of payor contracts, membership lists,provider network and covenants not-to-compete, is being amortized over weightedaverage useful lives of 60 months. The preliminary estimates may differsignificantly from the final determination by the valuation specialist. Theacquisition agreements contain provisions for certain purchase priceadjustments in the event that working capital and medical claims liabilitiesexceed, or are less than, the recorded balances on the acquisition date by morethan 10%. Any final settlement payments made to, or received from the Sellersof the ProMed entities will be reflected as an adjustment to the purchaseconsideration described above. Under the agreement, each principal sellingshareholder receiving $650,000 or more in merger consideration) is subject to acovenant not-to-compete for two years. Selling shareholders who are alsocontracting physicians of the ProMed Entities are also subject to covenantsnot-to-compete and exclusivity provisions for a two-year term with the Company.

In conjunction with the acquisition, we have enteredinto employment agreements, ranging from two to three years, and non-competeagreements, ranging from four to six years, with three key members of ProMed’smanagement. Each executive receives a base salary of $300,000 plus aperformance bonus equal to 6.67% of incremental EBITDA as defined for 2-5 yearperiods. The bonus will be recorded as compensation expense when earned.

9

----

The followingpro forma information for the three and nine months ended June 30, 2007 and2006 gives effect to the Genesis and ProMed acquisitions as if they hadoccurred at the beginning of each period. Such unaudited pro forma informationis based on historical financial information with respect to the ProMed andGenesis acquisitions and does not include operational or other changes thatmight have been effected by the Company.
|                             | ** ** | **For the period ended June 30**            | ** ** |
|-----------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                  | ** ** | **For the three months ended June 30** | ** ** | **For the nine months ended June 30** | ** ** |
| ** **                  | ** ** | **2007**                                                             | ** ** | **2006** | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net revenue                 |       | $                                                                    | 58,501,209 |   | $ | 47,119,164 |   | $ | 172,263,772 |   | $ | 170,856,050 |   |
| Net income  (loss)          |       | 3,704,483                                                            |       | 1,956,546 |   | 3,560,533 |   | 3,076,214 |   |
| Basic earnings  per share   |       | $                                                                    | 0.39       |   | $ | 0.23 |   | $ | 0.39 |   | $ | 0.37 |   |
| Diluted earnings per  share |       | $                                                                    | 0.37       |   | $ | 0.20 |   | $ | 0.36 |   | $ | 0.32 |   |

 

Proforma adjustments include increased interestexpense related to the acquisition-related debt, reduced interest income,amortization of intangibles acquired, and exclusion of approximately $7 millionin transaction bonuses that were directly related to the acquisition, each netof the related tax effect.

See Note 9 for discussion of the acquisition, onAugust 8, 2007, of Alta Healthcare System.

**Use of Estimates**

Thepreparation of financial statements in conformity with U.S. generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe reported amounts of assets, liabilities, revenues and expenses, and thedisclosure of contingent assets and liabilities at the date and for the periodsthat the financial statements are prepared. Actual results could differ fromthose estimates. Principal areas requiring the use of estimates include medicalclaims and accruals, settlements under risk/savings sharing programs, medicalreceivables, determination of allowances for uncollectible accounts, impairmentof long-lived and intangible assets, professional and general liability claims,reserves for the outcome of litigation and valuation allowances for deferredtax assets.

Duringthe nine months ended June 30, 2007 and 2006, we recorded approximately $429,000and $762,000, respectively, in reduced claims expense related to favorabledevelopment of fiscal 2006 and 2005 claims, respectively.

Duringthe three and nine months ended June 30, 2007, we recorded approximately $770,000and $960,000, respectively, in reduced hospital risk pool revenue as a resultof lowered receivables estimates for fiscal 2006 risk/savings sharing programs.

**8. New Accounting Pronouncements**

In May2005, the Financial Accounting Standards Board (FASB) issued StatementNo. 154 (SFAS No. 154), *AccountingChanges and Error Corrections*, which replaced APB OpinionNo. 20, *Accounting Changes*,and SFAS No. 3, *Reporting Changes in InterimFinancial Statements*. SFAS No. 154 requires retrospectiveapplication to prior periods’ financial statements of voluntary changes inaccounting principles and changes required by a new accounting standard whenthe standard does not include specific transition provisions. Previous guidancerequired most voluntary changes in accounting principle to be recognized byincluding in net income of the period in which the change was made thecumulative effect of changing to the new accounting principle. SFAS No. 154carries forward existing guidance regarding the reporting of the correction ofan error and a change in accounting estimate. SFAS No. 154 is effectivefor accounting changes and corrections of errors made in fiscal years beginningafter December 15, 2005. Adoption of SFAS No. 154 as ofOctober 1, 2006 did not have a material effect on our consolidatedfinancial position or results of operations.

InJuly 2006, the FASB issued Final Interpretation No. (FIN) 48, *Accounting for Uncertainty in Income Taxes**, an interpretation of SFAS No. 109**Accounting for Income Taxes*. FIN 48 clarifies the accountingfor income taxes by prescribing the minimum recognition threshold a taxposition is required to meet before being recognized in the financialstatements. FIN 48 also provides guidance on derecognition, measurement,classification, interest and penalties, accounting in interim periods,disclosure and transition. In addition, FIN 48 excludes income taxes from thescope of SFAS No. 5, *Accounting forContingencies*. FIN 48 is effective for fiscal years beginning afterDecember 15, 2006. Differences between the amounts recognized in theconsolidated balance sheets prior to the adoption of FIN 48 and the amountsreported after adoption are accounted for as a cumulative-effect adjustment tothe beginning balance of retained earnings. Adoption of FIN 48 as of October 1,2007 is not expected to have a material effect on our consolidated financialposition or results of operations.

InSeptember 2006, the FASB issued SFAS No. 157, “*Fair ValueMeasurements*.” This Statement defines fair value, establishes aframework for measuring fair value in generally accepted accounting principles,and expands disclosures about fair value measurements. This Statement appliesunder other accounting pronouncements that require or permit fair valuemeasurements, the Board having previously concluded in those accountingpronouncements that fair value is the relevant measurement attribute.Accordingly, this Statement does not require any new fair value measurements.This Statement is 

10

----

effective for financial statements issued for fiscalyears beginning after November 15, 2007, and interim periods within thosefiscal years. The Company is currently evaluating the impact of the provisionsof SFAS No. 157.

In September 2006,the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin(“SAB”) No. 108 regarding the process of quantifying financial statementmisstatements. SAB No. 108 states that registrants should use both abalance sheet approach and an income statement approach when quantifying andevaluating materiality of a misstatement. The interpretations in SABNo. 108 contain guidance on correcting errors under the dual approach aswell as provide transition guidance for correcting errors. This interpretationdoes not change the requirements within SFAS No. 154 for the correction ofan error in financial statements. SAB No. 108 is effective for annualfinancial statements covering the first fiscal year ending after November 15,2006. Adoption of SAB No. 108 as of October 1, 2006 did not have a materialeffect on our Consolidated Financial Position or Results of Operations.

Otherrecent accounting pronouncements issued by the FASB (including its EmergingIssues Task Force), the AICPA, and the SEC did not, or are not believed bymanagement to, have a material impact on our present or future consolidatedfinancial statements.

**9. Subsequent Events**

OnAugust 8, 2007, the Company completed the acquisition of Alta Healthcare System,Inc., which operates four acute care hospitals in Los Angeles, California(Alta), for combined purchase consideration of $144,000,000, includingrepayment of $41,484,650 of Alta’s existing debt, $51,257,675 in cash to theformer Alta shareholders and 1,887,136 shares and 1,672,880 shares ofcommon and Series B convertible preferred stock, respectively, valued, forpurposes of the transaction, at $51,257,675. Each share of preferred stock willautomatically convert into one common share upon approval by a shareholdersvote to be held in six months. If the preferred shares are not converted, eachshare will accrue dividends at 18% per year, compounding annually. However, nodividends will be paid upon conversion to common shares.

TheAlta transaction was financed by $155,000,000 senior secured credit facilityarranged by Bank of America, comprising $145,000,000 in term loans and a$10,000,000 revolver, of which $3,000,000 was drawn at closing. The term debtis comprised of a $95,000,000, seven year first-lien term loan at LIBOR plus400 basis points, and with quarterly principal payments of $1,250,000; and a$50,000,000 seven and one-half year second-lien term loan at LIBOR plus 825basis points, with all principal due at maturity.

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

**Forward-LookingStatements**

The following discussionof our financial condition and results of operations should be read inconjunction with the accompanying unaudited condensed consolidated financialstatements and the notes to those statements appearing elsewhere in this reportand the audited financial statements for the year ended September 30, 2006 appearingin our annual report on Form 10-K filed with the Securities and ExchangeCommission.

This discussion contains forward-looking statementsthat involve risks and uncertainties. These forward-looking statements areoften accompanied by words such as “believe,” “should,” “anticipate,” “plan,” “expect,”“potential,” “scheduled,” “estimate,” “intend,” “seek,” “goal,” “may” andsimilar expressions. These statements include, without limitation, statementsabout our market opportunity, our growth strategy, competition, expectedactivities and future acquisitions and investments and the adequacy of ouravailable cash resources. Investors are urged to read these statementscarefully, and are cautioned that matters subject to forward-looking statementsinvolve risks and uncertainties, including economic, regulatory, competitiveand other factors that may affect our business. These statements are notguarantees of future performance and are subject to risks, uncertainties andassumptions. Although we believe that the expectations reflected in the forward-lookingstatements are reasonable, we cannot guarantee future results, levels ofactivity, performance, or achievements. Moreover, we do not assume anyresponsibility for the accuracy and completeness of such statements in thefuture. Subject to applicable law, we do not plan to update any of the forward-lookingstatements after the date of this report to conform such statements to actualresults.

Forward-lookingstatements involve known and unknown risks and uncertainties that may cause ouractual results in future periods to differ materially from those projected orcontemplated in the forward-looking statements as a result of, but not limitedto, the following factors:
| · | Continued operating losses, or reductions in our  ability to borrow under our credit agreement, results in our having  insufficient cash to support future operations. |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                   |
| · | Decreases in the number of HMO enrollees using our  provider networks reduce our profitability and inhibit future growth.                                              |
|   |                                                                                                                                                                   |
| · | Our historical working capital deficit could  adversely affect our ability to satisfy our obligations as they come due.                                                |

 

11

----

 
| · | If the value of our goodwill and intangible assets  with indefinite useful lives becomes impaired, the impaired portion will have  to be written off, which could materially reduce the value of our assets and  reduce our net income for the year in which the write-off occurs.                                                                                        |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                      |
| · | We may not be able to make any additional  significant acquisitions without first obtaining additional financing and  obtaining the consent of our commercial lender.                                                                                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                      |
| · | If we are not able to comply with the financial  covenants and other conditions required by our loan agreement with our  commercial lender, our lender could require full repayment of the loan, which  would negatively impact our liquidity and preclude us from making further  acquisitions.                                                                          |
|   |                                                                                                                                                                                                                                                                                                                                                                      |
| · | Substantially all of our revenues are generated from  contracts with a limited number of HMOs, and if our affiliated physician  organizations were to lose HMO contracts or to renew HMO contracts on less  favorable terms, our revenues and profitability could be significantly  reduced.                                                                              |
|   |                                                                                                                                                                                                                                                                                                                                                                      |
| · | Our profitability may be reduced or eliminated if we  are not able to manage health care costs of our affiliated physician  organizations effectively.                                                                                                                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                                                                      |
| · | Our operating results could be adversely affected if  our actual health care claims exceed our reserves.                                                                                                                                                                                                                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                                                      |
| · | We may be exposed to liability or fail to estimate  IBNR claims accurately if we cannot process our increased volume of claims  accurately and timely.                                                                                                                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                                                                      |
| · | Medicare and private third-party payer cost  containment efforts and reductions in reimbursement rates could reduce our  revenue and our cash flow.                                                                                                                                                                                                                       |
|   |                                                                                                                                                                                                                                                                                                                                                                      |
| · | Risk-sharing arrangements that our affiliated  physician organizations have with HMOs and hospitals could result in their  costs exceeding the corresponding revenues, which could reduce or eliminate  any shared risk profitability.                                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                                                                      |
| · | If we do not successfully integrate the operations  of acquired physician organizations into our service network, our costs could  increase, our business could be disrupted, and we may not be able to realize  the anticipated benefits from those acquisitions.                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                                                      |
| · | When we acquire operations that have historically  operated at a loss, we may not be able to reverse those losses and operate  those businesses at a profit, which could reduce our earnings.                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                                                                      |
| · | If we are unable to identify suitable acquisition  candidates or to negotiate or complete acquisitions on favorable terms, our  prospects for growth could be limited.                                                                                                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                                                                      |
| · | Any acquisitions we complete in the future could  potentially dilute the equity interests of our current stockholders or could  increase our indebtedness and cost of debt service, thereby reducing our net  income and profitability.                                                                                                                                   |
|   |                                                                                                                                                                                                                                                                                                                                                                      |
| · | We operate in a competitive market; increased  competition could adversely affect our revenues.                                                                                                                                                                                                                                                                           |
|   |                                                                                                                                                                                                                                                                                                                                                                      |
| · | Failure to comply with federal and state regulations  could result in substantial penalties and changes in business operations.                                                                                                                                                                                                                                           |
|   |                                                                                                                                                                                                                                                                                                                                                                      |
| · | Future reforms in health care legislation and  regulation could reduce our revenues and profitability.                                                                                                                                                                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                                                                      |
| · | Whenever we seek to acquire an IPA, an HMO that has  a contract with that IPA could potentially refuse to consent to the transfer  of its contract, and this could deter us from completing the acquisition or  could deprive us of the enrollees and revenues associated with that HMO  contract if we chose to complete the acquisition without the HMO’s consent. |
|   |                                                                                                                                                                                                                                                                                                                                                                      |
| · | Our profitability could be adversely affected by any  changes that would reduce payments to HMOs under government-sponsored health  care programs.                                                                                                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                                                      |
| · | Our revenues and profits could be diminished if we  lose the services of key physicians in our affiliated physician organizations.                                                                                                                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                                                      |
| · | Because our business is currently limited to the  Southern California area, any reduction in our revenues and profitability  from a local economic downturn would not be offset by operations in other  geographic areas.                                                                                                                                                 |

 

12

----

 
| · | We are required to upgrade and modify our management  information systems to accommodate growth in our business and changes in  technology and to satisfy new government regulations. As we seek to implement  these changes, we may experience complications, delays and increasing costs,  which could disrupt our business and reduce our profitability. |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                        |
| · | If we were to lose the services of Dr. Terner  or other key members of management, we might not be able to replace them in a  timely manner with qualified personnel, which could disrupt our business and  reduce our profitability and revenue growth.                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                                                        |
| · | We and our affiliated physician organizations may  become subject to claims of medical malpractice or HMO bad-faith liability  claims for which our insurance coverage may not be adequate. Such claims  could materially increase our costs and reduce our profitability.                                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                                        |
| · | Fluctuations in our quarterly operating results may  make it difficult to predict our future results of operations, which could  decrease the market value of our common stock.                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                                                        |
| · | The National Association of Securities Dealers  (NASD) has conducted an informal inquiry regarding trading in our common  stock. Both the inquiry and our response occurred in February 2004.We have  not received any subsequent communication from NASD on the matter.                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                                                        |
| · | If we are not able to develop or sustain an active  trading market for our common stock, it may be difficult for stockholders to  dispose of their common stock.                                                                                                                                                                                            |
|   |                                                                                                                                                                                                                                                                                                                                                        |
| · | Even if an active market develops for our common  stock, the market price of our stock is likely to be volatile.                                                                                                                                                                                                                                            |
|   |                                                                                                                                                                                                                                                                                                                                                        |
| · | If our common stock becomes subject to the SEC’s  penny stock rules, our stockholders may find it difficult to sell their  stock.                                                                                                                                                                                                                      |

 

Investors should also refer to our Form 10-K annualreport filed with the Securities and Exchange Commission on December 28, 2006for a discussion of risk factors. Given these risks and uncertainties, we cangive no assurances that any forward-looking statements will in fact occur andtherefore caution investors not to place undue reliance on them.

**Overview**

Prospect Medical Holdings, Inc. (we, or the “Company”)is a health care management services organization. We provide managementservices to affiliated physician organizations that operate as independentphysician associations (“IPAs”) or medical clinics.  Our affiliated physician organizations enterinto agreements with health maintenance organizations (“HMOs”) to provideenrollees of the HMOs with a full range of medical services in exchange forfixed, prepaid monthly fees known as “capitation” payments.

The IPAs contract with physicians (primary care andspecialist) and other health care providers to provide all of their medicalservices. The medical clinics employ their primary care physicians, which providethe vast majority of their medical services, while contracting with specialistphysicians and other health care providers to provide other required medicalservices.

Through our management subsidiaries – Prospect MedicalSystems, Sierra Medical Management and ProMed HealthCare Administrators, Inc. –we have entered into long-term agreements to provide management services toeach of our affiliated physician organizations in exchange for a managementfee. The management services we provide include HMO contracting, physicianrecruiting, credentialing and contracting, human resources services, claimsadministration, financial services, provider relations, patient eligibility andother services, medical management including utilization management and qualityassurance, data collection, and management information systems.

Our management subsidiaries currently providemanagement services to fifteen affiliated physician organizations, whichinclude Prospect Medical Group, eleven other affiliated physician organizationsthat Prospect Medical Group owns or controls, and one affiliated physicianorganization (AMVI/Prospect Health Network) that is an unconsolidated jointventure in which Prospect Medical Group owns a 50% interest.  We have utilized Prospect Medical Group,which was our first affiliated physician organization, to acquire the ownershipinterest in all of our other affiliated physician organizations.  Thus, while Prospect Medical Group is itselfan affiliated physician organization that does the same business in its ownservice area as all of our other affiliated physician organizations do intheirs, Prospect Medical Group also serves as a holding company for our otheraffiliated physician organizations.

13

----

The fifteen affiliated physician organizations providemedical services to a combined total of approximately 247,000 HMO enrollees atJune 30, 2007, including approximately 7,300 AMVI Prospect Health Network andAmviCare enrollees that we manage for the economic benefit of our partner inthis joint venture, and for which we earn management fee income.

Currently, our affiliated physician organizations havecontracts with approximately thirteen HMOs, from which our revenue is primarilyderived. HMOs offer a comprehensive health care benefits package in exchangefor a capitation fee per enrollee that does not vary through the contractperiod regardless of the quantity of medical services required or used. HMOsenroll members by entering into contracts with employer groups or directly withindividuals to provide a broad range of health care services for a prepaidcharge, with minimal deductibles or co-payments required of the members. All ofthe contracts between our affiliated physician organizations and the HMOsprovide for the provision of medical services by the affiliated physicianorganization to the HMO enrollees in consideration for the prepayment of thefixed monthly capitation fee per enrollee.

Our consolidated business has grown through theacquisition of IPAs by Prospect Medical Group. Our plan is for Prospect MedicalGroup to continue to acquire additional IPAs. We do not intend to furtheracquire any individual or small medical practices, clinics or medical grouppractices.

We have chosen to concentrate our growthgeographically by limiting our acquisitions to IPAs in Orange County,California Los Angeles County, California and San Bernardino County, California.

Operating revenue consists primarily of fees formedical services provided by our affiliated physician organizations undercapitated contracts with various HMOs or under fee-for-service arrangements.Capitation revenue under HMO contracts is prepaid monthly to the affiliatesbased on the number of enrollees electing any one of the affiliates as theirhealth care provider. Capitation revenue may be subsequently adjusted toreflect changes in enrollment as a result of retroactive terminations oradditions. These adjustments have not had a material effect on capitation revenueand net income. Capitation revenue is also subject to risk adjustments.Beginning in calendar 2004, Medicare began a four year phase-in of a revisedcapitation model referred to as “Risk Adjustment.” Under the new model,capitation with respect to Medicare enrollees is subject to subsequentadjustment for the acuity of the enrollees to whom services were provided.Capitation for the current year is paid based on data submitted for eachenrollee for the preceding year. Capitation is paid at interim rates during theyear and is adjusted in subsequent periods (generally in the fourth quarter)after the final data is compiled. Positive or negative capitation adjustmentsare made for seniors with conditions requiring more or less healthcare servicesthan assumed in the interim payments. Since we do not currently have theability to reliably predict these adjustments, periodic changes in capitationamounts earned as a result of Risk Adjustment are recognized when those changesare communicated from the health plans, generally in the fourth quarter of thefiscal year to which the adjustments relate. Management fees primarily compriseamounts earned from managing the operations of AMVI, Inc., which is our jointventure partner in the AMVI/Prospect Health Network joint venture. Managementservices have historically related only to MediCal members. However, startingin fiscal 2006, this was expanded to also include management services relatedto Medicare members enrolling in CalOPTIMA’s OneCare HMO, as well as managementservices provided to Brotman Medical Center, an equity investee in which wehold a 38% interest. OneCare is a Medicare Advantage Special Needs Planlaunched in August 2005 by CalOPTIMA to serve dually-eligible members in OrangeCounty who are entitled to Medicare benefits and are also MediCal eligible.Management fee revenue is earned in the month the services are delivered. Otherrevenues include incentive payments from HMOs under “pay-for-performance”programs for quality medical care based on various criteria. These incentivesare generally received in the third and fourth quarters of our fiscal year andare recorded when such amounts are known since we do not have the informationto reliably estimate these amounts. Risk pool and pay-for-performanceincentives are affected by many factors, some of which are beyond the Company’scontrol, and may vary significantly from year to year.

We also earn additional incentive revenue or incurpenalties under HMO contracts by sharing in the risk for hospitalization basedupon inpatient services utilized. These amounts are included in capitationrevenue. Except for two contracts where we are contractually obligated fordown-side risk, shared risk deficits are not payable until and unless wegenerate future risk sharing surpluses. Risk pools are generally settled in thefollowing year. Management estimates risk pool incentives based on estimatedhospital utilization and associated costs compared to budget and, if available,interim risk-pool settlements reported by health plans. These estimates areinherently uncertain and could differ significantly from actual results.Differences between actual and estimated settlements are recorded when thefinal outcome is known.

Revenues are comprised of the following amounts:

14

----

 
|                 | ** ** | **Three months ended June 30** | ** ** | **% of Increase** | ** ** | **Nine months ended June 30** | ** ** | **% of Increase** | ** ** |
|-----------------|------------|----------------------------------------------------|------------|-----------------------------|------------|---------------------------------------------------|------------|-----------------------------|------------|
| ** **      | ** ** | **2007**                                           | ** ** | **2006**                    | ** ** | **(Decrease)**                                    | ** ** | **2007**                    | ** ** | **2006** | ** ** | **(Decrease)** | ** ** |
| Capitation      |       | $                                                  | 39,083,312 |                        | $          | 33,170,653                                        |       | 18%                         |       | $ | 105,630,649 |   | $ | 99,442,631 |   | 6% |   |
| Fee for service |       | 583,717                                            |       | 472,181                     |       | 24%                                               |       | 1,483,596                   |       | 1,595,946 |   | (7)% |   |
| Management fees |       | 161,633                                            |       | 296,123                     |       | (45)%                                             |       | 618,802                     |       | 927,890 |   | (33)% |   |
| Other           |       | 923,200                                            |       | 879,063                     |       | 5%                                                |       | 1,173,799                   |       | 888,458 |   | 32% |   |
| Total           |       | $                                                  | 40,751,862 |                        | $          | 34,818,020                                        |       | 17%                         |       | $ | 108,906,846 |   | $ | 102,856,931 |   | 6% |   |

 

We have increased our membership through acquisitions.These increases through acquisition are offset by HMO enrollment declines atour affiliated physician organizations, similar to the general HMO enrollmenttrends in California in recent years. The following table sets forth theapproximate number of members, by category, as of June 30, 2007 and 2006.
|                       | ** ** | **As of June 30** | ** ** |
|-----------------------|------------|----------------------------------|------------|
| ** **            | ** ** | ** **                       | ** ** | ** ** | ** ** | **% of Increase** | ** ** |
| ** **            | ** ** | **2007**                         | ** ** | **2006** | ** ** | **(Decrease)** | ** ** |
| Commercial -  owned   |       | 199,900                          |       | 144,900 |   | 38% |   |
| Commercial -  managed |       | 1,300                            |       | 1,400 |   | (7)% |   |
| Senior - owned        |       | 23,600                           |       | 14,400 |   | 64% |   |
| Senior - managed      |       | 200                              |       | 300 |   | (33)% |   |
| MediCal - owned       |       | 15,900                           |       | 8,500 |   | 87% |   |
| MediCal -  managed    |       | 6,200                            |       | 5,800 |   | 7% |   |
| **Total**             |       | 247,100                          |       | 175,300 |   | 41% |   |

 

15

----

The following table details total paid member months,by member category, for the three-month and nine-month periods ended June 30,2007 and 2006:
| ** **            | ** ** | **Three months ended June 30** | ** ** | **% of Increase ** | ** ** | **Nine months ended June 30** | ** ** | **% of Increase ** | ** ** |
|-----------------------|------------|----------------------------------------------------|------------|-----------------------------------|------------|---------------------------------------------------|------------|-----------------------------------|------------|
| ** **            | ** ** | **2007**                                           | ** ** | **2006**                          | ** ** | **(Decrease)**                                    | ** ** | **2007**                          | ** ** | **2006** | ** ** | **(Decrease)** | ** ** |
| Commercial -  owned   |       | 466,200                                            |       | 438,100                           |       | 6%                                                |       | 1,301,500                         |       | 1,347,400 |   | (3)% |   |
| Commercial -  managed |       | 3,900                                              |       | 4,000                             |       | (3)%                                              |       | 11,700                            |       | 12,000 |   | (3)% |   |
| Senior - owned        |       | 50,900                                             |       | 42,400                            |       | 20%                                               |       | 134,700                           |       | 130,000 |   | 4% |   |
| Senior - managed      |       | 500                                                |       | 800                               |       | (38)%                                             |       | 1,400                             |       | 2,500 |   | (44)% |   |
| MediCal - owned       |       | 37,200                                             |       | 19,300                            |       | 93%                                               |       | 96,100                            |       | 51,200 |   | 88% |   |
| MediCal - managed     |       | 18,400                                             |       | 17,600                            |       | 5%                                                |       | 53,100                            |       | 53,200 |   | 0% |   |
|                  |       |                                               |       |                              |       |                                              |       |                              |       |   |   |   |   |
| Total                 |       | 577,100                                            |       | 522,200                           |       | 11%                                               |       | 1,598,500                         |       | 1,596,300 |   | 0% |   |

 

Our operating expenses include expenses related to theprovision of medical care services (cost of revenues) and  general and administrative, or G&A,costs. Our results of operations depend on our ability to effectively manageexpenses related to health benefits and accurately predict costs incurred.

Expenses related to medical care services includepayments to contracted primary care physicians, payments to contractedspecialists and the cost of employed physicians at the Company’s medicalclinics. In general, primary care physicians are paid on a capitation basis,while specialists are paid on either a capitation or a fee-for-service basis.

Capitation payments are fixed in advance of periodscovered and are not subject to significant accounting estimates. These paymentsare expensed in the period the providers are obligated to provide services.Fee-for-service payments are expensed in the period services are provided toour members. Medical care costs include actual historical claims experience andestimates of medical expenses incurred but not reported, or IBNR. Monthly, weestimate our IBNR based on a number of factors, including prior claimsexperience. As part of this review, we also consider estimates of amounts tocover uncertainties related to fluctuations in provider billing patterns,claims payment patterns, membership and medical cost trends. These estimatesare adjusted monthly as more information becomes available. In addition to ourown IBNR estimation process, we obtain semi-annual certifications of our IBNRliability from independent actuaries. We believe that our process forestimating IBNR is adequate, but there can be no assurance that medical carecosts will not exceed such estimates. In addition to contractual reimbursementsto providers, we also make discretionary incentive payments to physicians,which are in large part based on how much we receive from pay-for-performanceawards, shared risk revenues and favorable senior capitation risk adjustmentpayments. Since the Company records these revenues generally in the third orfourth quarter of each fiscal year, when the incentives and capitationadjustments due from the health plans are known, the Company also records thediscretionary physician bonuses in the same period. Since incentives and riskadjustment revenues form the basis for these discretionary bonuses, variabilityin earnings due to fluctuations in revenues are mitigated by reductions inbonuses awarded.

G&A costs are largely comprised of wage andbenefit costs related to our employee base and other administrative expenses.G&A functions include claims processing, information systems, providerrelations, finance and accounting services, and legal and regulatory services.

16

----

**Resultsof Operations**

The following table sets forth selected revenuecategories, cost of revenue categories and other income statement items for thethree month and nine month periods ended June 30, 2007 and 2006
| ** **                               | ** ** | **Three months ended June 30** | ** ** | **Nine months ended June 30** | ** ** |
|------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                               | ** ** | ** **                                         | ** ** | ** **                                        | ** ** | **% Increase** | ** ** | ** ** | ** ** | ** ** | ** ** | **% Increase** | ** ** |
| ** **                               | ** ** | **2007**                                           | ** ** | **2006**                                          | ** ** | **(Decrease)** | ** ** | **2007** | ** ** | **2006** | ** ** | **(Decrease)** | ** ** |
| **Revenues:**                            |       |                                               |       |                                              |       |   |   |   |   |   |   |   |   |
| Capitation Revenue                       |       | $                                                  | 39,083,312 |                                              | $          | 33,170,653 |   | 18% |   | $ | 105,630,649 |   | $ | 99,442,631 |   | 6% |   |
| Fee for Service Revenue                  |       | 583,717                                            |       | 472,181                                           |       | 24% |   | 1,483,596 |   | 1,595,946 |   | (7)% |   |
| Management Fees                          |       | 161,633                                            |       | 296,123                                           |       | (45)% |   | 618,802 |   | 927,890 |   | (33)% |   |
| Other Operating Revenue                  |       | 923,200                                            |       | 879,063                                           |       | 5% |   | 1,173,799 |   | 888,458 |   | 32% |   |
| **Total  Revenues**                      |       | 40,751,862                                         |       | 34,818,020                                        |       | 17.0% |   | 108,906,846 |   | 102,854,925 |   | 5.9% |   |
| **Cost of  Revenues:**                   | ** ** | ** **                                         | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| PCP Capitation                           |       | 7,325,466                                          |       | 5,803,349                                         |       | 26% |   | 19,192,118 |   | 17,571,823 |   | 9% |   |
| Specialists Capitation                   |       | 6,755,981                                          |       | 5,251,308                                         |       | 29% |   | 16,885,476 |   | 15,930,505 |   | 6% |   |
| Claims expense                           |       | 16,685,777                                         |       | 13,045,513                                        |       | 28% |   | 45,067,178 |   | 37,191,218 |   | 21% |   |
| Physician salaries                       |       | 705,344                                            |       | 1,196,248                                         |       | (41)% |   | 2,075,650 |   | 2,504,511 |   | (17)% |   |
| Other cost of revenues                   |       | 418,348                                            |       | 111,637                                           |       | 275% |   | 876,876 |   | 659,877 |   | 33% |   |
| Total cost of revenues                   |       | 31,890,916                                         |       | 25,408,055                                        |       | 26% |   | 84,097,298 |   | 73,857,934 |   | 14% |   |
|                                     |       |                                               |       |                                              |       |   |   |   |   |   |   |   |   |
| Gross margin                             |       | 8,860,946                                          |       | 9,409,965                                         |       | (6)% |   | 24,809,548 |   | 28,996,991 |   | (14)% |   |
|                                     |       |                                               |       |                                              |       |   |   |   |   |   |   |   |   |
| General and administrative expenses      |       | 8,566,868                                          |       | 7,286,083                                         |       | 18% |   | 25,725,366 |   | 22,878,291 |   | 12% |   |
| Depreciation and amortization expense    |       | 616,393                                            |       | 338,140                                           |       | 82% |   | 1,399,419 |   | 995,729 |   | 41% |   |
| Total operating expenses                 |       | 9,183,261                                          |       | 7,624,223                                         |       | 20% |   | 27,124,785 |   | 23,874,020 |   | 14% |   |
|                                     |       |                                               |       |                                              |       |   |   |   |   |   |   |   |   |
| Income from unconsolidated joint venture |       | 1,551,088                                          |       | 321,125                                           |       | 383% |   | 2,314,666 |   | 998,019 |   | 132% |   |
| Operating Income                         |       | 1,228,773                                          |       | 2,106,867                                         |       | (42)% |   | (571 | ) | 6,120,990 |   | (100)% |   |
| Other (income) expense, net              |       | 307,428                                            |       | 50,295                                            |       | 511% |   | 345,145 |   | 156,847 |   | 120% |   |
| Income (loss) before income taxes        |       | 921,345                                            |       | 2,056,572                                         |       | (55)% |   | (345,716 | ) | 5,964,143 |   | (106)% |   |
| Provision (benefit) for income taxes     |       | 382,165                                            |       | 743,949                                           |       | (48)% |   | (129,173 | ) | 2,313,524 |   | (106)% |   |
| Minority interest                        |       | 5,210                                              |       | 8,632                                             |       | (40)% |   | 7,082 |   | 14,616 |   | (52)% |   |
| Net income (loss)                        |       | $                                                  | 533,970    |                                              | $          | 1,303,991 |   | (59)% |   | $ | (223,626 | ) | $ | 3,636,003 |   | (106)% |   |

                                                

17

----

The following table sets forth selected operatingitems, expressed as a percentage of total revenue:
| ** **                               | ** ** | **Three months ended June 30** | ** ** | **Nine months ended June 30** | ** ** |
|------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                               | ** ** | **2007**                                           | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
| **Revenues:**                            |       |                                               |       |                                              |       |   |   |   |   |
| Capitation Revenue                       |       | 95.9                                               | %          | 95.3                                              | %          | 97.0 | % | 96.7 | % |
| Fee for Service Revenue                  |       | 1.4                                                | %          | 1.4                                               | %          | 1.4 | % | 1.5 | % |
| Management Fees                          |       | 0.4                                                | %          | 0.8                                               | %          | 0.6 | % | 0.9 | % |
| Other Operating Revenue                  |       | 2.3                                                | %          | 2.5                                               | %          | 1.1 | % | 0.9 | % |
| **Total  Revenues**                      |       | 100.0                                              | %          | 100.0                                             | %          | 100.0 | % | 100.0 | % |
| **Cost of  Revenues:**                   | ** ** | ** **                                         | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| PCP Capitation                           |       | 18.0                                               | %          | 16.7                                              | %          | 17.6 | % | 17.1 | % |
| Specialists Capitation                   |       | 16.6                                               | %          | 15.1                                              | %          | 15.5 | % | 15.5 | % |
| Claims expense                           |       | 40.9                                               | %          | 37.4                                              | %          | 41.4 | % | 36.2 | % |
| Physician salaries                       |       | 1.7                                                | %          | 3.5                                               | %          | 1.9 | % | 2.4 | % |
| Other cost of revenues                   |       | 1.0                                                | %          | 0.3                                               | %          | 0.8 | % | 0.6 | % |
| Total cost of revenues                   |       | 78.2                                               | %          | 73.0                                              | %          | 77.2 | % | 71.8 | % |
|                                     |       |                                               |       |                                              |       |   |   |   |   |
| Gross margin                             |       | 21.8                                               | %          | 27.0                                              | %          | 22.8 | % | 28.2 | % |
|                                     |       |                                               |       |                                              |       |   |   |   |   |
| General and administrative expenses      |       | 21.0                                               | %          | 20.9                                              | %          | 23.6 | % | 22.2 | % |
| Depreciation and amortization expense    |       | 1.5                                                | %          | 1.0                                               | %          | 1.3 | % | 1.0 | % |
| Total operating expenses                 |       | 22.5                                               | %          | 21.9                                              | %          | 24.9 | % | 23.2 | % |
|                                     |       |                                               |       |                                              |       |   |   |   |   |
| Income from unconsolidated joint venture |       | 3.8                                                | %          | 0.9                                               | %          | 2.1 | % | 0.9 | % |
|                                     |       |                                               |       |                                              |       |   |   |   |   |
| Operating Income                         |       | 3.1                                                | %          | 6.0                                               | %          | 0.0 | % | 5.9 | % |
|                                     |       |                                               |       |                                              |       |   |   |   |   |
| Other (income) expense, net              |       | 0.8                                                | %          | 0.1                                               | %          | 0.3 | % | 0.2 | % |
|                                     |       |                                               |       |                                              |       |   |   |   |   |
| Income (loss) before income taxes        |       | 2.3                                                | %          | 5.9                                               | %          | (0.3 | )% | 5.7 | % |
|                                     |       |                                               |       |                                              |       |   |   |   |   |
| Provision (benefit) for income taxes     |       | 1.0                                                | %          | 2.1                                               | %          | (0.1 | )% | 2.2 | % |
|                                     |       |                                               |       |                                              |       |   |   |   |   |
| Minority interest                        |       | 0.0                                                | %          | 0.0                                               | %          | 0.0 | % | 0.0 | % |
|                                     |       |                                               |       |                                              |       |   |   |   |   |
| Net income (loss)                        |       | 1.3                                                | %          | 3.8                                               | %          | (0.2 | )% | 3.5 | % |

 

18

----

**ThreeMonths Ended June 30, 2007 Compared to Three Months Ended June 30, 2006**

*CapitationRevenue*

Capitation revenue for the three months ended June 30,2007 was $39,083,312, representing an increase of $5,912,659 (17.8%) fromcapitation revenue for the three months ended June 30, 2006, of $33,170,653.

Effective January 1, 2007, the MediCal and HealthFamily enrollees under the CalOptima contract were reassigned from theAVMI/Prospect Joint Venture directly to Prospect Medical Group. As a result,revenues and service costs related to these enrollees, which were previouslyincluded in income from unconsolidated joint venture, are reported ascapitation revenue and medical costs, respectively, beginning in the second quarterof fiscal 2007. This change in reporting accounted for $1,042,733 of theincrease in capitation revenue in the 2007 quarter as compared to the priorperiod. Excluding this reporting change, capitation revenue increased $4,869,926or 14.7% compared to the 2006 period.

The decrease is comprised of four main factors. Weestimate that higher capitation rates on our core business contributedapproximately $1,350,000 in increased capitation revenue during the 2007 periodas compared to the 2006 period. We estimate that enrollment declines related toour core business reduced capitation revenue by approximately $1,860,000 duringthe 2007 period, as compared to the 2006 period.  Acquisitions of ProMed contributed $7,540,000in additional capitation revenue in the 2007 period.  We estimate that lower hospital risk poolrevenue, primarily the result of the sale of certain of our key hospitalpartners in the 2007 period, contributed approximately $1,328,000 in decreasedcapitation revenue.

*Feefor service revenue*

Fee for service revenue for the three months endedJune 30, 2007 was $583,717 representing a increase of $111,536 (23.6%) from feefor service revenue for the three months ended June 30, 2006, of $472,181.

The increase in fee for service revenue during the2007 period was primarily due to fluctuations in patient visits at our ownedclinics.

*Managementfee revenue*

Management fee revenue for the three months ended June30, 2007 was $161,633, representing a decrease of $134,490 (45.4%) frommanagement fee revenue for the three months ended June 30, 2006, of $296,123.

The decrease in management fee revenue during the 2007period was primarily the result of the termination of a portion of our jointventure management contract related to CalOptima MediCal and Healthy Familyenrollees and a decrease in the management fee with Brotman Medical.

*Otherrevenue*

Other revenue for the three months ended June 30, 2007was $923,200, representing an increase of $44,137 (5.0%) over other revenue forthe three months ended June 30, 2006, of $879,063.

The increase in other revenue during the 2007 periodwas primarily the result of timing of pay for performance incentives from oneof our contracted Health Plans. Acquisitions contributed $16,175 of this increase.

*PCPCapitation Expense*

Primary care physician (PCP) capitation expense forthe three months ended June 30, 2007 was $7,325,466, representing an increaseof $1,522,117 (26.2%) over PCP capitation expense for the three months ended June30, 2006, of $5,803,349.

We estimate that higher capitation rates increased PCPcapitation expense by approximately $320,000 during the 2007 period as comparedto the 2006 period. We estimate that enrollment declines reduced PCP capitationexpense by approximately $150,000 during the 2007 period, as compared to the2006 period.  Acquisitions of ProMed inJune 2007 increased PCP capitation by $1,340,000 as compare to none in the 2006period.

19

----

*SpecialistCapitation Expense*

Specialist Capitation expense for the three monthsended June 30, 2007 was $6,755,981, representing an increase of $1,504,673(28.7%) from specialist capitation expense for the three months ended June 30,2006, of $5,251,308.

We estimate that higher capitation rates, combinedwith some specialties moving to fee for service, reduced specialist capitationexpense by approximately $360,000 during the 2007 period as compared to the2006 period. We estimate that enrollment declines reduced specialist capitationexpense by approximately $130,000 during the 2007 period, as compared to the2006 period. .  Acquisitions increasedspecialist capitation by $2,000,000 as compare to none in the 2006 period.

*ClaimsExpense*

Claims expense for the three months ended June 30,2007 was $16,685,777, representing an increase of $3,640,264 (27.9%) overclaims expense for the three months ended June 30, 2006, of $13,045,513.

We estimate that higher claims per member rates,including the result of moving some specialties from capitation to fee forservice, increased claims expense by approximately $1,470,000 during the 2007period as compared to the 2006 period. We estimate that enrollment declinesreduced claims expense by approximately $320,000 during the 2007 period, ascompared to the 2006 period.  Acquisitionsof ProMed in June 2007 increased claims expense by $2,490,000 as compare tonone in the 2006 period.

*PhysicianSalaries Expense*

Physician salaries expense for the three months endedJune 30, 2007 was $705,344, representing a decrease of $490,904 (41.0%) fromphysician salaries expense for the three months ended June 30, 2006, of$1,196,248.

The decrease in physician salaries expense during the2007 period was primarily the result of lower bonus accruals than in the 2006period.

*OtherCost of Revenue*

Other cost of revenue for the three months ended June30, 2007 was $418,348, representing an increase of $306,711 (274.7%) from othercost of revenue for the three months ended June 30, 2006, of $111,637.

The increase in other cost of revenue during the 2007period was the result of an increase in the level of certain pharmacy andinjectibles being paid as contracted. a decrease in stop loss recoveries andthe higher cost  of professional liabilityinsurance.  Acquisitions increased othercost of revenues by $176,000 in the 2007 period.

*GrossMargin*

Medical care costs as a percentage of medical revenues(the medical care ratio) largely determines our gross margin. Our gross margindecreased 5.3%, to 21.7% for the three months ended June 30, 2007, from 27.0%for the three months ended June 30, 2006.

The decrease in our gross margin percentage betweenthe 2006 and 2007 periods was primarily the result of the increase in claimsexpense, specialist capitation, and PCP capitation expense as a percent ofrevenue by 6.3% compared to the same period in 2006.  This was offset by a decrease in physiciansbonuses.

*Generaland Administrative Expenses*

General and administrative expenses were $8,566,868for the 2007 period, representing 21.0% of total revenues, as compared with$7,286,083, or 20.9% of total revenues, for the 2006 period.

The increase in general and administrative expensesduring the 2007 period was primarily the result of increased personnel andpersonnel related costs and outside services. This is due to the addition and upgrading of several key positions,staffing for Medicare Risk Score initiatives and hospital cost controlinitiatives, and higher levels of transaction and legal expenses in the currentperiod. The acquisition of ProMed added $490,000 to general and administrationexpenses during the period which represented 6.5% of the revenue that was addedby the acquisition.

20

----

*Depreciationand Amortization*

Depreciation and amortization expense for the threemonths ended June 30, 2007 increased to $616,393 from $338,140 for the sameperiod of the prior year. The increase of $278,253 was primarily due to theamortization of identifiable intangible assets related to the ProMed andGenesis acquisitions, as well as additional depreciation expense for increasedcapital expenditures.

*Incomefrom Unconsolidated Joint Venture*

The income from unconsolidated joint venture for thethree months ended June 30, 2007 increased to $1,551,088 from $321,125 for thesame period of the prior year.  Theincrease is due to the participation in the OneCare program effective January1, 2006, whereby some of the Medicare beneficiaries joining CalOptima’s One Careprogram were assigned to AMVI/Prospect. Effective January 1, 2007, OneCare removed certain minimum healthcarespending requirements, improving the profitability of the program.  Also, on January 1, 2007, the MediCal andHealthy Families members that we have with CalOptima were reassigned directlyto Prospect Medical Group instead of the joint venture, leaving only the OneCare program in AMVI/Prospect. Revenues and service costs related to thereassigned members are included in capitation revenue and medical costsbeginning January 1, 2007, rather than as income from the joint venture.

*Other expense net*

Other expense, net for the three months ended June 30,2007 increased to a net expense of $307,428 from $50,295 for the same period ofthe prior year. The increase in net interest expense during the 2007 period wasprimarily due to a prepayment penalty on the payoff of the RFC term loan andthe increased interest expense under the new $48 million term loan with Bank ofAmerica in connection with the ProMed acquisition of June 1, 2007.

*Provision for Income Taxes*

We reported income tax expense of $743,949 in the 2006period compared to $382,165 in the 2007 period. The effective tax rate is 41%for 2007 period and 36%for the 2006 period.

**NineMonths Ended June 30, 2007 Compared to Nine Months Ended June 30, 2006**

*CapitationRevenue*

Capitation revenue for the nine months ended June 30,2007 was $105,630,649, representing an increase of $6,188,018 (6.2%) fromcapitation revenue for the nine months ended June 30, 2006, of $99,442,631.

Effective January 1, 2007, the MediCal and HealthFamily enrollees under the CalOptima contract were reassigned from theAVMI/Prospect Joint Venture directly to Prospect Medical Group. As a result,revenues and service costs related to these enrollees, which were previouslyincluded in income from unconsolidated joint venture, are reported ascapitation revenue and medical costs, respectively, beginning in the secondquarter of fiscal 2007. This change in reporting accounted for $2,235,298 of theincrease in capitation revenue in the 2007 period as compared to the prior yearperiod. Excluding this reporting change, capitation revenue increased$3,957,020 or 4.0% compared to the 2006 period.

We estimate that higher capitation rates on our corebusiness, exclusive of acquisitions, contributed approximately $2,750,000 inincreased capitation revenue during the 2007 period as compared to the 2006period. We estimate that enrollment declines related to our core businessreduced capitation revenue by approximately $6,450,000 during the 2007 period,as compared to the 2006 period.  Weestimate that lower hospital risk pool revenue, primarily the result of thesale of certain of our key hospital partners in the 2007 period, contributedapproximately $890,000 in decreased capitation revenue. The June 2007acquisition or ProMed and the November 2005 acquisition of Genesis increasedcapitation revenue approximately $8,550,000 in the 2007 period as compared tothe 2006 period.

*Feefor service revenue*

Fee for service revenue for the nine months ended June30, 2007 was $1,483,596 representing a decrease of $112,350 (7.0%) from fee forservice revenue for the nine months ended June 30, 2006, of $1,595,946.

The decrease in fee for service revenue during the2007 period was primarily due to fluctuations in patient visits at our ownedclinics.

*Managementfee revenue*

Management fee revenue for the nine months ended June30, 2007 was $618,802, representing a decrease of 

21

----

$309,088 (33.3%) from management fee revenue for thenine months ended June 30, 2006, of $927,890.

The decrease in management fee revenue during the 2007period was primarily the result of the termination of a portion of our jointventure management contract related to the CalOptima MediCal and Healthy Familymembers and a decrease in the management fee with Brotman Medical.

*Otherrevenue*

Other revenue for the nine months ended June 30, 2007was $1,173,799, representing an increase of $285,342 (32.1%) over other revenuefor the nine months ended June 30, 2006, of $888,458.

The increase in other revenue during the 2007 periodwas primarily the result of timing of pay for performance and other incentivesfrom our contracted Health Plans.

*PCPCapitation Expense*

Primary care physician (PCP) capitation expense forthe nine months ended June 30, 2007 was $19,192,118, representing an increaseof $1,620,295 (9.2%) over PCP capitation expense for the nine months ended June30, 2006, of $17,571,823.

We estimate that net membership growth from the June1, 2007 acquisition of ProMed and the November 1, 2005 acquisition of Genesiscontributed approximately $1,570,000 in increased PCP capitation expense duringthe 2007 period, as compared to the 2006 period.  We estimate that higher capitation ratesincreased PCP capitation expense by approximately $810,000 during the 2007period, as compared to the 2006 period. We estimate that enrollment declinesreduced PCP capitation expense by approximately $760,000 during the 2007period, as compared to the 2006 period.

*SpecialistCapitation Expense*

Specialist capitation expense for the nine monthsended June 30, 2007 was $16,885,476, representing an increase of $954,971(6.0%) from specialist capitation expense for the nine months ended June 30,2006, of $15,930,505.

We estimate that net membership growth from the June1, 2007 acquisition of ProMed and the November 1, 2005 acquisition of Genesiscontributed approximately $2,120,000 in increased specialist capitation expenseduring the 2007 period, as compared to the 2006 period.   We estimate that enrollment declines reducedspecialist capitation expense by approximately $690,000 during the 2007 period,as compared to the 2006 period.  Weestimate that the combined impact of higher capitation rates, offset by anincrease in specialty costs being paid for on a fee-for-service basis loweredspecialist capitation expense by approximately $480,000 during the 2007 period,as compared to the 2006 period.

*ClaimsExpense*

Claims expense for the nine months ended June 30, 2007was $45,067,178, representing an increase of $7,875,960 (21.2%) over claimsexpense for the nine months ended June 30, 2006, of $37,191,218.

We estimate that net membership growth from the June1, 2007 acquisition of ProMed and the November 1, 2005 acquisition of Genesiscontributed approximately $2,810,000 in increased claims expense during the2007 period, as compared to the 2006 period. We estimate that higher claims per member rates, in part the result ofmoving some specialties from capitation to fee for service, increased claimsexpense by approximately $6,670,000 during the 2007 period as compared to the2006 period. We estimate that enrollment declines reduced claims expense byapproximately $1,600,000 during the 2007 period, as compared to the 2006 period

*PhysicianSalaries Expense*

Physician salaries expense for the nine months endedJune 30, 2007 was $2,075,650, representing a decrease of $428,861 (17.1%) overphysician salaries expense for the nine months ended June 30, 2006, of$2,504,511.

The decrease in physician salaries expense during the2007 period was primarily the result of lower bonus accruals than in the 2006period.

*OtherCost of Revenue*

Other cost of revenue for the nine months ended June30, 2007 was $876,876, representing an increase of $216,999

22

----

(32.9%) over other cost of revenue for the nine monthsended June 30, 2006, of $659,877.

The June 1, 2007 acquisition of ProMed and theNovember 1, 2005 acquisition of Genesis contributed approximately $210,000 inincreased other cost of revenues during the 2007 period, as compared to the2006 period.

*GrossMargin*

Medical care costs as a percentage of medical revenues(the medical care ratio) largely determine our gross margin. Our gross margindecreased 5.4%, to 22.8% for the nine months ended June 30, 2007, from 28.2%for the nine months ended June 30, 2006.

The decrease in our gross margin percentage betweenthe 2006 and 2007 periods was primarily the result of the increase in claimsexpense, partially offset by the decrease in specialist capitation andphysicians salaries as a percent of revenue as compared to the same period in2006.

*Generaland Administrative Expenses*

General and administrative expenses were $25,725,366for the 2007 period, representing 23.6% of total revenues, as compared with$22,878,291, or 22.2% of total revenues, for the 2006 period.

The increase in general and administrative expensesduring the 2007 period was primarily the result of increased personnel andpersonnel related costs and outside services. This is due to the addition and upgrading of several key positions,staffing for Medicare Risk Score initiatives and hospital cost controlinitiatives, staffing for management of the Genesis operation which was broughtin house in October, 2006.  Offsettingthis increase in general and administrative expense, the acquisition ofProMed  added $490,000 to general andadministration expenses during the period which represented 6.5% of the revenueadded by the acquisition.

*Depreciationand Amortization*

Depreciation and amortization expense for the ninemonths ended June 30, 2007 increased to $1,399,419 from $995,729 for the sameperiod of the prior year. The increase of $403,690 was primarily due to theamortization of identifiable intangible assets related to the ProMed and theGenesis acquisitions, as well as additional depreciation expense for increasedcapital expenditures.

*Income From Unconsolidated Joint Venture*

The income from unconsolidated joint venture for thenine months ended June 30, 2007 increased to $2,314,666 from $998,019 for thesame period of the prior year.  Theincrease is due to the participation in the OneCare program effective January1, 2006, whereby some of the Medicare beneficiaries joining CalOptima’s OneCare program were assigned to AMVI/Prospect. Effective January 1, 2007, OneCare removed certain minimum healthcarespending requirements improving the profitability of the program.  Also, on January 1, 2007, the medical andhealthy families members that we have with CalOptima were reassigned directlyto Prospect Medical Group instead of the joint venture, leaving only theOneCare program in AMVI/Prospect. Revenues and service costs related to thereassigned members are included in capitation revenues and medical costsbeginning in the second quarter of 2007 rather than as income from the jointventure.

*Otherexpense net*

Other expense, net for the nine months ended June 30,2007 increased to a net expense of $345,145 from $156,847 for the same periodof the prior year.  The increase in netinterest expense during the 2007 period was primarily due to a prepaymentpenalty on the payoff of the RFC term loan and the increased interest expense underthe new $48 million term loan with Bank of America in connection with theacquisition of ProMed on June 1, 2007.

*Provisionfor Income Taxes*

We reported income tax expense of $ 2,313,524 in the2006 period to a tax benefit of $129,173 in the 2007 period. The effective taxrate is 37% for the 2007 and  39% for the2006 period.

23

----

**Liquidityand Capital Resources**

We generate cash from capitation revenue, healthcareservices provided on a fee-for-service basis at our clinics, management feerevenue and investment income. Our primary uses of cash include the payment ofexpenses related to medical care services and general and administrativeexpenses. We generally receive capitation revenue in advance of payment ofcapitation expenses and claims for related health care services.

Our investment policies are designed to preserveprincipal, maintain liquidity for operations and statutory requirements, andmaximize investment return. As of June 30, 2007 we invested a substantialportion of our cash in a high yield money market account  and overnight money market funds. All ofthese amounts are classified as current assets and included in cash and cashequivalents in the accompanying balance sheets. We are also required by some ofour HMO contracts to set aside certain amounts in restricted certificates ofdeposit to secure our ability to pay medical claims. These restrictedcertificates of deposit, with an average maturity of approximately 90 days asof June 30, 2007, are included in current investments in the accompanyingfinancial statements as they are restricted for payment of current liabilities.

Net cash provided by operations was $1,220,282 and$1,232,099 for the nine months ended June 30, 2007  and 2006, respectively.  The decrease in net cash provided byoperations for the nine months ended June 30, 2007 when compared to the ninemonths ended June 30, 2007 was due to the following factors:

·    netloss of $223,626 compared to net income of $3,636,003;

·    changes in risk pool receivables, a sourceof $244,357 in the nine months ended June 30, 2007 compared to a use of $735,120in the nine months ended June 30, 2006; primarily as a result of the lower riskpool revenue in the 2007 period;

·    changes in other accounts receivablebalances, a use of $833,645 in the nine months ended June 30, 2007 compared toa source of $1,045,836 in the nine months ended June 30, 2006;

·    changes in prepaid expenses and other, a useof $217,821  in the nine months endedJune 30, 2007 compared to a source of $42,254 in the nine months ended June 30,2006;

·    changes in deposits and other assets, a useof $393,572 in the nine months ended June 30, 2007 compared to a use of $52,194in the nine months ended June 30, 2006;

·    changes in refundable income tax, a sourceof $679,114 for the nine months ended June 30, 2007 compared to a use of$2,643,588 for the nine months ended June 30, 2006. The 2006 use was primarilydue to receivables generated through estimated tax overpayment and deductionsfrom stock option exercises which were applied to reduce tax payments in 2007;

·    changes in medical claims liabilities, asource of $2,914,990 in the nine months ended June 30, 2007 compared to a useof $1,212,191 in the nine months ended June 30, 2006 primarily the result ofhigher claims expense trends in the current period which are reflected in themedical claims liability.

·    changes in accounts payable and otheraccrued liabilities, a use of $3,139,853 in the nine months ended June 30, 2007compared to a source of $343,152 in the nine months ended June 30, 2006primarily as a result of physician bonus payments during the 2007 period andreduction in net advances from the AVMI/Prospect Joint Venture due to transferof enrollees in the MediCal and Healthy Family programs to Prospect MedicalGroup effective January 1, 2007.

Net cash used in investing activities was $37,788,288for the nine months ended June 30, 2007 and $6,727,626 for the nine monthsended June 30, 2006. The 2006 period included $6,596,080 in cash paid for theNovember 2005 Genesis acquisition. $4,000,000 of the purchase price wasfinanced through borrowings. Investing activities also included purchases offixed assets, a use of $693,312 in the nine months ended June 30, 2007 comparedto a use of $466,833 in the nine months ended June 30, 2006. Investingactivities also included capitalized expenses related to potential and actualacquisitions, a use of $1,178,419 in the nine months ended June 30, 2007compared to none in the nine months ended June 30, 2006.  The 2007 period includes $36,137,282 in cashpaid for the June 2007 ProMed acquisition. The acquisition was financed through $48 million in additionalborrowings and issuance of stock valued at $6,960,000.

24

----

Net cash provided by financing activities was $36,868,936 and  $3,421,814 for the nine months ended June 30,2007 and 2006 respectively. The increase in net cash provided by financingactivities was due to the following factors:

·    proceeds from $48,000,000 in term loans inthe nine months ended June 30, 2007 of which $36,137,282 was used to financethe June 2007 ProMed acquisition compared to $6,000,000 in borrowings of which$4,000,000 was to finance the November 2005 Genesis acquisition in the ninemonths ended June 30, 2006;

·    $12,500,000 in repayments of line of creditand term loans, during the nine months ended June 30, 2007, compared to$3,966,667 in the nine months ended June 30, 2006;

·    $2,041,385 in proceeds from common stockissuances related to stock option and warrant exercises during the nine monthsended June 30, 2007, compared to $929,140 in the nine months ended June 30,2006;

·    tax benefit from options exercised, a sourceof $318,465 in the nine months ended June 30, 2007 compared to $459,341 in thenine months ended June 30, 2006.

At June 30, 2007, we had negative working capital of$2,516,014 as compared to negative working capital of $123,898 at June 30,2006. At June 30, 2007 and June 30, 2006, cash and cash equivalents were$16,924,337 and $16,623,407, respectively.

The reduction in working capital in 2007 is primarilydue to the increase in the current portion of the outstanding term loan and anincrease in the claims expense which is reflected in the medical claimsliability.

Our subsidiaries are required to maintain minimumcapital prescribed by various HMOs with whom we contract. As of June 30, 2007,all of our subsidiaries were in compliance with the minimum capitalrequirements. Barring any change in regulatory requirements, we believe that wewill continue to be in compliance with these requirements at least through theend of fiscal 2007. We also believe that our cash resources and internallygenerated funds will be sufficient to support our operations, regulatoryrequirements, debt service, and capital expenditures for at least the next 12months.

**Contractual Obligations**

When we prepare our consolidated financial statements,we use estimates and assumptions that may affect reported amounts anddisclosures. The determination of our liability for medical claims and otherhealth care costs payable is particularly important to the determination of ourfinancial position and results of operations and requires the application ofsignificant judgment by our management and, as a result, is subject to aninherent degree of uncertainty.

Our medical care costs include actual historicalclaims experience and estimates for medical care costs incurred but notreported to us (“IBNR”). We, together with our independent actuaries, estimatemedical claims liabilities using actuarial methods based upon historical dataadjusted for payment patterns, cost trends, product mix, utilization of healthcare services and other relevant factors. The estimation methods and theresulting reserves are frequently reviewed and updated, and adjustments, ifnecessary, are reflected in the period known. While we believe our estimatesare adequate, it is possible that future events could require us to makesignificant adjustments or revisions to these estimates. In assessing theadequacy of accruals for medical claims liabilities, we consider our historicalexperience, the terms of existing contracts, our knowledge of trends in theindustry, information provided by our customers and information available fromother sources as appropriate.

The most significant estimates involved in determiningour claims liability concern the determination of claims payment completionfactors and trended per member per month cost estimates.

We consider historicalactivity for the current month, plus the prior 24 months, in our IBNRcalculation. For the months of service five months prior to the reporting dateand earlier, we estimate our outstanding claims liability based upon actualclaims paid, adjusted for estimated completion factors. Completion factors seekto measure the cumulative percentage of claims expense that will have been paidfor a given month of service as of a date subsequent to that month of service.Completion factors are based upon historical payment patterns. For the fourmonths of service immediately prior to the reporting date, actual claims paidare not a reliable measure of our ultimate liability, given the delay inherentbetween the patient/physician encounter and the actual submission of a claimfor payment. For these months of service we estimate our claims liability basedupon trended per member per month (“PMPM”) cost estimates. These estimatesreflect recent trends in payments and expense, utilization patterns, authorizedservices and other relevant factors. The following tables reflect (i) thechange in our estimate of claims liability as of June 30, 2007 that would haveresulted had we changed our completion factors for all applicable months ofservice included in our IBNR calculation (i.e., the preceding 5th through 25th months) by the 

25

----

percentages indicated; and (ii) the change in ourestimate of claims liability as of June 30, 2007 that would have resulted hadwe changed trended PMPM factors for all applicable months of service includedin our IBNR calculation (i.e., the preceding 1st through 4th months) by thepercentages indicated. Changes in estimate of the magnitude indicated in theranges presented are considered reasonably likely.

26

----

 
| Increase (Decrease) in  Estimated  Completion Factors | ** ** | **ncrease (Decrease) in  Accrued **Medical  Claims Payable | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------------------------------------------|------------|
| (3)%                                                            |       | $                                                                              | 4,857,000  |   |
| (2)%                                                            |       | $                                                                              | 3,238,000  |   |
| (1)%                                                            |       | $                                                                              | 1,619,000  |   |
| 1%                                                              |       | $                                                                              | (1,619,000 | ) |
| 2%                                                              |       | $                                                                              | (3,238,000 | ) |
| 3%                                                              |       | $                                                                              | (4,857,000 | ) |

 
| Increase (Decrease) in Trended PMPM Factors | ** ** | **Increase (Decrease) in Accrued Medical  Claims Payable** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------------------------------------------------|------------|
| (3)%                                                                 |       | $                                                                              | (1,011,000 | ) |
| (2)%                                                                 |       | $                                                                              | (674,000   | ) |
| (1)%                                                                 |       | $                                                                              | (337,000   | ) |
| 1%                                                                   |       | $                                                                              | 337,000    |   |
| 2%                                                                   |       | $                                                                              | 674,000    |   |
| 3%                                                                   |       | $                                                                              | 1,011,000  |   |

 

Additionally, for each 1% difference between our June30, 2007 estimated claims liability (of $20,628,526) and the actual claimsincurred run-out, pre-tax income for the three and nine months ended June 30,2007 would increase or decrease by approximately $206,000.

The following table shows the components of the changein medical claims and benefits payable for the nine months ended June 30, 2007and 2006:
|                                                         | ** ** | **2007**    | ** ** | **2006**    | ** ** |
|---------------------------------------------------------|------------|-------------|------------|-------------|------------|
| IBNR as of  beginning of year                           |       | $           | 11,400,000 |        | $          | 11,532,328 |   |
| Health care  claim expenses incurred during the period: |       |        |       |        |       |
| Related to current year                                 |       | 45,496,461  |       | 37,953,115  |       |
| Related to prior year                                   |       | (429,283    | )          | (761,897    | )          |
| Total incurred                                          |       | 45,067,178  |       | 37,191,218  |       |
| Health care  claims paid during the period:             |       |        |       |        |       |
| Related to current year                                 |       | (31,616,669 | )          | (27,336,714 | )          |
| Related to prior year                                   |       | (10,535,519 | )          | (11,066,695 | )          |
| Total paid                                              |       | (42,152,188 | )          | (38,403,409 | )          |
| IBNR acquired  during the period                        |       | 6,313,536   |       | 997,863     |       |
| IBNR as of end of year                                  |       | $           | 20,628,526 |        | $          | 11,318,000 |   |

 

Bracketedamounts reported in the table above for the incurred related to prior periodsresult from claims being ultimately settled for amounts less than originallyestimated (a favorable development).  Apositive amount reported for incurred related to prior periods would resultfrom claims ultimately being settled for amounts greater than originallyestimated (an unfavorable development).

27

----

Through June 30, 2007, the $429,283 changes inestimate related to IBNR as of September 30, 2006 represented approximately 4%of the IBNR balance as of September 30, 2006, approximately 1% of claimsexpense and, after consideration of tax affect, approximately 89% of net incomefor the year then ended. Through June 30, 2006, the $761,897 changes inestimate related to IBNR as of September 30, 2005 representedapproximately 7% of the IBNR balance as of September 30, 2005, approximately2% of claims expense and, after consideration of tax affect, approximately 21%of net income for the year then ended.

Past fluctuations in the IBNR estimates might also bea useful indicator of the potential magnitude of future changes in theseestimates. Quarterly IBNR estimates include provisions for adverse developmentbased on historical volatility. We maintain similar provisions at each quarterend.

**Inflation**

According to U.S. Bureau of Labor Statistics Data, thenational health care cost inflation rate has exceeded the general inflationrate for the last four years. We use various strategies to mitigate thenegative effects of health care cost inflation. Specifically, we try to controlmedical and hospital costs through contracts with independent providers ofhealth care services. Through these contracted providers, we emphasizepreventive health care and appropriate use of specialty and hospital services.

While we currently believe our strategies to mitigatehealth care cost inflation will continue to be successful, competitivepressures, new health care and pharmaceutical product introductions, demandsfrom health care providers and customers, applicable regulations or otherfactors may affect our ability to control health care costs.

**Item3. Quantitative and Qualitative Disclosures About Market Risk.**

**Concentrationsof Credit Risk**

Financial instruments that potentially subject us toconcentrations of credit risk consist primarily of cash and cash equivalents,receivables, restricted cash and debt.

As of June 30, 2007, we had cash and cash equivalentsof $16,924,337. Cash equivalents consist of highly liquid securities withoriginal maturities of up to three months. We invest a substantial portion ofour cash equivalents in high yield money market funds. We also had $1,092,971 ofinvestments, primarily consisting of restricted, interest-bearing certificatesof deposit required by various HMOs with whom we do business. These investmentsare subject to interest rate risk and will decrease in value if market ratesincrease. All non-restricted investments are maintained at fair market value onthe balance sheet. We have the ability to hold these investments untilmaturity, and as a result, we would not expect the value of these investmentsto decline significantly as a result of a sudden change in market interestrates. Declines in interest rates over time will reduce our investment income.Concentration of credit risk related to receivables is generally limited toamounts due from large HMO’s.

Our term loan with Bank of America, with a balance of$47,500,000 at June 30, 2007, required monthly principal payments of $500,000, plusinterest. The fair value of this debt instrument is affected by changes inmarket interest rates. As of June 30, 2007, the carrying value of our term loanapproximated its estimated fair value. Considerable judgment is required todevelop estimates of fair value. Accordingly, the estimate is not necessarilyindicative of the amount we could realize in a current market exchange. The useof different market assumptions and/or estimation methodologies may have amaterial effect on the estimated fair value amounts. For terms relating to ourlong-term debt, see Note 6 of the Notes to Condensed Consolidated FinancialStatements.

**Item4. Controls and Procedures.**

***Evaluation ofDisclosure Controls and Procedures:***Our management, withthe participation of our Chief Executive Officer and our Chief FinancialOfficer, has concluded, based upon its evaluation as of the end of the periodcovered by this report, that the Company’s “disclosure controls and procedures”(as defined in Rules 13(a)-15(e) and 15d-15(e) under the Securities Exchange Actof 1934 (the “Exchange Act”)) are effective to ensure that information requiredto be disclosed in the reports that the Company files or submits under theExchange Act is recorded, processed, summarized and reported within the timeperiods specified in the Securities and Exchange Commission’s rules and forms.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Therefore,even those systems determined to be effective can provide only reasonableassurance with respect to financial statement preparation and presentation.

28

----

***Changes in InternalControls:***There were no changes in the Company’s internalcontrol over financial reporting during the three months ended June 30, 2007that have materially affected, or are reasonably likely to materially affect,the Company’s internal controls over financial reporting.

***Sarbanes-Oxley 404Compliance:***We have begun a detailed assessment of ourinternal controls as called for by the Sarbanes-Oxley Act of 2002. We are stillin the evaluation of design phase. We have supplemented our internal projectteam with the services of an outside specialist. Although we have made thisproject a priority for the Company, there can be no assurances that all controldeficiencies that may be identified and validated will be remediated before therequired due date of September 30, 2008.

29

----

**PARTII – OTHER INFORMATION**

**Item1.    Legal Proceedings.**

We and our affiliatedphysician organizations are parties to legal actions arising in the ordinarycourse of business. We believe that liability, if any, under these claims willnot have a material adverse effect on our consolidated financial position orresults of operations.

**Item1A.  Risk Factors.**

None.

**Item2.    Unregistered Sales of EquitySecurities and Use of Proceeds.**

Not applicable.

**Item 3.    DefaultsUpon Senior Securities.**

At March 31, 2007, theCompany was not in compliance with the fixed charge coverage ratio (0.95,versus 1.25 required minimum) and debt to EBITDA ratio (1.62, versus 1.50required maximum) under the senior secured credit agreement with ResidentialFunding Corporation (RFC) and had not yet completed the process of securingwaivers for these past covenant violations. This non-compliance continuedthrough June 1, 2007.

Effective June 1, 2007,in connection with its acquisition of the ProMed Entities, the Company enteredinto a new, $53,000,000, senior secured credit facility through Bank ofAmerica, part of the proceeds of which were used to repay, in full, all amountsowing to RFC.

Effective August 8, 2007,in connection with its acquisition of Alta Healthcare System, Inc., the Companyentered into a new $155,000,000 senior secured credit facility through Bank ofAmerica, part of the proceeds of which were used to repay, in full, all amountsowing under the June 1, 2007, $53,000,000, senior secured credit facility.

As such, all debt thatwas outstanding as of June 30, 2007 has subsequently been repaid. The Companybelieves that it was in compliance with the terms of its existing seniorsecured credit facility as of June 30, 2007.

The first covenantcompliance measurement date under the August 8, 2007, $155,000,000, seniorsecured credit facility is July 31, 2007, which compliance will be evaluated nolater than August 30, 2007.

**Item 4.    Submissionof Matters to a Vote of Security Holders.**

None.

**Item 5.    OtherInformation.**

None.

**Item 6.    Exhibits.**

The following documents are being filed as exhibits tothis report:
| Exhibit No. | ** ** | **Title** |
|------------------|------------|-----------|
|             | 2.1        |      | Form of Agreement and Plan of Reorganization Among  Prospect Medical Holdings, Inc., Prospect Health Administrators, Inc., ProMed  Health Services Company, ProMed Health Care Administrators, the ProMed  Executive Officers, and the Principal ProMed Shareholders, dated as of May  21, 2007 |
|             |       |      |   |
|             |       |      | Pursuant to Regulation S-K, Item 601(b)(2), the  following schedules and exhibits will be provided supplementally to the  Commission upon request: |
|             |       |      |   |
|             |       |      | Schedule 2.4 - ProMed Company Consent Requirements,  Schedule 2.6(a) - List of Holders of Record and Number of Shares Held in  ProMed Company, Schedule 2.6(b) - ProMed Company Options Outstanding,  Schedule 2.8 - Liabilities or Obligations Not Shown on the Financial  Statements or incurred in the ordinary course of business, Schedule 2.9 -  Actions or Proceedings for Taxes, Schedule 2.11 - Real Estate Leased,  Schedule 2.12(b) - Aggregate Tangible Personal Property, Schedule 2.13-  Intellectual Property, Schedule 2.14 -Material Contracts, Schedule 2.15(a) -  Existing/Threatened Claims, Schedule 2.15(b) - Existing/Threatened Claims  cont'd, Schedule 2.17(a) – Employees, Schedule 2.17(b) - Employees contd.,  Schedule 2.18 – Insurance, Schedule 2.19 - Management; Powers of Attorney,  Schedule 2.23 - Confidentiality and Non-Compete Agreements, Schedule 2.24 –  Inspections, Schedule 2.26 – Permits, Schedule 2.30 - Bank Accounts, Schedule  3.3 - Holdings Consent Requirements, Schedule 7.2(b) - Principal ProMed  Shareholder and ProMed Executive Officer Indemnification Limit, Exhibit A -  Form of Agreement of Merger, Exhibit B - Principal ProMed Shareholders,  Exhibit C - Form of Joinder Agreement, Exhibit D - Piggy-Back Registration  Rights, Exhibit E - Form of Prasad Non-Compete Agreement, Exhibit F - Form of  Thapar Non-Compete Agreement, Exhibit G - Form of Bahremand Non-Compete  Agreement, Exhibit H - Prasad Employment Agreement, Exhibit I - Thapar  Employment Agreement, Exhibit J - Bahremand Employment Agreement, Exhibit K -  Investment Representation Certificate, Exhibit L - ProMed Company/ProMed  Subsidiary Legal Opinion Matters, Exhibit M - Holdings Legal Opinion Matters |
|             |       |      |   |
|             | 2.2        |      | Form of Agreement and Plan of Reorganization Among  Prospect Medical Group, Inc., Prospect Pomona Medical Group, Inc., Prospect Medical  Holdings, Inc., Pomona Valley Medical Group, Inc., the ProMed Executive  Officers, and the Principal ProMed Shareholders, dated as of May 21, 2007 |
|             |       |      |   |
|             |       |      | Pursuant to Regulation S-K, Item 601(b)(2), the  following schedules and exhibits will be provided supplementally to the  Commission upon request: |
|             |       |      |   |
|             |       |      | Schedule 2.4- ProMed Pomona Consent Requirements,  Schedule 2.6 - List of Holders of Record and Number of Shares Held in ProMed  Pomona, Schedule 2.8 - Liabilities or Obligations Not Shown on the Financial  Statements or incurred in the ordinary course of business, Schedule 2.9 -  Actions or Proceedings for Taxes, Schedule 2.12(b) - Aggregate Tangible  Personal Property, Schedule 2.13 - Intellectual Property, Schedule 2.14 -  Material Contracts, Schedule 2.15(a) - Existing/Threatened Claims, Schedule  2.15(b) - Existing/Threatened Claims Not Covered By Insurance, Schedule -  2.17(a) – Employees, Schedule 2.17(b) - Employees contd., Schedule - 2.17(c)  - Employees contd., Schedule - 2.18 - Insurance, Schedule 2.19 - Management;  Powers of Attorney, Schedule 2.23 - Confidentiality and Non-Compete  Agreements, Schedule 2.24 – Inspections, Schedule 2.26 – Permits, Schedule  2.28 - Fraud and Abuse, Schedule 2.32 - Bank Accounts, Schedule 3.3 - Group  Consent Requirements, Schedule 5.2 - Amendment to Primary Care Provider  Agreement of ProMed Pomona and, if applicable, ProMed Upland, Schedule 5.15 -  Physician Retention Bonus, Schedule 7.2(b) - Principal ProMed Shareholder and  ProMed Executive Officer Indemnification Limit, Exhibit A - Form of Agreement  of Merger, Exhibit B - Principal ProMed Shareholders, Exhibit C - Form of  Joinder Agreement, Exhibit D - Piggy-Back Registration Rights, Exhibit E -  Form of Prasad Non-Compete Agreement, Exhibit F - Form of Thapar Non-Compete  Agreement, Exhibit G - Form of Bahremand Non-Compete Agreement, Exhibit H -  Prasad Employment Agreement, Exhibit I - Thapar Employment Agreement, Exhibit  J - Bahremand Employment Agreement, Exhibit K - Investment Representation  Certificate, Exhibit L - ProMed Pomona Legal Opinion Matters, Exhibit M -  Group/Group Subsidiary/Holdings Legal Opinion Matters |
|             |       |      |   |
|             | 2.3        |      | Form of Stock Purchase Agreement Among Prospect  Medical Group, Inc., Prospect Medical Holdings, Inc., Upland Medical Group, a  Professional Medical Corporation, and Jeereddi Prasad, M.D., dated as of May  21, 2007 |
|             |       |      |   |
|             |       |      | Pursuant to Regulation S-K, Item 601(b)(2), the  following schedules and exhibits will be provided supplementally to the  Commission upon request: |
|             |       |      |   |
|             |       |      | Schedule 1.2 - ProMed Upland Shares, Schedule 1.4 -  Purchase Price Allocation, Schedule 2.4 - 

ProMed Upland Consent Requirements, Schedule 2.8 -  Liabilities or Obligations Not Shown on the Financial Statements or Incurred  in the Ordinary Course of Business, Schedule 2.9 - Actions or Proceedings for  Taxes, Schedule 2.12(b) - Aggregate Tangible Personal Property, Schedule 2.13  - Intellectual Property, Schedule 2.14 - Material Contracts, Schedule 2.15(a)  - Existing/Threatened Claims, Schedule 2.15(b) - Existing/Threatened Claims contd.,  Schedule 2.17(a) - Employees, Schedule 2.17(b) - Employees contd., Schedule  2.17(c) - Employees contd., Schedule 2.18 - Insurance, Schedule 2.19 -  Management; Powers of Attorney, Schedule 2.23 - Confidentiality and  Non-Compete Agreements, Schedule 2.24 - Inspections, Schedule 22.7 - Permits,  Schedule 2.28- Fraud and Abuse, Schedule 2.32 - Bank Accounts, Schedule 3.3 -  Group Consent Requirements, Schedule 5.13(a) - Physician Retention Bonus,  Schedule 5.13(b) - Amendment to Primary Care Provider Agreement of ProMed  Upland and if applicable, ProMed Pomona., Exhibit A - Piggy-Back Registration  Rights, Exhibit C [sic] - Form of Prasad Non-Compete Agreement, Exhibit C -  Form of Thapar Non-Compete Agreement, Exhibit E - Form of Bahremand  Non-Compete Agreement, Exhibit F - Prasad Employment Agreement, Exhibit G -  Thapar Employment Agreement, Exhibit H - Bahremand Employment Agreement,  Exhibit I - Investment Representation Certificate, Exhibit J - ProMed Upland  Legal Opinion Matters, Exhibit K - Group/Holdings Legal Opinion Matters |
|             |       |      |   |
|             | 2.4        |      | Form of Agreement and Plan of Reorganization by and  among Prospect Medical Holdings, Inc., Prospect Hospitals System, LLC, Alta  HealthCare System, Inc. and the Shareholders of Alta HealthCare System, Inc.,  dated as of July 25, 2007 |
|             |       |      |   |
|             | 3.1        |      | Amended and Restated Certificate of Incorporation of  Prospect Medical Holdings, Inc.(1) |
|             |       |      |   |
|             | 3.2        |      | Certificate of Amendment of Amended and Restated  Certificate of Incorporation of Prospect Medical Holdings, Inc.(1) |
|             |       |      |   |
|             | 3.3        |      | Certificate of Amendment of Amended and Restated  Certificate of Incorporation of Prospect Medical Holdings, Inc.(1) |
|             |       |      |   |
|             | 3.4        |      | Certificate of Designation of Series A Convertible  Preferred Stock of Prospect Medical Holdings, Inc.(1) |
|             |       |      |   |

 

30

----

 
|        | 3.5    |   | Certificate of Elimination of Series A Convertible  Preferred Stock of Prospect Medical Holdings, Inc.                                                                                                                                                                                                                                                                      |
|--------|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                        |
|   | 3.6    |   | Certificate of Designation of Series B Preferred  Stock of Prospect Medical Holdings, Inc.(2)                                                                                                                                                                                                                                                                               |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                        |
|   | 3.7    |   | Amended and Restated Bylaws of Prospect Medical  Holdings, Inc.(1)                                                                                                                                                                                                                                                                                                          |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                        |
|   | 3.8    |   | First Amendment to Amended and Restated Bylaws of  Prospect Medical Holdings, Inc.(1)                                                                                                                                                                                                                                                                                       |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                        |
|   | 3.9    |   | Second Amendment to Amended and Restated Bylaws of  Prospect Medical Holdings, Inc. (2)                                                                                                                                                                                                                                                                                     |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                        |
|   | 4.1    |   | Specimen Common Stock Certificate(1)                                                                                                                                                                                                                                                                                                                                        |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                        |
|   | 10.1   |   | Form of Credit Agreement dated as of June 1, 2007  among Prospect Medical Holdings, Inc. and Prospect Medical Group, Inc. as the  Borrowers, Bank of America, N.A., as Administrative Agent and L/C Issuer,  Banc of America Capital Solutions LLC as a Lender and certain other Lenders,  and Banc of America Securities LLC, as Sole Lead Arranger and Sole Book  Manager |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                        |
|   | 10.2   |   | Form of Security Agreement dated as of June 1, 2007  among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc., and  their affiliates as Pledgors, and Bank of America, N.A. as Administrative  Agent                                                                                                                                                             |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                        |
|   | 10.3   |   | Form of Pledge Agreement dated as of June 1, 2007  between Prospect Medical Holdings, Inc. as Pledgor and Bank of America, N.A.  as Administrative Agent                                                                                                                                                                                                                    |

 
|        | 10.4   |   | Form of Pledge Agreement dated as of June 1, 2007  between ProMed Health Services Company as Pledgor and Bank of America, N.A.  as Administrative Agent                                                                                        |
|--------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                                           |
|   | 10.5   |   | Form of Pledge Agreement dated as of June 1, 2007  between Prospect Medical Group, Inc. as Pledgor and Bank of America, N.A. as  Administrative Agent                                                                                          |
|   |   |   |                                                                                                                                                                                                                                           |
|   | 10.6   |   | Form of Guaranty of Prospect Medical Group, Inc. and  affiliates in favor of Bank of America, N.A. as Administrative Agent, dated  as of June 1, 2007                                                                                          |
|   |   |   |                                                                                                                                                                                                                                           |
|   | 10.7   |   | Form of Second Amended and Restated Assignable  Option Agreement, dated as of June 1, 2007, by and among Prospect Medical  Systems, Inc., Prospect Medical Group, Inc., and Jacob Y. Terner, M.D. as Shareholder                               |
|   |   |   |                                                                                                                                                                                                                                           |
|   | 10.8   |   | Form of Collateral Assignment of ProMed Acquisition  Documents, dated as of June 1, 2007, by and between Prospect Medical  Holdings, Inc., and Prospect Medical Group, Inc., as Assignors, and Bank of  America, N.A., as Administrative Agent |
|   |   |   |                                                                                                                                                                                                                                           |
|   | 31.1   |   | Certification of Chief Executive Officer pursuant to  Rules 13a-14(a)/15d-14(a) under the Securities Exchange Act of 1934, as  amended.                                                                                                        |
|   |   |   |                                                                                                                                                                                                                                           |
|   | 31.2   |   | Certification of Chief Financial Officer pursuant to  Rules 13a-14(a)/15d-14(a) under the Securities Exchange Act of 1934, as amended.                                                                                                         |
|   |   |   |                                                                                                                                                                                                                                           |
|   | 32.1   |   | Certification of Chief Executive Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                           |
|   |   |   |                                                                                                                                                                                                                                           |
|   | 32.2   |   | Certification of Chief Financial Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                           |

 

----

(1)           Previously filed as anexhibit to our Form 10 registration statement on May 27, 2004, and incorporatedherein by reference.

(2)           Previously filed as anexhibit to our Form 8-K current report on August 10, 2006, and incorporatedherein by reference.

** **

31

----

**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|                 |       | PROSPECT MEDICAL HOLDINGS, INC.   |
|-----------------|------------|-----------------------------------|
|            |       | (Registrant)                      |
|            |       |                              |
| August 20, 2007 |       | /s/ JACOB Y. TERNER               |
|            | ** ** | **Jacob Y. Terner, M.D.**         |
|            | ** ** | **Chairman of the Board and**     |
|            | ** ** | **Chief Executive Officer**       |
|            | ** ** | **(Principal Executive Officer)** |
|            |       |                              |
| August 20, 2007 |       | /s/ MIKE HEATHER                  |
|            | ** ** | **Mike Heather**                  |
|            | ** ** | **Chief Financial Officer**       |
|            | ** ** | **(Principal Financial Officer)** |

 

32

----

Exhibit Index

 
| Exhibit No. | ** ** | **Title** |
|------------------|------------|-----------|
|             | 2.1        |      | Form of Agreement and Plan of Reorganization Among  Prospect Medical Holdings, Inc., Prospect Health Administrators, Inc., ProMed  Health Services Company, ProMed Health Care Administrators, the ProMed  Executive Officers, and the Principal ProMed Shareholders, dated as of May  21, 2007 |
|             |       |      |   |
|             |       |      | Pursuant to Regulation S-K, Item 601(b)(2), the  following schedules and exhibits will be provided supplementally to the  Commission upon request: |
|             |       |      |   |
|             |       |      | Schedule 2.4 - ProMed Company Consent Requirements,  Schedule 2.6(a) - List of Holders of Record and Number of Shares Held in  ProMed Company, Schedule 2.6(b) - ProMed Company Options Outstanding,  Schedule 2.8 - Liabilities or Obligations Not Shown on the Financial  Statements or incurred in the ordinary course of business, Schedule 2.9 -  Actions or Proceedings for Taxes, Schedule 2.11 - Real Estate Leased,  Schedule 2.12(b) - Aggregate Tangible Personal Property, Schedule 2.13-  Intellectual Property, Schedule 2.14 -Material Contracts, Schedule 2.15(a) -  Existing/Threatened Claims, Schedule 2.15(b) - Existing/Threatened Claims  cont'd, Schedule 2.17(a) – Employees, Schedule 2.17(b) - Employees contd.,  Schedule 2.18 – Insurance, Schedule 2.19 - Management; Powers of Attorney,  Schedule 2.23 - Confidentiality and Non-Compete Agreements, Schedule 2.24 –  Inspections, Schedule 2.26 – Permits, Schedule 2.30 - Bank Accounts, Schedule  3.3 - Holdings Consent Requirements, Schedule 7.2(b) - Principal ProMed  Shareholder and ProMed Executive Officer Indemnification Limit, Exhibit A -  Form of Agreement of Merger, Exhibit B - Principal ProMed Shareholders,  Exhibit C - Form of Joinder Agreement, Exhibit D - Piggy-Back Registration  Rights, Exhibit E - Form of Prasad Non-Compete Agreement, Exhibit F - Form of  Thapar Non-Compete Agreement, Exhibit G - Form of Bahremand Non-Compete  Agreement, Exhibit H - Prasad Employment Agreement, Exhibit I - Thapar  Employment Agreement, Exhibit J - Bahremand Employment Agreement, Exhibit K -  Investment Representation Certificate, Exhibit L - ProMed Company/ProMed  Subsidiary Legal Opinion Matters, Exhibit M - Holdings Legal Opinion Matters |
|             |       |      |   |
|             | 2.2        |      | Form of Agreement and Plan of Reorganization Among  Prospect Medical Group, Inc., Prospect Pomona Medical Group, Inc., Prospect  Medical Holdings, Inc., Pomona Valley Medical Group, Inc., the ProMed  Executive Officers, and the Principal ProMed Shareholders, dated as of May  21, 2007 |
|             |       |      |   |
|             |       |      | Pursuant to Regulation S-K, Item 601(b)(2), the  following schedules and exhibits will be provided supplementally to the  Commission upon request: |
|             |       |      |   |
|             |       |      | Schedule 2.4- ProMed Pomona Consent Requirements,  Schedule 2.6 - List of Holders of Record and Number of Shares Held in ProMed  Pomona, Schedule 2.8 - Liabilities or Obligations Not Shown on the Financial  Statements or incurred in the ordinary course of business, Schedule 2.9 -  Actions or Proceedings for Taxes, Schedule 2.12(b) - Aggregate Tangible Personal  Property, Schedule 2.13 - Intellectual Property, Schedule 2.14 - Material  Contracts, Schedule 2.15(a) - Existing/Threatened Claims, Schedule 2.15(b) -  Existing/Threatened Claims Not Covered By Insurance, Schedule - 2.17(a) –  Employees, Schedule 2.17(b) - Employees contd., Schedule - 2.17(c) -  Employees contd., Schedule - 2.18 - Insurance, Schedule 2.19 - Management;  Powers of Attorney, Schedule 2.23 - Confidentiality and Non-Compete  Agreements, Schedule 2.24 – Inspections, Schedule 2.26 – Permits, Schedule  2.28 - Fraud and Abuse, Schedule 2.32 - Bank Accounts, Schedule 3.3 - Group  Consent Requirements, Schedule 5.2 - Amendment to Primary Care Provider  Agreement of ProMed Pomona and, if applicable, ProMed Upland, Schedule 5.15 -  Physician Retention Bonus, Schedule 7.2(b) - Principal ProMed Shareholder and  ProMed Executive Officer Indemnification Limit, Exhibit A - Form of Agreement  of Merger, Exhibit B - Principal ProMed Shareholders, Exhibit C - Form of  Joinder Agreement, Exhibit D - Piggy-Back Registration Rights, Exhibit E -  Form of Prasad Non-Compete Agreement, Exhibit F - Form of Thapar Non-Compete  Agreement, Exhibit G - Form of Bahremand Non-Compete Agreement, Exhibit H -  Prasad Employment Agreement, Exhibit I - Thapar Employment Agreement, Exhibit  J - Bahremand Employment Agreement, Exhibit K - Investment Representation  Certificate, Exhibit L - ProMed Pomona Legal Opinion Matters, Exhibit M -  Group/Group Subsidiary/Holdings Legal Opinion Matters |
|             |       |      |   |
|             | 2.3        |      | Form of Stock Purchase Agreement Among Prospect  Medical Group, Inc., Prospect Medical Holdings, Inc., Upland Medical Group, a  Professional Medical Corporation, and Jeereddi Prasad, M.D., dated as of May  21, 2007 |
|             |       |      |   |
|             |       |      | Pursuant to Regulation S-K, Item 601(b)(2), the  following schedules and exhibits will be provided supplementally to the  Commission upon request: |
|             |       |      |   |
|             |       |      | Schedule 1.2 - ProMed Upland Shares, Schedule 1.4 -  Purchase Price Allocation, Schedule 2.4 - 

ProMed Upland Consent Requirements, Schedule 2.8 -  Liabilities or Obligations Not Shown on the Financial Statements or Incurred  in the Ordinary Course of Business, Schedule 2.9 - Actions or Proceedings for  Taxes, Schedule 2.12(b) - Aggregate Tangible Personal Property, Schedule 2.13  - Intellectual Property, Schedule 2.14 - Material Contracts, Schedule 2.15(a)  - Existing/Threatened Claims, Schedule 2.15(b) - Existing/Threatened Claims  contd., Schedule 2.17(a) - Employees, Schedule 2.17(b) - Employees contd.,  Schedule 2.17(c) - Employees contd., Schedule 2.18 - Insurance, Schedule 2.19  - Management; Powers of Attorney, Schedule 2.23 - Confidentiality and  Non-Compete Agreements, Schedule 2.24 - Inspections, Schedule 22.7 - Permits,  Schedule 2.28- Fraud and Abuse, Schedule 2.32 - Bank Accounts, Schedule 3.3 -  Group Consent Requirements, Schedule 5.13(a) - Physician Retention Bonus,  Schedule 5.13(b) - Amendment to Primary Care Provider Agreement of ProMed  Upland and if applicable, ProMed Pomona., Exhibit A - Piggy-Back Registration  Rights, Exhibit C [sic] - Form of Prasad Non-Compete Agreement, Exhibit C -  Form of Thapar Non-Compete Agreement, Exhibit E - Form of Bahremand  Non-Compete Agreement, Exhibit F - Prasad Employment Agreement, Exhibit G -  Thapar Employment Agreement, Exhibit H - Bahremand Employment Agreement,  Exhibit I - Investment Representation Certificate, Exhibit J - ProMed Upland  Legal Opinion Matters, Exhibit K - Group/Holdings Legal Opinion Matters |
|             |       |      |   |
|             | 2.4        |      | Form of Agreement and Plan of Reorganization by and  among Prospect Medical Holdings, Inc., Prospect Hospitals System, LLC, Alta  HealthCare System, Inc. and the Shareholders of Alta HealthCare System, Inc.,  dated as of July 25, 2007 |
|             |       |      |   |
|             | 3.1        |      | Amended and Restated Certificate of Incorporation of  Prospect Medical Holdings, Inc.(1) |
|             |       |      |   |
|             | 3.2        |      | Certificate of Amendment of Amended and Restated  Certificate of Incorporation of Prospect Medical Holdings, Inc.(1) |
|             |       |      |   |
|             | 3.3        |      | Certificate of Amendment of Amended and Restated  Certificate of Incorporation of Prospect Medical Holdings, Inc.(1) |
|             |       |      |   |
|             | 3.4        |      | Certificate of Designation of Series A Convertible  Preferred Stock of Prospect Medical Holdings, Inc.(1) |
|             |       |      |   |
|             | 3.5        |      | Certificate of Elimination of Series A Convertible  Preferred Stock of Prospect Medical Holdings, Inc. |
|             |       |      |   |
|             | 3.6        |      | Certificate of Designation of Series B Preferred  Stock of Prospect Medical Holdings, Inc.(2) |
|             |       |      |   |
|             | 3.7        |      | Amended and Restated Bylaws of Prospect Medical  Holdings, Inc.(1) |
|             |       |      |   |
|             | 3.8        |      | First Amendment to Amended and Restated Bylaws of  Prospect Medical Holdings, Inc.(1) |
|             |       |      |   |
|             | 3.9        |      | Second Amendment to Amended and Restated Bylaws of  Prospect Medical Holdings, Inc. (2) |
|             |       |      |   |
|             | 4.1        |      | Specimen Common Stock Certificate(1) |
|             |       |      |   |
|             | 10.1       |      | Form of Credit Agreement dated as of June 1, 2007  among Prospect Medical Holdings, Inc. and Prospect Medical Group, Inc. as the  Borrowers, Bank of America, N.A., as Administrative Agent and L/C Issuer,  Banc of America Capital Solutions LLC as a Lender and certain other Lenders,  and Banc of America Securities LLC, as Sole Lead Arranger and Sole Book  Manager |
|             |       |      |   |
|             | 10.2       |      | Form of Security Agreement dated as of June 1, 2007  among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc., and  their affiliates as Pledgors, and Bank of America, N.A. as Administrative  Agent |
|             |       |      |   |
|             | 10.3       |      | Form of Pledge Agreement dated as of June 1, 2007  between Prospect Medical Holdings, Inc. as Pledgor and Bank of America, N.A.  as Administrative Agent |
|             |       |      |   |

 

33

----

 
|        | 10.4   |   | Form of Pledge Agreement dated as of June 1, 2007  between ProMed Health Services Company as Pledgor and Bank of America, N.A.  as Administrative Agent                                                                                        |
|--------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                                           |
|   | 10.5   |   | Form of Pledge Agreement dated as of June 1, 2007  between Prospect Medical Group, Inc. as Pledgor and Bank of America, N.A. as  Administrative Agent                                                                                          |
|   |   |   |                                                                                                                                                                                                                                           |
|   | 10.6   |   | Form of Guaranty of Prospect Medical Group, Inc. and  affiliates in favor of Bank of America, N.A. as Administrative Agent, dated  as of June 1, 2007                                                                                          |
|   |   |   |                                                                                                                                                                                                                                           |
|   | 10.7   |   | Form of Second Amended and Restated Assignable  Option Agreement, dated as of June 1, 2007, by and among Prospect Medical  Systems, Inc., Prospect Medical Group, Inc., and Jacob Y. Terner, M.D. as Shareholder                               |
|   |   |   |                                                                                                                                                                                                                                           |
|   | 10.8   |   | Form of Collateral Assignment of ProMed Acquisition  Documents, dated as of June 1, 2007, by and between Prospect Medical  Holdings, Inc., and Prospect Medical Group, Inc., as Assignors, and Bank of  America, N.A., as Administrative Agent |
|   |   |   |                                                                                                                                                                                                                                           |
|   | 31.1   |   | Certification of Chief Executive Officer pursuant to  Rules 13a-14(a)/15d-14(a) under the Securities Exchange Act of 1934, as  amended.                                                                                                        |
|   |   |   |                                                                                                                                                                                                                                           |
|   | 31.2   |   | Certification of Chief Financial Officer pursuant to  Rules 13a-14(a)/15d-14(a) under the Securities Exchange Act of 1934, as  amended.                                                                                                        |
|   |   |   |                                                                                                                                                                                                                                           |
|   | 32.1   |   | Certification of Chief Executive Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                           |
|   |   |   |                                                                                                                                                                                                                                           |
|   | 32.2   |   | Certification of Chief Financial Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                           |

 

----

(1)           Previously filed as anexhibit to our Form 10 registration statement on May 27, 2004, and incorporatedherein by reference.

(2)           Previously filed as anexhibit to our Form 8-K current report on August 10, 2006, and incorporatedherein by reference.

 

34

----