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** **

 

** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**Form 10-Q**

 

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| **x** | **Quarterly report pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934** |
|-------|--------------------------------------------------------------------------------------------------------|

** **

**For thequarterly period ended****March 31, 2009**

** **

**or**

 

| **o** | **Transition report pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934** |
|-------|---------------------------------------------------------------------------------------------------------|

** **

**For thetransition period from                 to                **

 

**Commission file number: 1-32203**

 

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**ProspectMedical Holdings, Inc.**

(Exact name of registrant asspecified in its charter)

 

| **Delaware**(State or other jurisdiction of incorporation or  organization)                                    | ** ** | **33-0564370**(I.R.S. Employer Identification No.) |
|----------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|
| ** **                                                                                                     | ** ** | ** **                                         |
| **10780  Santa Monica Blvd., Suite 400  Los Angeles, California**(Address of principal executive offices) | ** ** | **90025**(Zip Code)                                |

 

**(310) 943-4500**(Registrant’s telephone number, including area code)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes x  No o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateweb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T during the preceding 12 months(or for such shorter period that the registrant was required to submit and postsuch files). Yes o  No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See the definitions of “largeaccelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2of the Exchange Act. (Check one):

 
| Large accelerated filer o | Accelerated filer o         |
|--------------------------------|----------------------------------|
|                           |                             |
| Non-accelerated filer o   | Smaller reporting company x |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act): Yes o  No x

 

The number of shares of theissuer’s Common Stock, par value $0.01 per share, outstanding as of May 08,2009 was 20,575,111.

 

 

 

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Table of Contents

 

**PROSPECT MEDICAL HOLDINGS, INC.**

 

**Index**

 
| **Part I—Financial Information** |
|--------------------------------------------|
|                                       |   |   |
| Item 1.                               | Financial Statements |   |
|                                       | Condensed Consolidated Balance Sheets as of  March 31, 2009 and September 30, 2008 (unaudited) | 3 |
|                                       | Condensed  Consolidated Statements of Operations for the three-month and six-month  periods ended March 31, 2009 and 2008 (unaudited) | 5 |
|                                       | Condensed  Consolidated Statements of Cash Flows for the six-month periods ended  March 31, 2009 and 2008 (unaudited) | 6 |
|                                       | Notes to Condensed Consolidated Financial Statements  (unaudited) | 7 |
| Item 2.                               | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 28 |
| Item 3.                               | Quantitative  and Qualitative Disclosures About Market Risk | 58 |
| Item 4T.                              | Controls  and Procedures | 58 |
| Part II—Other  Information       |
| Item 1.                               | Legal  Proceedings | 59 |
| Item 1A.                              | Risk Factors | 59 |
| Item 2.                               | Unregistered  Sales of Equity Securities and Use of Proceeds | 59 |
| Item 3.                               | Defaults  Upon Senior Securities | 59 |
| Item 4.                               | Submission  of Matters to a Vote of Security Holders | 60 |
| Item 5.                               | Other  information | 60 |
| Item 6.                               | Exhibits | 61 |
| Signatures                                 |   | 63 |

 

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**PART I—FINANCIAL INFORMATION**

 

**Item 1. Financial Statements.**

 

**PROSPECT MEDICAL HOLDINGS, INC.**

 

**CONDENSED CONSOLIDATED BALANCE SHEETS**

 

**(Unaudited)**

 
| ** **                                                                                                                                           | ** ** | **March 31,  2009** | ** **  | **September 30,  2008** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|-------------|------------------------------|------------|
| **ASSETS**                                                                                                                                           |       |                     |        |                         |       |
| **Current assets:**                                                                                                                                  |       |                     |        |                         |       |
| Cash and cash equivalents                                                                                                                            |       | $                        | 31,533,427  |                         | $          | 33,582,686 |   |
| Investments, primarily restricted certificates of deposit                                                                                            |       | 664,172                  |        | 637,213                      |       |
| Patient accounts receivable, net of allowance for doubtful accounts of  $4,616,977 and $3,890,762 at March 31, 2009 and September 30, 2008 |       | 22,570,809               |        | 18,314,495                   |       |
| Government program receivables                                                                                                                       |       | 2,853,507                |        | 4,365,063                    |       |
| Risk pool receivables                                                                                                                                |       | —                   |        | 337,948                      |       |
| Other receivables                                                                                                                                    |       | 2,750,866                |        | 2,598,466                    |       |
| Third party settlements                                                                                                                              |       | 1,136,589                |        | 216,198                      |       |
| Notes receivable, current portion                                                                                                                    |       | 204,267                  |        | 224,063                      |       |
| Refundable income taxes, net                                                                                                                         |       | 728,070                  |        | 2,653,634                    |       |
| Deferred income taxes, net                                                                                                                           |       | 5,788,068                |        | 5,788,068                    |       |
| Prepaid expenses and other current assets                                                                                                            |       | 4,674,155                |        | 4,235,925                    |       |
| Total current assets                                                                                                                                 |       | 72,903,930               |        | 72,953,759                   |       |
| Property, improvements and equipment:                                                                                                                |       |                     |        |                         |       |
| Land and land improvements                                                                                                                           |       | 18,501,280               |        | 18,452,000                   |       |
| Buildings                                                                                                                                            |       | 22,412,976               |        | 22,233,000                   |       |
| Leasehold improvements                                                                                                                               |       | 1,912,247                |        | 1,504,656                    |       |
| Equipment                                                                                                                                            |       | 10,622,681               |        | 10,627,945                   |       |
| Furniture and fixtures                                                                                                                               |       | 912,622                  |        | 912,622                      |       |
|                                                                                                                                                 |       | 54,361,806               |        | 53,730,223                   |       |
| Less accumulated depreciation and amortization                                                                                                       |       | (9,374,768               | )           | (7,911,229                   | )          |
| Property, improvements and equipment, net                                                                                                            |       | 44,987,038               |        | 45,818,994                   |       |
| Notes receivable, less current portion                                                                                                               |       | 236,430                  |        | 238,334                      |       |
| Deposits and other assets                                                                                                                            |       | 2,221,872                |        | 778,343                      |       |
| Deferred financing costs, net                                                                                                                        |       | 593,791                  |        | 661,481                      |       |
| Goodwill                                                                                                                                             |       | 128,877,234              |        | 128,877,234                  |       |
| Other intangible assets, net                                                                                                                         |       | 45,615,301               |        | 47,739,873                   |       |
| Total assets                                                                                                                                         |       | $                        | 295,435,596 |                         | $          | 297,068,018 |   |

 

The accompanying notes arean integral part of the unaudited condensed consolidated financial statements.

 

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**PROSPECT MEDICAL HOLDINGS, INC.**

 

**CONDENSED CONSOLIDATED BALANCE SHEETS**

 

**(Unaudited)**

 
| ** **                                                                                                                                                 | ** ** | **March 31,  2009** | ** **  | **September 30,  2008** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|-------------|------------------------------|------------|
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                              |       |                     |        |                         |       |
| **Current liabilities:**                                                                                                                                   |       |                     |        |                         |       |
| Accrued medical claims and other health care costs payable                                                                                                 |       | $                        | 19,374,178  |                         | $          | 20,480,380 |   |
| Accounts payable and other accrued liabilities                                                                                                             |       | 11,227,474               |        | 16,295,770                   |       |
| Accrued salaries, wages and benefits                                                                                                                       |       | 12,852,577               |        | 11,256,563                   |       |
| Income taxes payable, net                                                                                                                                  |       | 1,997,875                |        | —                       |       |
| Current portion of capital leases                                                                                                                          |       | 403,404                  |        | 340,681                      |       |
| Debt, due on demand (see Note 7)                                                                                                                           |       | 137,832,056              |        | 12,100,000                   |       |
| Interest rate swap liability, due on demand (see Note 7)                                                                                                   |       | 14,725,992               |        | —                       |       |
| Other current liabilities                                                                                                                                  |       | 689,082                  |        | 107,181                      |       |
| Total current liabilities                                                                                                                                  |       | 199,102,638              |        | 60,580,575                   |       |
| Long-term debt, less current portion (see Note 7)                                                                                                          |       | —                   |        | 131,920,730                  |       |
| Deferred income taxes                                                                                                                                      |       | 21,129,238               |        | 24,433,362                   |       |
| Malpractice reserve                                                                                                                                        |       | 786,000                  |        | 786,000                      |       |
| Capital leases, net of current portion                                                                                                                     |       | 380,385                  |        | 442,191                      |       |
| Interest rate swap liability                                                                                                                               |       | —                   |        | 6,013,168                    |       |
| Other long-term liabilities                                                                                                                                |       | 15,000                   |        | —                       |       |
| Total liabilities                                                                                                                                          |       | 221,413,261              |        | 224,176,026                  |       |
| Minority interest                                                                                                                                          |       | 84,997                   |        | 80,664                       |       |
| **Commitments, Contingencies and Subsequent Event**                                                                                                        |       |                     |        |                         |       |
| **Shareholders’ equity:**                                                                                                                             |       |                     |        |                         |       |
| Common stock, $0.01 par value; 40,000,000 shares authorized;  20,508,444 shares issued and outstanding at March 31, 2009 and  September 30, 2008 |       | 205,084                  |        | 205,084                      |       |
| Additional paid-in capital                                                                                                                                 |       | 93,989,465               |        | 93,407,031                   |       |
| Accumulated other comprehensive loss                                                                                                                       |       | (4,477,548               | )           | (4,917,384                   | )          |
| Accumulated deficit                                                                                                                                        |       | (15,779,663              | )           | (15,883,403                  | )          |
| Total shareholders’ equity                                                                                                                            |       | 73,937,338               |        | 72,811,328                   |       |
| Total liabilities and shareholders’ equity                                                                                                            |       | $                        | 295,435,596 |                         | $          | 297,068,018 |   |

 

The accompanying notes arean integral part of the unaudited condensed consolidated financial statements.

 

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**PROSPECT MEDICAL HOLDINGS, INC.**

 

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

 

**(Unaudited)**

 
| ** **                                                       | ** ** | **Three Months Ended  March 31,** | ** ** | **Six Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                                                       | ** ** | **2009**                               | ** ** | **2008**                             | ** ** | **2009** | ** ** | **2008** | ** ** |
| Revenues:                                                        |       |                                   |       |                                 |       |   |   |   |   |
| Managed care revenues                                            |       | $                                      | 48,159,102 |                                 | $          | 50,680,973 |   | $ | 96,290,351 |   | $ | 101,249,529 |   |
| Net hospital services revenues                                   |       | 37,908,033                             |       | 32,396,126                           |       | 73,230,440 |   | 59,682,354 |   |
| Total revenues                                                   |       | 86,067,135                             |       | 83,077,099                           |       | 169,520,791 |   | 160,931,883 |   |
| Operating expenses:                                              |       |                                   |       |                                 |       |   |   |   |   |
| Managed care cost of revenues                                    |       | 36,955,503                             |       | 40,208,302                           |       | 74,567,432 |   | 81,475,734 |   |
| Hospital services operating expenses                             |       | 22,857,814                             |       | 20,966,977                           |       | 45,003,369 |   | 38,968,324 |   |
| General and administrative                                       |       | 13,379,522                             |       | 14,280,993                           |       | 25,765,025 |   | 26,935,282 |   |
| Depreciation and amortization                                    |       | 1,822,715                              |       | 1,907,412                            |       | 3,588,649 |   | 3,807,935 |   |
| Total operating expenses                                         |       | 75,015,554                             |       | 77,363,684                           |       | 148,924,475 |   | 151,187,275 |   |
| Operating income from unconsolidated joint venture               |       | 594,623                                |       | 694,219                              |       | 947,205 |   | 1,168,959 |   |
| Operating income                                                 |       | 11,646,204                             |       | 6,407,634                            |       | 21,543,521 |   | 10,913,567 |   |
| Other (income) expense:                                          |       |                                   |       |                                 |       |   |   |   |   |
| Investment income                                                |       | (19,500                                | )          | (149,068                             | )          | (67,745 | ) | (443,192 | ) |
| Interest expense and amortization of deferred financing costs    |       | 6,576,053                              |       | 5,293,849                            |       | 12,713,951 |   | 9,493,304 |   |
| (Gain) loss in value of interest rate swap arrangements          |       | (955,201                               | )          | —                               |       | 8,712,824 |   | 876,680 |   |
| Total other (income) expense, net                                |       | 5,601,352                              |       | 5,144,781                            |       | 21,359,030 |   | 9,926,792 |   |
| Income from continuing operations before income taxes            |       | 6,044,852                              |       | 1,262,853                            |       | 184,491 |   | 986,775 |   |
| Provision for income taxes                                       |       | 2,495,832                              |       | 456,123                              |       | 76,417 |   | 355,391 |   |
| Income from continuing operations before minority interest       |       | 3,549,020                              |       | 806,730                              |       | 108,074 |   | 631,384 |   |
| Minority interest                                                |       | 781                                    |       | 3,000                                |       | 4,335 |   | 8,497 |   |
| Income from continuing operations                                |       | 3,548,239                              |       | 803,730                              |       | 103,739 |   | 622,887 |   |
| Loss from discontinued operations, net of tax (see Note 4)  |       | —                                 |       | (75,743                              | )          | — |   | (391,899 | ) |
| Net income before preferred dividend                             |       | 3,548,239                              |       | 727,987                              |       | 103,739 |   | 230,988 |   |
| Dividends to preferred stockholders                              |       | —                                 |       | (1,982,999                           | )          | — |   | (3,864,989 | ) |
| Net income (loss) attributable to common stockholders            |       | $                                      | 3,548,239  |                                 | $          | (1,255,012 | ) | $ | 103,739 |   | $ | (3,634,001 | ) |
| Per share data:                                                  |       |                                   |       |                                 |       |   |   |   |   |
| Net income (loss) per share attributable to common stockholders: |       |                                   |       |                                 |       |   |   |   |   |
| Basic:                                                           |       |                                   |       |                                 |       |   |   |   |   |
| Continuing operations                                            |       | $                                      | 0.17       |                                 | $          | (0.10 | ) | $ | 0.01 |   | $ | (0.28 | ) |
| Discontinued operations                                          |       | $                                      | —     |                                 | $          | (0.01 | ) | $ | — |   | $ | (0.03 | ) |
|                                                             |       | $                                      | 0.17       |                                 | $          | (0.11 | ) | $ | 0.01 |   | $ | (0.31 | ) |
| Diluted:                                                         |       |                                   |       |                                 |       |   |   |   |   |
| Continuing operations                                            |       | $                                      | 0.17       |                                 | $          | (0.10 | ) | $ | 0.01 |   | $ | (0.28 | ) |
| Discontinued operations                                          |       | $                                      | —     |                                 | $          | (0.01 | ) | $ | — |   | $ | (0.03 | ) |
|                                                             |       | $                                      | 0.17       |                                 | $          | (0.11 | ) | $ | 0.01 |   | $ | (0.31 | ) |

 

The accompanying notes arean integral part of the unaudited condensed consolidated financial statements.

 

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**PROSPECT MEDICAL HOLDINGS, INC.**

 

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

 

**(Unaudited)**

 
| ** **                                                                                                              | ** ** | **Six Months Ended  March 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                              | ** ** | **2009**                             | ** ** | **2008** | ** ** |
| **Operating activities**                                                                                                |       |                                 |       |   |   |
| Net income before preferred dividends                                                                                   |       | $                                    | 103,739    |   | $ | 230,988 |   |
| Adjustments to reconcile net income before preferred dividends to net  cash provided by (used in) operating activities: |       |                                 |       |   |   |
| Depreciation and amortization                                                                                           |       | 3,588,649                            |       | 3,807,935 |   |
| Amortization of deferred financing costs                                                                                |       | 67,690                               |       | 447,255 |   |
| Provision for bad debts                                                                                                 |       | 3,708,943                            |       | 2,039,172 |   |
| Payment-in-kind interest expense                                                                                        |       | 276,675                              |       | — |   |
| Amortization of other accumulated comprehensive income related to  interest rate swap arrangements                      |       | 439,836                              |       | — |   |
| Deferred income taxes, net                                                                                              |       | (3,304,124                           | )          | (1,234,948 | ) |
| Stock-based compensation                                                                                                |       | 582,434                              |       | 57,763 |   |
| Loss on interest rate swap agreements                                                                                   |       | 8,712,824                            |       | 876,681 |   |
| Pre-tax loss from discontinued operations                                                                               |       | —                               |       | 610,121 |   |
| Changes in assets and liabilities:                                                                                      |       |                                 |       |   |   |
| Risk pool receivables                                                                                                   |       | 460,194                              |       | (5,330 | ) |
| Patient, government program and other receivables                                                                       |       | (7,523,738                           | )          | (4,266,721 | ) |
| Prepaid expenses and other current assets                                                                               |       | (438,230                             | )          | (1,195,531 | ) |
| Refundable income taxes and taxes payable                                                                               |       | 3,923,439                            |       | 1,527,192 |   |
| Deposits and other assets                                                                                               |       | (1,654,309                           | )          | (153,366 | ) |
| Accrued medical claims and other health care costs payable                                                              |       | (1,106,202                           | )          | 398,419 |   |
| Accounts payable, accrued liabilities, and other liabilities                                                            |       | (2,789,600                           | )          | (1,151,430 | ) |
| Net cash used in operating activities from discontinued operations                                                      |       | —                               |       | (573,350 | ) |
| Net cash provided by operating activities                                                                               |       | 5,048,220                            |       | 1,414,850 |   |
| **Investing activities**                                                                                                |       |                                 |       |   |   |
| Purchases of property, improvements and equipment                                                                       |       | (436,639                             | )          | (952,149 | ) |
| Proceeds from notes receivable                                                                                          |       | 21,700                               |       | 25,813 |   |
| Capitalized expenses related to acquisitions                                                                            |       | —                               |       | (15,864 | ) |
| Increase in restricted certificates of deposits                                                                         |       | (26,959                              | )          | — |   |
| Other investing activities                                                                                              |       | 4,331                                |       | 8,497 |   |
| Net cash used in investing activities from discontinued operations                                                      |       | —                               |       | (2,535 | ) |
| Net cash used in investing activities                                                                                   |       | (437,567                             | )          | (936,238 | ) |
| **Financing activities**                                                                                                |       |                                 |       |   |   |
| Borrowings on line of credit                                                                                            |       | —                               |       | 10,750,000 |   |
| Repayments on line of credit                                                                                            |       | —                               |       | (8,000,000 | ) |
| Repayments of long-term debt                                                                                            |       | (6,465,348                           | )          | (2,500,000 | ) |
| Payments on capital leases                                                                                              |       | (194,564                             | )          | (171,257 | ) |
| Proceeds from exercises of stock options                                                                                |       | —                               |       | 1,200,000 |   |
| Net cash (used in) provided by financing activities                                                                     |       | (6,659,912                           | )          | 1,278,743 |   |
| Increase (decrease) in cash and cash equivalents                                                                        |       | (2,049,259                           | )          | 1,757,356 |   |
| Cash and cash equivalents at beginning of period                                                                        |       | 33,582,686                           |       | 22,094,693 |   |
| Cash and cash equivalents at end of period                                                                              |       | $                                    | 31,533,427 |   | $ | 23,852,048 |   |
| **Supplemental disclosure of cash flow information**                                                                    |       |                                 |       |   |   |
| Equipment acquired under capital lease                                                                                  |       | $                                    | 195,481    |   | $ | 170,077 |   |
| Accrued dividend to preferred shareholders                                                                              |       | $                                    | —     |   | $ | 3,864,989 |   |
| Interest paid                                                                                                           |       | $                                    | 11,865,690 |   | $ | 9,106,085 |   |
| Income taxes paid                                                                                                       |       | $                                    | 3,148,000  |   | $ | 500,000 |   |

 

The accompanying notes arean integral part of the unaudited condensed consolidated financial statements.

 

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**PROSPECT MEDICAL HOLDINGS, INC.**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**March 31, 2009**

 

**(Unaudited)**

 

**1. Business**

 

Prospect Medical Holdings, Inc.(“Prospect” or the “Company”) is a Delaware corporation. Prior to the August 8,2007 acquisition of Alta Hospitals System, LLC (“Alta”), which waspreviously known as Alta Healthcare System, Inc., the Company wasprimarily engaged in providing management services to affiliated physicianorganizations that operate as independent physician associations (“IPAs”) ormedical clinics. With the acquisition of Alta, the Company now owns and operatesseveral community-based hospitals in Southern California, and its operationsare now organized into three primary reportable segments: IPA Management,Hospital Services, and Corporate as discussed below.

 

***Liquidity and Recent OperatingResults***

 

As discussed in Note 7,the Company is subject to certain financial and administrative covenants, crossdefault provisions and other conditions required by the loan agreements withits lenders, including a maximum senior debt/EBITDA ratio, a minimum fixed-chargecoverage ratio and, effective May 15, 2008, a minimum EBITDA level. Whilethe Company has met all debt service requirements timely, it did not complywith certain financial and administrative covenants as of September 30,2007, December 31, 2007 and March 31, 2008. The Company and itslenders entered into a series of forbearance agreements and on May 15,2008, the credit agreements were formally modified to waive past defaults,amend certain covenant provisions prospectively and make changes to the interestrates and payment terms. These changes resulted in a substantial modificationto the credit facilities, which was accounted for as an extinguishment of theexisting debt during the quarter ended June 30, 2008, with the modifieddebt recorded as new debt.

 

The Company has met all ofthe May 15, 2008 amended financial covenant provisions for all subsequentreporting periods and continues to meet all debt service requirements on atimely basis.  However, on March 19,2009, the Company received notices from its lenders asserting that the Companywas in default of a requirement to sell certain assets by a specifieddate.  Additionally, on April 17, 2009, the Company received noticesfrom its lenders asserting that the Company’s April 14, 2009 increase inownership of Brotman Medical Center, Inc. (see Note 15) violated certainprovisions of the amended credit agreements. Based on such notices of default, the Company has classified all amountsdue under the credit agreements as current, due on demand at March 31,2009 (See Note 7). Also, due to cross default provisions, the swap liabilitywas also classified as current at March 31, 2009.  The Company has contested both assertions andis currently in discussions with its lenders to seek resolution of these matters.  However, there can be no assurance that thesematters will be resolved on a basis favorable to the Company. The lendersmay not grant waivers and could require full repayment of the loans andsettlement of the swap liability, which would negatively impact the Company’sliquidity, it’s ability to operate and raises substantial doubt about itsability to continue as a going concern. The lenders also began assessing default interest (additional 2% perannum) effective with the first asserted event of default, or as of March 19,2009.

 

During the six-month periodended March 31, 2009 and fiscal 2008 and 2007, the Company reportedoperating losses associated with legacy IPA entities within its IPA Managementsegment. Any future improvement of the Company’s legacy IPA Managementoperations will require significant investment and management attention.Management is reviewing its operations to improve profitability and efficiencyand to reduce costs, which may include the divestiture of non-strategic assets (seeNote 4).

 

Management has implemented aplan to improve the operating results of the legacy IPA Management operation,including measures to retain enrollment, increase health plan reimbursement andreduce medical and operating costs. However, there can be no assurance that theCompany’s operational improvement efforts will have a successful outcome andthat the Company will be able to meet all of the financial covenants and otherconditions required by the loan agreements for future periods.

 

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*** ***

***IPA Management***

 

The IPA Management segmentis comprised of Prospect Medical Systems and ProMed HealthCare Administrators,two health care management services organizations that provide managementservices to affiliated physician organizations that operate as IPAs. Theaffiliated physician organizations enter into agreements with healthmaintenance organizations (“HMOs”) to provide enrollees of the HMOs with a fullrange of medical services in exchange for fixed, prepaid monthly fees known as “capitation”payments. The IPAs contract with physicians (primary care and specialist) andother health care providers to provide all of their medical services.

 

***Hospital Services***

 

Alta, which was acquired on August 8,2007, is a wholly-owned subsidiary of Prospect Medical Holdings, Inc. Altaowns and operates (i) Alta Hollywood Hospitals, Inc., a Californiacorporation dba Hollywood Community Hospital and Van Nuys Community Hospital;and (ii) Alta Los Angeles Hospitals, Inc., a California corporationdba Los Angeles Community Hospital and Norwalk Community Hospital. As of March 31,2009, Alta and its subsidiaries (collectively, the “Hospital Services segment”)owns and operates four hospitals in the greater Los Angeles area, with acombined 339 licensed beds, served by 315 on-staff physicians.  The hospitals in Hollywood, Los Angeles andNorwalk offer a comprehensive range of medical and surgical services, includinginpatient, outpatient, skilled nursing and urgent care services. The hospitalin Van Nuys provides acute inpatient and outpatient psychiatric services topatients who are admitted on a voluntary basis. Admitting physicians areprimarily practitioners in the local area. The hospitals have paymentarrangements with Medicare, Medi-Cal (the California version of Medicaid) andother third-party payers, including some commercial insurance carriers, HMOsand preferred provider organizations (“PPOs”). Effective April 14, 2009 (the “Effective Date”), the Companyincreased its approximately 33.1% ownership stake in Brotman Medical Center, Inc.,a California corporation (“Brotman”), to approximately 71.9% via an incrementalinvestment of approximately $2.5 million, $1.8 million of which had been paidas of March 31, 2009 and $0.7 million of which will be paid within sixmonths thereafter.  Brotman is a 420-bedlicensed and accredited acute care hospital located in Culver City,California.  The Company will beginconsolidating the results of Brotman, as part of its Hospital Services segment,as of the Effective Date, and expects to file it’s amended Form 8K(A) withproforma financial informtion by no later than June 30, 2009.  Accordingly, results for the second quarterof fiscal 2009 exclude Brotman.

 

**2. Summary of Significant Accounting Policies**

 

***Basis of Presentation***

 

The accompanying unauditedcondensed consolidated financial statements of the Company have been preparedin conformity with generally accepted accounting principles in the UnitedStates of America (“U.S. GAAP”) for interim consolidated financial informationand with the instructions for Form 10-Q and Article 10 of RegulationS-X.  In accordance with the instructionsand regulations of the Securities and Exchange Commission (“SEC”) for interimreports, certain information and footnote disclosures normally included infinancial statements prepared in conformity with U.S. GAAP for annual reportshave been omitted or condensed.  Alladjustments (consisting of normal recurring adjustments) and disclosuresconsidered necessary for fair presentation have been included in theaccompanying unaudited condensed consolidated financial statements.

 

The results of operationsfor the three months and six months ended March 31, 2009 are notnecessarily indicative of the results to be expected for the full year. Theinformation included in this Quarterly Report on Form 10-Q should be readin conjunction with the audited consolidated financial statements for the yearended September 30, 2008 and notes thereto included in the Company’sAnnual Report on Form 10-K filed with the SEC on December 29, 2008.

 

***Principles of Consolidation***

 

The unaudited interimcondensed consolidated financial statements include the accounts of the Companyand all majority owned subsidiaries and controlled entities under EmergingIssues Task Force (“EITF”) No. 97-2, “*Applicationof FASB Statement No. 94 and APB Opinion No. 16 to Physician PracticeManagement Entities and Certain Other Entities with Contractual ManagementArrangements”* and Financial Accounting Standards Board (“FASB”)Interpretation No. 46, “*Consolidationof Variable Interest Entities, an Interpretation of ARB No. 51*”(“FIN 46”). All adjustments considered necessary for a fair presentationof the 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.

 

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***Discontinued Operations***

 

As discussed in Note 4,effective August 1, 2008, the Company sold all of the issued andoutstanding stock of Sierra Medical Management (“SMM”), Sierra Primary CareMedical Group, Antelope Valley Medical Associates, Inc. and PegasusMedical Group, Inc., (collectively, the “AV Entities”) to a third party.As required by the Statement of Financial Accounting Standards (“SFAS”) No. 144,“*Accounting for the Impairment or Disposalof Long-Lived Assets*” (“SFAS No. 144”), the assets andliabilities of the AV Entities and their operations have been presented in thecondensed consolidated financial statements as discontinued operations for allperiods presented. All prior year amounts have been reclassified in accordancewith the provisions of SFAS No. 144. All references to operating resultsreflect the ongoing operations of the Company, excluding the AV Entities,unless otherwise noted.

 

***Revenues***

 

Revenues by reportablesegment are comprised of the following amounts:

 
| ** **                        | ** ** | **Three Months Ended  March 31,** | ** ** | **Six Months Ended  March 31,** | ** ** |
|-----------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                        | ** ** | **2009**                               | ** ** | **2008(1)**                          | ** ** | **2009** | ** ** | **2008(1)** | ** ** |
| IPA Management                    |       |                                   |       |                                 |       |   |   |   |   |
| Capitation                        |       | $                                      | 47,874,277 |                                 | $          | 50,464,854 |   | $ | 95,636,452 |   | $ | 100,775,264 |   |
| Management fees                   |       | 143,863                                |       | 146,767                              |       | 288,195 |   | 254,395 |   |
| Other                             |       | 140,962                                |       | 69,352                               |       | 365,704 |   | 219,870 |   |
| Total revenues: IPA Management    |       | $                                      | 48,159,102 |                                 | $          | 50,680,973 |   | $ | 96,290,351 |   | $ | 101,249,529 |   |
| Hospital Services                 |       |                                   |       |                                 |       |   |   |   |   |
| Inpatient                         |       | $                                      | 35,560,711 |                                 | $          | 30,159,537 |   | $ | 68,800,172 |   | $ | 55,250,624 |   |
| Outpatient                        |       | 1,941,093                              |       | 1,860,356                            |       | 3,663,137 |   | 3,581,715 |   |
| Other                             |       | 406,229                                |       | 376,233                              |       | 767,131 |   | 850,015 |   |
| Total revenues: Hospital Services |       | $                                      | 37,908,033 |                                 | $          | 32,396,126 |   | $ | 73,230,440 |   | $ | 59,682,354 |   |
| Total revenues                    |       | $                                      | 86,067,135 |                                 | $          | 83,077,099 |   | $ | 169,520,791 |   | $ | 160,931,883 |   |

 

----

(1)               The above amounts excluderevenue related to the AV Entities, given their classification as discontinuedoperations in the accompanying Condensed Consolidated Financial Statements.

 

The Company presents segmentinformation externally the same way management uses financial data internallyto make operating decisions and assess performance. With the acquisition ofAlta in August 2007, the Company’s operations are now organized into threereporting segments: (i) IPA Management, (ii) Hospital Services, and (iii) Corporate(see Note 9). Corporate represents expenses incurred in Prospect MedicalHoldings, Inc., which were not allocated to the IPA Management andHospital Services segments.

 

***Comprehensive Income (Loss)***

 

Comprehensive income (loss)includes net income (loss) and changes in the fair value of interest rate swapssubject to hedge accounting that are recorded as other comprehensive income. Asof April 1, 2008, the swaps ceased to be eligible for hedge accountingunder SFAS No. 133, “*Accounting For DerivativesAnd Hedging Activities*” (“SFAS No. 133”). As a result, allsubsequent changes in the fair value of the swaps were recorded in thecondensed consolidated statements of operations and the effective portion ofthe swaps of approximately $5.4 million, after tax, that was recorded inother comprehensive income through March 31, 2008 continues to beamortized to interest expense, using the effective interest method, over theremaining life of the swaps.

 

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The components ofcomprehensive income (loss) for the periods ended March 31 are as follows:

 
| ** **                                                    | ** ** | **Three Months Ended  March 31,** | ** ** | **Six Months Ended  March 31,** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                                                    | ** ** | **2009**                               | ** ** | **2008**                             | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net income (loss) including discontinued operations           |       | $                                      | 3,548,239  |                                 | $          | 727,987 |   | $ | 103,739 |   | $ | 230,988 |   |
| Change in fair value of interest rate swaps, net of tax       |       | —                                 |       | (2,951,145                           | )          | — |   | (5,153,624 | ) |
| Amortization of fair value of interest rate swaps, net of tax |       | 219,918                                |       | —                               |       | 439,836 |   | — |   |
| Comprehensive income (loss)                                   |       | $                                      | 3,768,157  |                                 | $          | (2,223,158 | ) | $ | 543,575 |   | $ | (4,922,636 | ) |

 

**3. Equity-Based Compensation Plans**

 

On August 13, 2008, followingstockholder approval, the Company adopted the 2008 Omnibus Equity IncentivePlan (“2008 Plan”) to provide flexibility in implementing equity awards,including incentive stock options (“ISO”), non-qualified stock options (“NQSO”),restricted stock grants, stock appreciation rights (“SAR”) and performancebased awards to employees, directors and outside consultants, as determined bythe Compensation Committee of the Board of Directors (the “Committee”). Inconjunction with the adoption of the 2008 Plan, effective August 13, 2008,additional equity awards under the Company’s 1998 Stock Option Plan (“1998 Plan”)have been discontinued and new equity awards are now granted under the 2008Plan. Remaining authorized shares under the 1998 Plan that were not subject tooutstanding awards as of August 13, 2008, were canceled on August 13,2008. The 1998 Plan will remain in effect as to outstanding equity awardsgranted under the 1998 Plan prior to August 13, 2008. At the inception ofthe 2008 Plan, 4,000,000 shares were reserved for issuance under the Plan. Asof March 31, 2009, there were 1,896,250 shares available for future grantsunder the 2008 Plan.

 

Under the terms of the 2008Plan, the exercise price of an ISO may not be less than 100% of the fair marketvalue of the Company’s Common Stock on the date of grant and, if granted to ashareholder owning more than 10% of the Company’s Common Stock, then not lessthan 110%. Stock options granted under the 2008 Plan have a maximum term of10 years from the grant date, and will be exercisable at such time andupon such terms and conditions as determined by the Committee. Stock optionsgranted to employees generally vest over four years, while options granted tocertain executives typically vest over a shorter period, subject to continuedservice. In the case of an ISO, the amount of the aggregate fair market valueof Common Stock (determined at the time of grant) with respect to which ISO areexercisable for the first time by an employee during any calendar year may notexceed $100,000.

 

The base price, above whichany appreciation of a SAR issued under the 2008 Plan is measured, will in noevent be less than 100% of the fair market value of the Company’s stock on thedate of grant of the SAR or, if the SAR is granted in tandem with a stockoption, the exercise price under the associated option. The restrictionsimposed on shares granted under a restricted stock award will lapse inaccordance with the vesting requirements specified by the Committee in theaward agreement. Such vesting requirements may be based on the continuedservice of the participant with the Company for a specified time, or on theattainment of specified performance goals established by the Committee in itsdiscretion. If the vesting requirements of a restricted stock award are notsatisfied prior to the termination of the participant’s service, the unvestedportion of the award will be forfeited and the shares of Common Stock subjectto the unvested portion of the award will be returned to the Company.

 

***Stock Options Activities***

 

The following tablesummarizes information about our stock options outstanding at March 31,2009 and activity during the six-month period then ended:

 
| ** **                                       | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Aggregate  Intrinsic  Value** | ** ** | **Weighted  Average  Remaining  Contractual  Term  (Months)** | ** ** |
|--------------------------------------------------|------------|------------|------------|----------------------------------------|------------|---------------------------------|------------|---------------------------------------------------------------|------------|
| Outstanding as of September 30, 2008        |       | 5,087,637  |       | $                                      | 3.17       |                            |       |                                                          |       |   |
| Granted                                          |       | 57,500     |       | $                                      | 2.25       |                            |       |                                                          |       |   |
| Exercised                                        |       | —     |       | $                                      | —     |                            |       |                                                          |       |   |
| Forfeited                                        |       | (692,180   | )          | $                                      | 4.56       |                            |       |                                                          |       |   |
| Outstanding as of March 31, 2009            |       | 4,452,957  |       | $                                      | 2.94       |                            | $          | —                                                        |       | 41 |   |
| Vested and Exercisable as of March 31, 2009 |       | 2,896,331  |       | $                                      | 3.20       |                            | $          | —                                                        |       | 35 |   |

 

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The aggregate intrinsic valueof the options exercised during the six months ended March 31, 2008 was$741,700.

 

The aggregate intrinsicvalue is calculated as the difference between the exercise price of theunderlying awards and the quoted price of our common stock for those awardsthat have an exercise price currently below the quoted value. As discussed inNote 7, due to untimely filing of its Form 10-K for the year ended December 31,2007 and its Forms 10-Q for the quarters ended December 31, 2007 and March 31,2008, trading of the Company’s shares was suspended effective January 16,2008. As such, the aggregate intrinsic value of the outstanding and the vestedand exercisable stock options at March 31, 2008, could not be determined.

 

***Stock-Based Compensation Expense***

 

Under SFAS No. 123(R), “*Share-Based Payment*,” compensation costfor all share-based payments in exchange for employee services (including stockoptions and restricted stock) is measured at fair value on the date of grant,estimated using an option pricing model.

 

Compensation costs forstock-based awards are measured and recognized in the financial statements, netof estimated forfeitures over the awards’ requisite service period. The Companyuses the Black-Scholes option pricing model and a single option award approachto estimate the fair value of options granted. Estimated forfeitures will berevised in future periods if actual forfeitures differ from the estimates andwill impact compensation cost in the period in which the change in estimateoccurs. The determination of fair value using the Black-Scholes option-pricingmodel is affected by the Company’s stock price as well as assumptions regardinga number of complex and subjective variables, including expected stock pricevolatility, risk-free interest rate, expected dividends and projected employeestock option exercise behaviors. Equity-based compensation is classified withinthe same line items as cash compensation paid to employees. Cash retained as aresult of excess tax benefits relating to share-based payments are presented inthe statement of cash flows as a financing cash inflow.

 

The weighted averageassumptions used in determining the value of options granted and a summary ofthe methodology applied to develop each assumption are as follows:

 
| ** **                                                           | ** ** | **Six Months Ended  March 31, 2009** | ** ** |
|----------------------------------------------------------------------|------------|-------------------------------------------|------------|
| Weighted average fair value of option grants                         |       | $0.71                                     |       |
| Market price of the Company’s common stock on the date of grant |       | $2.25                                     |       |
| Weighted average expected life of the options                        |       | 3.18 years  — 3.5 years    |       |
| Risk-free interest rate                                              |       | 1.07%                                     |       |
| Weighted average expected volatility                                 |       | 43.14%                                    |       |
| Dividend yield                                                       |       | 0.00%                                     |       |

 

Expected Term—The expectedterm of options granted represents the period of time that they are expected tobe outstanding. The Company has adopted the “simplified method” of determiningthe expected term for “plain vanilla” options, as allowed under StaffAccounting Bulletin (SAB) No. 107. The “simplified method” states that theexpected term is equal to the sum of the vesting term plus the contract term,divided by two. “Plain vanilla” options are defined as those grantedat-the-money, having service time vesting as a condition to exercise, providingthat non-vested options are forfeited upon termination and that there is alimited time to exercise the vested options after termination of service,usually 90 days, and providing the options are non-transferable andnon-hedgeable. We will continue to gather additional information about theexercise behavior of participants and will adjust the expected term of ouroption awards to reflect the actual exercise experience when such historicalexperience becomes sufficient.

 

Expected Volatility—TheCompany estimates the volatility of the common stock at the date of grant basedon the average of the historical volatilities of a group of peer companies.Since the Company’s shares did not become publicly traded until May 2005,management believes there is currently not enough historical volatility dataavailable to predict the stock’s future volatility. The Company has identifieda group of comparable companies to calculate historical volatility frompublicly available data for sequential periods approximately equal to theexpected terms of the option grants. In selecting comparable companies,management considered several factors including industry, stage of development,size and market capitalization.

 

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Risk-Free Interest Rate—TheCompany bases the risk-free interest rate on the implied yield in effect at thetime of option grant on U.S. Treasury zero-coupon issues with equivalentremaining terms.

 

Dividends—The Company hasnever paid any cash dividends on its common stock and does not anticipatepaying any cash dividends in the foreseeable future.

 

Forfeitures—Share basedcompensation is recognized only for those awards that are ultimately expectedto vest. Compensation expense is recorded net of estimated forfeitures. Thoseestimates are revised in subsequent periods if actual forfeitures differ fromthose estimates. The Company used historical data since May 2005 toestimate pre-vesting option forfeitures for all our employees on a combinedbasis.

 

Stock-based compensationexpense, related to stock options under the fair value method, recognized inthe six months ended March 31, 2009 and 2008 was approximately $502,000and $58,000, respectively. At March 31, 2009, there were 1,566,626unvested options with related compensation expense of approximately $735,000,which will be recognized ratably over a weighted average remaining vestingperiod of 53 months.

 

***Restricted Stock Award Activities***

 

As of March 31, 2009,the Company had 66,667 unvested shares of restricted stock outstanding thatwere granted on August 15, 2008, with a weighted-average grant date fairvalue of $2.40 and an aggregated unrecognized compensation expense ofapproximately $56,000. Compensation expense of approximately $80,000 wasrecorded during the six months ended March 31, 2009.

 

**4. Discontinued Operations**

 

On August 1, 2008, theCompany sold all of the outstanding stock of Sierra Medical Management, Inc.(“SMM”), a management subsidiary, and all of the outstanding stock of SierraPrimary Care Medical Group, Antelope Valley Medical Associates, Inc. andPegasus Medical Group, Inc., each of which is an independent physicianassociation (collectively with SMM, the “AV Entities”) pursuant to a StockPurchase Agreement (“SPA”). As part of the sale, the Company also entered intoa non-competition agreement in the Antelope Valley region of Los Angeles Countyfor the benefit of the buyer.

 

Total consideration paid bythe buyer was $8,000,000, of which $2,000,000 was paid into an escrow accountto fund certain AV Entities’ liabilities and approximately $815,000 was paiddirectly to AV Entities’ vendors, employees and physicians. Of the remainingamount totaling approximately $5,185,000, $4,219,000 was paid directly to theCompany’s lenders as required under the modified debt facilities, and approximately$966,000 was retained by the Company for transaction expenses and the requiredbalance sheet reconciliation items.

 

The Company recorded a gainof approximately $7.1 million in connection with this transaction in thefourth quarter of fiscal 2008. The SPA contains certain post-acquisitionpurchase price adjustment provisions for working capital and claims liabilitieswhich require a final determination of the gain by August 10, 2010. Oncethe purchase price has been finalized and the net gain on the transactiondetermined, any adjustment to the gain will be recorded in discontinuedoperations.

 

Pursuant to SFAS No. 144and EITF Issue 03-13, “*Applying theConditions in Paragraph 42 of FASB Statement No. 144 in DeterminingWhether to Report Discontinued Operations*,” the AV Entities havebeen classified as discontinued operations for all periods presented. Asdiscontinued operations, revenues and expenses of the AV Entities have beenaggregated and stated separately from the respective captions of continuingoperations in the unaudited interim condensed consolidated statements ofoperations. Expenses include direct costs of the business that will beeliminated from future operations as a result of the sale. The Company alsoallocated interest expense associated with the portion of debt required to berepaid for the six months ended March 31, 2008 to discontinued operationsin accordance with EITF Issue 87-24, “*Allocationof Interest to Discontinued Operations.*”

 

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The results of operations ofthe AV Entities reported as discontinued operations are summarized as follows:

 
| ** **                        | ** ** | **Three Months Ended  March 31, 2008** | ** ** | **Six Months Ended  March 31, 2008** | ** ** |
|-----------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| Managed care revenues             |       | $                                           | 4,265,647  |                                      | $          | 8,671,476 |   |
| Operating expenses:               |       |                                        |       |                                      |       |
| Managed care cost of revenues     |       | 2,622,153                                   |       | 5,743,831                                 |       |
| General and administrative        |       | 1,655,563                                   |       | 3,314,551                                 |       |
| Depreciation and amortization     |       | 11,131                                      |       | 37,441                                    |       |
| Total operating expenses          |       | 4,288,847                                   |       | 9,095,823                                 |       |
| Operating loss                    |       | (23,200                                     | )          | (424,347                                  | )          |
| Other expense                     |       | 89,143                                      |       | 185,774                                   |       |
| Loss before income taxes          |       | (112,343                                    | )          | (610,121                                  | )          |
| Income tax benefit                |       | (36,600                                     | )          | (218,222                                  | )          |
| Loss from discontinued operations |       | $                                           | (75,743    | )                                         | $          | (391,899 | ) |

 

**5. Earnings per Share**

 

The Company follows SFAS No. 128,“*Earnings per Share,*” whichestablished standards regarding the computation of basic and diluted earningsper share (“EPS”). Basic net income (loss) per share is calculated by dividingnet income (loss) attributable to common stockholders by the weighted averagenumber of common shares outstanding. Diluted earnings (loss) per share iscomputed by dividing net income (loss) attributable to common stockholders bythe weighted average number of common shares outstanding, after giving effectto potentially dilutive shares computed using the treasury stock method. Suchshares are excluded if determined to be anti-dilutive.

 

The calculations of basicand diluted net income (loss) per share for the three months and six monthsended March 31, 2009 and 2008 are as follows:

 
| ** **                                                              | ** ** | **Three Months Ended  March 31,** | ** ** | **Six Months Ended  March 31,** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                                                              | ** ** | **2009**                               | ** ** | **2008**                             | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Basic:**                                                              |       |                                   |       |                                 |       |   |   |   |   |
| Continuing operations                                                   |       | $                                      | 3,548,239  |                                 | $          | 803,730 |   | $ | 103,739 |   | $ | 622,887 |   |
| Dividends to preferred stockholders                                     |       | —                                 |       | (1,982,999                           | )          | — |   | (3,864,989 | ) |
|                                                                    |       | 3,548,239                              |       | (1,179,269                           | )          | 103,739 |   | (3,242,102 | ) |
| Discontinued operations                                                 |       | —                                 |       | (75,743                              | )          | — |   | (391,899 | ) |
| Net income (loss) attributable to common stockholders                   |       | $                                      | 3,548,239  |                                 | $          | (1,255,012 | ) | $ | 103,739 |   | $ | (3,634,001 | ) |
| Weighted average number of common shares outstanding                    |       | 20,508,444                             |       | 11,782,567                           |       | 20,508,444 |   | 11,747,942 |   |
| Basic net income (loss) per share attributable to common  stockholders: |       |                                   |       |                                 |       |   |   |   |   |
| Continuing operations                                                   |       | $                                      | 0.17       |                                 | $          | (0.10 | ) | $ | 0.01 |   | $ | (0.28 | ) |
| Discontinued operations                                                 |       | $                                      | —     |                                 | $          | (0.01 | ) | $ | — |   | $ | (0.03 | ) |
|                                                                    |       | $                                      | 0.17       |                                 | $          | (0.11 | ) | $ | 0.01 |   | $ | (0.31 | ) |

 

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| ** **                                                                                                 | ** ** | **Three Months Ended  March 31,** | ** ** | **Six Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2009**                               | ** ** | **2008**                             | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Diluted:**                                                                                               |       |                                   |       |                                 |       |   |   |   |   |
| Continuing operations                                                                                      |       | $                                      | 3,548,239  |                                 | $          | (1,179,269 | ) | $ | 103,739 |   | $ | (3,242,102 | ) |
| Discontinued operations                                                                                    |       | —                                 |       | (75,743                              | )          | — |   | (391,899 | ) |
| Net income (loss) attributable to common stockholders                                                      |       | $                                      | 3,548,239  |                                 | $          | (1,255,012 | ) | $ | 103,739 |   | $ | (3,634,001 | ) |
| Weighted average number of common shares outstanding                                                       |       | 20,508,444                             |       | 11,782,567                           |       | 20,508,444 |   | 11,747,942 |   |
| Weighted average number of dilutive common equivalents from options  and warrants to purchase common stock |       | 170,803                                |       | —                               |       | 173,078 |   | — |   |
|                                                                                                       |       | 20,679,247                             |       | 11,782,567                           |       | 20,681,522 |   | 11,747,942 |   |
| Diluted net income (loss) earnings per share attributable to common  stockholders                          |       |                                   |       |                                 |       |   |   |   |   |
| Continuing operations                                                                                      |       | $                                      | 0.17       |                                 | $          | (0.10 | ) | $ | 0.01 |   | $ | (0.28 | ) |
| Discontinued operations                                                                                    |       | $                                      | —     |                                 | $          | (0.01 | ) | $ | — |   | $ | (0.03 | ) |
|                                                                                                       |       | $                                      | 0.17       |                                 | $          | (0.11 | ) | $ | 0.01 |   | $ | (0.31 | ) |

 

The number of stock optionsand warrants excluded from the computation of diluted earnings per share duringthe three and six months ended March 31, 2009 were 4,452,957 and 475,774respectively, prior to the application of the treasury stock method, due totheir anti-dilutive effect. Due to net losses, all potentially dilutivesecurities were excluded from the calculation of diluted loss per share attributableto common stockholders during the three and six months ended March 31,2008, as their effect would be anti-dilutive. The number of stock options andwarrants excluded from the computation of diluted earnings per share during thethree and six months ended March 31, 2008 were 1,830,886, and 1,016,536,respectively. 1,672,880 Series B preferred shares were also excluded fromdiluted earnings per share during the three months and six months ended March 31,2008, since their conversion was contingent upon stockholder approval and wouldhave been anti-dilutive.

 

Following stockholderapproval on August 13, 2008, the holders of all of the outstanding sharesof Series B Preferred Stock elected to convert their preferred shares intoCommon Stock. The former holders also ceased to have any right to receivedividends on the preferred shares. All such dividends terminated and ceased toaccrue, and all previously accrued dividends through August 13, 2008 wereforgiven and the liability was reclassified to additional paid-in capital.Accordingly, an adjustment to additional paid-in-capital in the amount of$7,881,890 was recorded as of that date.

 

The following proforma basicand diluted earnings per share assume the conversion of preferred shares intocommon stock at a ratio of 1:5 at the beginning of the quarter ended December 31,2007:

 
| ** **                                                                                                           | ** ** | **Three Months Ended  March 31, 2008** | ** ** | **Six Months Ended  March 31, 2008** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| Basic and diluted:                                                                                                   |       |                                        |       |                                      |       |
| Income from continuing operations                                                                                    |       | $                                           | 803,730    |                                      | $          | 622,887 |   |
| Loss from discontinued operations                                                                                    |       | (75,743                                     | )          | (391,899                                  | )          |
| Net income attributable to common stockholders—proforma                                                         |       | $                                           | 727,987    |                                      | $          | 230,988 |   |
| Weighted average number of common shares outstanding—historical                                                 |       | 11,782,567                                  |       | 11,747,942                                |       |
| Add weighted number of preferred shares converted to common shares                                                   |       | 8,364,400                                   |       | 8,364,400                                 |       |
| Add weighted average number of dilutive common equivalent shares from  options and warrants to purchase common stock |       | *—                                     |       | *—                                   |       |
| Weighted average number of common shares outstanding—proforma                                                   |       | 20,146,967                                  |       | 20,112,342                                |       |
| Basic and diluted net income per share—proforma                                                                 |       | $                                           | 0.04       |                                      | $          | 0.03 |   |
| Continuing operations                                                                                                |       | $                                           | —     |                                      | $          | (0.02 | ) |
| Discontinued operations                                                                                              |       | $                                           | 0.04       |                                      | $          | 0.01 |   |

 

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* No effect has been givento the dilutive common equivalent shares from options and warrants since theCompany’s common stock suspended trading during the period January 16,2008 through June 17, 2008 and thus, the weighted average share pricecannot be determined for the periods presented.

 

**6. Related Party Transactions**

 

Prospect Medical Holdings, Inc.has a controlling financial interest in the affiliated physician organizationsincluded in its unaudited interim condensed consolidated financial statementswhich are owned by a nominee physician shareholder designated by the Company.The control is effectuated through assignable option agreements and managementservices agreements, which provide the Company a unilateral right to establishor effect a change of the nominee shareholder for the affiliated physicianorganizations at will, and without the consent of the nominee, on an unlimitedbasis and at nominal cost through the term of the management agreement. JacobY. Terner, M.D. was, through August 8, 2008, the sole shareholder, soledirector and Chief Executive Officer of Prospect Medical Group, Inc. (“PMG”)and was the Chief Executive Officer of each of PMG’s subsidiary physicianorganizations, except for AMVI/Prospect Health Network and Nuestra FamiliaMedical Group. Dr. Terner is a shareholder of the Company, and formerlyserved as its Chairman and Chief Executive Officer through part of fiscal 2008.

 

The Company had anemployment agreement with Dr. Terner that expired on August 1, 2008and provided for base compensation (most recently $400,000 per year) andfurther provided that if the Company terminated Dr. Terner’s employmentwithout cause, the Company would be required to pay him $12,500 for each monthof past service as the Chief Executive Officer, commencing as of July 31,1996, up to a maximum of $1,237,500. Dr. Terner resigned as the ChiefExecutive Officer of the Company effective March 19, 2008 and resigned asthe chairman of the board of directors effective May 12, 2008. Inconsideration of Dr. Terner’s resignation and other provisions in hisresignation agreement, the Company agreed to pay to his family trust the sum of$19,361 each month during the twelve-month period ending on April 30, 2009and the sum of $42,694 each month during the twenty-four month period ending onApril 30, 2011, for the total sum of $1,257,000, which amount was recordedas a general and administrative expense in fiscal 2008.

 

Dr. Terner continued toserve temporarily as the sole shareholder, sole director and Chief ExecutiveOfficer of Prospect Medical Group, Inc. and its subsidiary physicianorganizations until a suitable replacement was found. Dr. Arthur Lippercurrently serves as the nominee shareholder of Prospect Medical Group and asthe sole director of all subsidiary physician organizations (except NuestraFamilia Medical Group, where he is one of two directors) and the ChiefExecutive Officer, President and Treasurer of all legacy subsidiary physicianorganizations (i.e., not including the ProMed Entities).

 

Through the ProMedAcquisition (See Note 8), the Company acquired the lease of an office facilitywhich is jointly owned by a former officer of the ProMed Entities. The totallease payments during the six months ended March 31, 2009 and 2008 underthat lease were approximately $240,000 and $232,000, respectively.

 

**7. Debt**

 

Debt at March 31, 2009and September 30, 2008, respectively, consists of the following:

 
| ** **                  | ** ** | **March 31,  2009** | ** **  | **September 30,  2008** | ** ** |
|-----------------------------|------------|--------------------------|-------------|------------------------------|------------|
| ** **                  | ** ** | **(unaudited)**          | ** **  | ** **                   | ** ** |
| Term loans                  |       | $                        | 130,732,056 |                         | $          | 136,920,730 |   |
| Revolving credit facility   |       | 7,100,000                |        | 7,100,000                    |       |
|                        |       |                     | 137,832,056 |                         |       | 144,020,730 |   |
| Less current maturities (*) |       | (137,832,056             | )           | (12,100,000                  | )          |
| Long-term portion           |       | $                        | —      |                         | $          | 131,920,730 |   |

 

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* Due to default on theamended credit facility agreements (see below), all payments due after 12months, as of March 31, 2009, were reclassified as current.

 

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On June 1, 2007, theCompany entered into a three-year senior secured credit facility with Bank ofAmerica, N.A. in connection with the purchase of the ProMed Entities (seeNote 8). The Bank of America facility totaled $53,000,000, and wascomprised of a $48,000,000 variable-rate term loan and a $5,000,000 revolver(which was not drawn at the date of acquisition). $8,051,000 of the term loanproceeds were used to repay existing debt and the balance was used to financethe ProMed Acquisition. The $48,000,000 term loan was repaid on August 8,2007, with proceeds from a new $155,000,000 syndicated senior secured creditfacility arranged by Bank of America in connection with the acquisition of Alta(see Note 8), comprised of a $95,000,000 seven-year first-lien term loan atLIBOR plus 400 basis points, with quarterly principal payments of $1,250,000and an annual principal payment of 50% of excess cash flow, as defined in theloan agreement; a $50,000,000 seven and one-half year second-lien term loan atLIBOR plus 825 basis points, with all principal due at maturity and a revolvingcredit facility of $10,000,000 bearing interest at prime plus a margin thatranged from 275 to 300 basis points based on the consolidated leverage ratio.The Company could borrow, make repayments and re-borrow under the revolveruntil August 8, 2012, at which time all outstanding amounts must berepaid.

 

The Company recorded aninterest charge of $895,914 to write off deferred financing costs upon theextinguishment of the $53 million credit facility and capitalizedapproximately $6.9 million in deferred financing costs on the$155 million credit facility in August 2007, which was beingamortized over the term of the related debt using the effective interestmethod.

 

The Company is subject tocertain financial and administrative covenants, cross default provisions andother conditions required by the loan agreements with the lenders, including amaximum senior debt/EBITDA (earnings before interest, taxes, depreciation andamortization) ratio, and a minimum fixed-charge coverage ratio, and, effective May 15,2008, a minimum EBITDA level, each computed quarterly (except for the testperiods from April 30, 2008 through June 30, 2009, when computationsare monthly) based on consolidated trailing twelve-month operating results. Theadministrative covenants and other restrictions with which the Company mustcomply include, among others, restrictions on additional indebtedness, incurrenceof liens, engaging in business other than the Company’s primary business,paying dividends, acquisitions and asset sales. The credit facilities providethat an event of default will occur if there is a change in control of theCompany. The payment of principal and interest under the credit facilities isguaranteed, jointly and severally, by the Company and most of its existingwholly-owned subsidiaries. Substantially all of the Company’s assets arepledged to secure the credit facilities.

 

***Default and Debt Modification***

 

The Company exceeded themaximum senior debt/EBITDA ratio of 3.75 as of September 30, 2007, December 31,2007 and March 31, 2008. The Company also failed to meet the minimum fixedcharge coverage ratio of 1.25 as of and for the trailing twelve-month periodsended December 31, 2007 and March 31, 2008. In addition, the Companydid not comply with certain administrative covenants, including the timelyfiling of its Form 10-K for the year ended September 30, 2007 and itsForms 10-Q for the quarters ended December 31, 2007 and March 31,2008.

 

On February 13, 2008, April 10,2008 and May 14, 2008, the Company and its lenders entered intoforbearance agreements, whereby the lenders agreed not to exercise their rightsunder the credit facilities through May 15, 2008, subject to satisfactionof specified conditions. For the period January 28, 2008 through April 10,2008, interest was assessed at default rates of 11.4% with respect to the firstlien term loan and 15.4% with respect to the second-lien term loan. Under the April 2008forbearance agreements, the applicable margins on the first and second lienterm loans were permanently increased to 750 and 1,175 basis points,respectively, and the range of applicable margins on the revolving line ofcredit was increased from 500 to 750 basis points effective April 10,2008. The modified agreements also stipulate that the LIBOR rate shall not beless than 3.5% for the term of the credit facilities. Additionally, theavailable line of credit under the revolving credit facility was permanentlyreduced from $10,000,000 to $7,250,000. The Company also agreed to pay certainfees and expenses to the lenders and their advisors.

 

On May 15, 2008, theCompany and its lenders entered into agreements to waive past covenantviolations and amended the financial covenant provisions prospectively,starting in April 2008, to modify the required ratios and to increase thefrequency of compliance reporting from quarterly to monthly for a specifiedperiod. Effective May 15, 2008, the maximum senior debt/EBITDA ratios wereincreased to levels ranging from 3.90 to 7.15 for future monthly reportingperiods from April 30, 2008 through June 30, 2009 and were increasedto levels ranging from 3.30 to 3.75 beginning with the September 30, 2009quarterly reporting period, through maturity of the term loan. The minimumfixed charge coverage ratios were reduced to levels ranging from 0.475 to 0.925for monthly reporting periods from April 30, 2008 through June 30,2009 and were reduced to levels ranging from 0.85 to 0.90 beginning with the September 30,2009 quarterly reporting period, through maturity of the term loan. The Companyis also required to meet a new minimum EBITDA requirement for monthly reportingperiods from April 30, 2008 through June 30, 2009 and the remainingquarterly reporting periods through maturity of the term loan.

 

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In connection with obtainingforbearance and waivers of past covenant violations, during the second andthird quarters of fiscal 2008, the Company paid $450,000 in fees to Bank ofAmerica, which was included in general and administrative expenses and $1,525,000in forbearance fees to the lenders, which was included in interest expense. Inaddition, the Company incurred $860,000 in legal and consulting fees to thelenders’ advisors related to the forbearance activities, which was included ingeneral and administrative expenses. Pursuant to the amended senior creditfacility agreement, the Company was also required to pay an amendment fee of$758,000 in cash and to add 1% to the principal balance of the first andsecond-lien debt and the revolving line of credit, totaling $1,514,000. Theamendment fees were expensed as loss on debt extinguishment in the thirdquarter of 2008. The Company also began to incur an additional 4%payment-in-kind (“PIK”) interest expense on the second lien debt, which accruedand was added to the principal balance on a monthly basis. The 4% could bereduced on a quarterly basis by 0.50% for each 0.25% reduction in the Company’sconsolidated leverage ratio.  Effective January 2009,the Company’s consolidated leverage ratio had been sufficiently reduced to endthis PIK interest accrual.

 

In the third quarter offiscal 2008, the Company accounted for the modifications of its first andsecond-lien term debt in accordance with EITF Issue 96-19, “*Debtor’s Accounting for a Modification or Exchange ofDebt Instruments*,” and the modification of its revolving creditfacility in accordance with EITF Issue 98-14, “*Debtor’sAccounting for Changes in Line-of-Credit or Revolving Debt Arrangements*.”Pursuant to EITF Issue 96-19 and EITF Issue 98-14, the Company is required toaccount for these modifications as debt extinguishments if the terms of thedebt have changed substantially. A substantial modification occurs when thediscounted future cash flows have changed by more than 10% before and after themodification in the case of the term loans; and if the product of the remainingterm and the maximum available credit (i.e. the borrowing capacity) of thenew revolver has decreased in relation to the existing line of credit. As aresult of the increased interest and principal payments (including “payment-in-kind”interest) under the term loans and reduction in the maximum borrowing limit forthe revolver, the Company determined that these modifications should beaccounted for as an extinguishment of the existing credit facilities effective April 10,2008. The modified facilities are recorded as new debt instruments at fairvalue, which equal their face value.

 

In connection with themodifications of the first and second-lien term debt and the revolving line ofcredit, considered as an early extinguishment of debt, the Company wrote offthe remaining unamortized discount and debt issuance costs of $6,036,000, andexpensed as debt extinguishment loss $758,000 in amendment fees paid to lendersand $1,514,000 of PIK interest added to the new debt, resulting in a totalcharge of $8,308,000 in connection with this debt extinguishment. Additionally,the Company capitalized $327,000 of deferred financing costs related to the newcredit agreements, which is being amortized over their remaining terms. Underthe amended senior credit facility agreement, all net proceeds from any futuresale of one or more of the Company’s IPAs are to be used to prepay theoutstanding balance of the first lien debt (see Note 4).

 

                    The Company filed its 2007 Form 10-K on June 2, 2008 and its Forms 10-Q for the quarters ended December 31, 2007 and March 31, 2008 on June 9, 2008 and June 16, 2008, respectively, and was in compliance with the amended financial covenant provisions for the April 2008 through March 2009 monthly reporting periods.  While the Company continues to meet all debt service requirements on a timely basis, on March 19, 2009, the Company received written notices from its lenders asserting that the Company was in default of a requirement to sell certain assets by a specified date.  Additionally, on April 17, 2009, the Company received notices from its lenders asserting that the Company’s April 14, 2009 increase in ownership of Brotman Medical Center, Inc. violated certain provisions of the amended credit agreements.  Based on such notices and in accordance with SFAS No. 78, “*Classification of Obligations That Are Callable by the Creditor - An Amendment to ARB 43, Chapter 3A*,” the Company has classified all scheduled payments due after twelve months as current at March 31, 2009. The Company has contested both assertions and is currently in discussions with its lenders to seek resolution of these matters; however, there can be no assurance that these matters will be resolved on a basis favorable to the Company. The lenders may not grant waivers and could require full repayment of the loans, which would negatively impact the Company’s liquidity, ability to operate and its ability to continue as a going concern. Effective with the first asserted default, the lenders instituted default rates of 13.0% with respect to the first lien term loan, 17.25% with respect to the second lien term loan and 13.25% with respect to the revolving line of credit.

 

***Interest Rate Swaps***

 

As required by the$53 million credit facility, on May 16, 2007, the Company enteredinto a $48 million interest rate swap, to effectively convert the variableinterest rate (the LIBOR component) under the original credit facility to afixed rate of 5.3%, plus the applicable margin per year throughout the term ofthe loan. This interest rate swap remains in effect even though the relatedterm loan was repaid in August 2007.

 

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In addition to thepre-existing $48,000,000 interest rate swap described above, on September 5,2007, the Company entered into a separate interest rate swap agreement for theincremental debt, initially totaling $97,750,000, to effectively convert thevariable interest rate (the LIBOR component) under the incremental portion ofthe original $155 million credit facility to a fixed rate of 5.05%, plusthe applicable margin, per year, throughout the term of the loan. The notionalamounts of these interest rate swaps are scheduled to decline as the principalbalances owing under the term loans decline. Under these swaps, the Company isrequired to make monthly fixed-rate payments to the swap counterpartiescalculated on the notional amount of the swap and the interest rate for theparticular swap, while the swap counterparties are obligated to make certainmonthly floating rate payments to the Company referencing the same notionalamount. These interest rate swaps effectively fix the weighted average annualinterest rate payable on the term loans to 5.13%, plus the applicable margin.Notwithstanding the terms of the interest rate swap transactions, the Companyis ultimately obligated for all amounts due and payable under its creditfacilities.

 

The interest rate swapagreements contain cross-default provisions whereby, in the event the Companyis in default under its credit agreements, the Company is also deemed to be indefault under the swap agreements.  Giventhe asserted credit agreement defaults, the interest rate swap liability hasbeen classified as a current liability at March 31, 2009.

 

The interest rate swapagreements were designated as cash flow hedges of expected interest payments onthe term loans with the effective date of the $48,000,000 swap being December 31,2007 and the effective date of the $97,750,000 swap being September 6,2007. Prior to the hedge effective dates, all mark-to-market adjustments in thevalue of the swaps were charged to expense. After the hedge effective date, theeffective portions of the fair value gains or losses on these cash flow hedgeswere recorded as a component of other comprehensive income, net of tax, to besubsequently reclassified into earnings when the forecasted transaction affectsearnings. Effective April 1, 2008, in anticipation of changes to the loanagreements that would impact recording of interest rate swaps, the Companyelected to discontinue hedge accounting. Changes in the fair value of theinterest rate swaps after March 31, 2008 are recorded as other income orexpense. Total net loss on the interest rate swaps included in earnings for thesix months ended March 31, 2009 and 2008 were approximately $8,713,000 and$877,000, respectively. The effective portion of the swaps of approximately$5.4 million, after tax, that was recorded in other comprehensive incomethrough March 31, 2008 will continue to be amortized as expense over theremaining life of the swaps. Approximately $440,000 was amortized to expensefor the six months ended March 31, 2009.

 

**8. Acquisitions**

 

***ProMed Health Services Company***

 

On June 1, 2007, theCompany and its affiliated physician organization, Prospect Medical Group, Inc.(“PMG”) completed the acquisition of ProMed Health Services Company, aCalifornia corporation, and its subsidiary, ProMed Health Care Administrators, Inc.(“PHCA”) (collectively “ProMed Health Care Administrators”), and two affiliatedIPAs: Pomona Valley Medical Group, Inc. dba ProMed Health Network (“PomonaValley Medical Group”), and Upland Medical Group, Inc. (“Upland MedicalGroup”) (collectively the “ProMed Entities”). PHCA manages the medical care ofHMO enrollees served by Pomona Valley Medical Group and Upland Medical Group.Total purchase consideration of $48,000,000 included $41,040,000 of cash and1,543,237 shares of Prospect Medical Holdings, Inc. common stock valued at$6,960,000, or $4.51 per share. The transaction is referred to as the “ProMedAcquisition.”

 

The ProMed Acquisition, and$392,000 in related transaction costs, was financed by $48,000,000 inborrowings (less $896,000 in debt issuance costs) and $2,379,000 from cashreserves. The debt proceeds and cash reserves were used to fund the cashconsideration of $41,040,000 and to repay all existing debt of Prospect MedicalHoldings, Inc. ($7,842,000 plus $209,000 of prepayment penalties). The$48,000,000 in borrowings used to finance the acquisition of the ProMedEntities was refinanced in August 2007, using proceeds from the$155,000,000 credit facility entered into in connection with the Altatransaction, described below. The purchase agreements provide for certainpost-closing working capital and medical claims reserve adjustments. Duringfiscal 2008, the Company recorded a post-closing working capital adjustment ofapproximately $560,000 as a reduction in goodwill.

 

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***Alta Healthcare System, Inc.***

 

On August 8, 2007, theCompany acquired all of the outstanding common shares of Alta and the name ofthe surviving entity was changed to Alta Hospitals System, LLC. Thepurchase transaction is referred to as the “Alta Acquisition.” Alta is afor-profit hospital management company that, through two subsidiarycorporations, owns and operates four community-based hospitals—Van NuysCommunity Hospital, Hollywood Community Hospital, Los Angeles CommunityHospital and Norwalk Community Hospital. These hospitals provide a comprehensiverange of medical, surgical and psychiatric services and have a combined 339licensed beds served by 315 on-staff physicians. Total purchase consideration,including transaction costs, was approximately $154,935,000, comprised ofrepayment of approximately $41,500,000 of Alta’s existing debt, payment ofapproximately $51,300,000 in cash to the former Alta shareholders, issuance of1,887,136 shares of Prospect common stock, issuance of 1,672,880 shares ofProspect convertible preferred stock valued, for purposes of the transaction,at $61,030,000, and payment of transaction costs of approximately$1.2 million. Each share of preferred stock was convertible into fivecommon shares upon stockholder approval (which occurred on August 13,2008). Prior to conversion, each share of preferred stock accrued dividends at18% per year, compounding annually. Such dividends (amounting to $7,881,890)were canceled upon conversion to common shares on August 13, 2008, and therelated liability reclassified to additional paid in capital. For purposes ofdetermining the number of shares to be issued in connection with thetransaction, Prospect common stock was valued at $5.00 per share and Prospectpreferred stock was valued at $25.00 per share. However, for purposes of recordingthe transaction, (i) the value per share of common stock was estimated at$5.58, based on the average of the stock’s closing prices before and after theacquisition announcement date of July 25, 2007, and (ii) the valueper share of preferred stock was estimated at $30.19, based on the closingstock price of a common share on the acquisition date, plus a premium for thepreference features of the stock. As such, total recorded purchaseconsideration, exclusive of transaction costs, was approximately $153,772,000.

 

The Alta Acquisition, theextinguishment of Alta’s existing debt and the refinancing of the ProMedAcquisition debt described above were financed by a $155,000,000 senior securedcredit facility arranged by Bank of America, comprised of $145,000,000 in termloans and a $10,000,000 revolver, of which $3,000,000 was drawn at closing (seeNote 7 for discussion of debt). Net proceeds of $141.1 million (netof issuance discount and financing costs of $6.9 million) were used torepay Alta’s existing borrowings of $41.5 million, refinance$47.0 million in outstanding ProMed Acquisition debt, pay the cash portionof the purchase price of $51.3 million and fund approximately$1.2 million in transaction costs.

 

***Investment in Brotman Medical Center, Inc***

 

Effective August 31,2005, the Company acquired an approximately 33.1% stake in Brotman, for$1,000,000. The Company made the investment with the intention that it, withBrotman, would be able to offer joint contracting to HMOs operating in Brotman’sservice area. Brotman, previously owned by Tenet HealthCare, had been incurringsignificant operating deficits. The new investors, including Prospect, hoped tohelp turn around Brotman’s operations and restore profitability.

 

During September 2005,the first month of operation under new ownership, Brotman experienced a netloss of approximately $1,000,000, of which Prospect’s portion totaledapproximately $350,000. Brotman continued to incur significant losses after September 30,2005 and, based on these significant operating deficits, uncertain ability toincrease revenues and reduce costs, and limited capital, management of Prospectbelieved that the remaining investment in Brotman at September 30, 2005was impaired and wrote off its entire investment as of September 30, 2005.The Company has not recognized any equity in earnings since its initialinvestment as Brotman continued to incur losses.

 

The Company had entered intoa consulting services agreement with Brotman on August 1, 2005, pursuantto which, the Company would receive a monthly consulting fee of $20,000,amended on October 25, 2007 to $100,000 monthly. The receivable balance due from Brotman under thisarrangement was $300,000 at March 31, 2009.

 

In October 2007,Brotman filed for bankruptcy protection under Chapter 11 of the U.S.Bankruptcy Code. Effective April 22, 2008, Samuel S. Lee (the Company’sCEO and Chairman of the Board) was appointed as the Chairman of the Board ofDirectors of Brotman. The bankruptcy plan was confirmed by the U.S. BankruptcyCourt, Central District of California, Los Angeles Division, on January 21,2009, and was declared effective on April 14, 2009.

 

See Note 15 for discussionof subsequent event relating to Brotman.

 

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**9. Segment Information**

 

SFAS No. 131, “*Disclosures about Segments of an Enterprise andRelated Information*,” provides disclosure guidelines for segments ofa company based on a management approach to defining reporting segments.

 

With the acquisition of Altain August 2007, the Company’s operations are now organized into threereporting segments: (i) IPA Management—which is comprised of the Prospectand ProMed reporting units, provides management services to affiliatedphysician organizations that operate as independent physician associations (“IPAs”);(ii) Hospital Services—which owns and operates four community-basedhospitals—Los Angeles Community Hospital, Hollywood Community Hospital, NorwalkCommunity Hospital and Van Nuys Community Hospital and (iii) Corporate.Corporate represents expenses incurred in Prospect Medical Holdings, Inc.(the “Parent Entity”), which were not allocated to the IPA Management and HospitalServices segments.

 

The accounting policies ofthe reporting segments are the same as those described in the summary ofsignificant accounting policies (see Note 2). The Company evaluatesfinancial performance and allocates resources primarily based on earnings fromcontinuing operations before interest expense, interest income, income taxes,depreciation and amortization, as well as income or loss from operations beforeincome taxes, excluding infrequent or unusual items.

 

The reporting segments are strategicbusiness units that offer different services within the healthcare continuum.Business in each reporting segment is conducted by one or more direct orindirect wholly-owned subsidiaries of the Company.

 

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The following tablesummarizes certain information for each of the reporting segments regularlyprovided to and reviewed by the chief operating decision maker as of and forthe three months ended March 31, 2009 and 2008:

 
| ** **                                                         | ** ** | **As of and for the Three Months Ended March 31, 2009** | ** **  |
|--------------------------------------------------------------------|------------|--------------------------------------------------------------|-------------|
| ** **                                                         | ** ** | **IPA  Management**                                          | ** **  | **Hospital  Services** | ** ** | **Corporate** | ** ** | **Intersegment  Eliminations** | ** ** | **Consolidated** | ** ** |
| Revenues from external customers                                   |       | $                                                            | 48,159,102  |   | $ | 37,908,033 |   | $ | — |   | $ | — |   | $ | 86,067,135 |   |
| Intersegment revenues                                              |       | —                                                       |        | — |   | — |   | — |   | — |   |
| Total revenues                                                     |       | 48,159,102                                                   |        | 37,908,033 |   | — |   | — |   | 86,067,135 |   |
| Operating income (loss)                                            |       | 3,434,826                                                    |        | 11,065,118 |   | (2,853,740 | ) | — |   | 11,646,204 |   |
| Investment income                                                  |       | (5,461                                                       | )           | 388 |   | (14,427 | ) | — |   | (19,500 | ) |
| Interest expense and amortization of deferred financing costs |       | 19                                                           |        | 51,258 |   | 6,524,776 |   | — |   | 6,576,053 |   |
| Loss on interest rate swap arrangements                            |       | —                                                       |        | — |   | (955,201 | ) | — |   | (955,201 | ) |
| Income (loss) from continuing operations before income taxes       |       | $                                                            | 3,440,268   |   | $ | 11,013,472 |   | $ | (8,408,888 | ) | $ | — |   | $ | 6,044,852 |   |
| Identifiable segment assets (liabilities)                          |       | $                                                            | 161,714,515 |   | $ | 208,207,429 |   | $ | (74,486,348 | ) | $ | — |   | $ | 295,435,596 |   |
| Segment capital expenditures, net of dispositions                  |       | $                                                            | 20,686      |   | $ | 194,202 |   | $ | — |   | $ | — |   | $ | 214,888 |   |
| Segment goodwill                                                   |       | $                                                            | 22,338,519  |   | $ | 106,538,715 |   | $ | — |   | $ | — |   | $ | 128,877,234 |   |

 
| ** **                                                    | ** ** | **As of and for the Three Months Ended March 31, 2008** | ** **  |
|---------------------------------------------------------------|------------|--------------------------------------------------------------|-------------|
| ** **                                                    | ** ** | **IPA  Management**                                          | ** **  | **Hospital  Services** | ** ** | **Corporate** | ** ** | **Intersegment  Eliminations** | ** ** | **Consolidated** | ** ** |
| Revenues from external customers                              |       | $                                                            | 50,680,973  |   | $ | 32,396,126 |   | $ | — |   | $ | — |   | $ | 83,077,099 |   |
| Intersegment revenues                                         |       | —                                                       |        | — |   | — |   | — |   | — |   |
| Total revenues                                                |       | 50,680,973                                                   |        | 32,396,126 |   | — |   | — |   | 83,077,099 |   |
| Operating income (loss)                                       |       | 2,792,871                                                    |        | 7,494,411 |   | (3,879,648 | ) | — |   | 6,407,634 |   |
| Investment income                                             |       | (81,048                                                      | )           | — |   | (68,020 | ) | — |   | (149,068 | ) |
| Interest expense and amortization of deferred financing costs |       | —                                                       |        | 41,279 |   | 5,252,570 |   | — |   | 5,293,849 |   |
| Loss on interest rate swap arrangements                       |       | —                                                       |        | — |   | — |   | — |   | — |   |
| Income (loss) from continuing operations before income taxes  |       | $                                                            | 2,873,919   |   | $ | 7,453,132 |   | $ | (9,064,198 | ) | $ | — |   | $ | 1,262,853 |   |
| Identifiable segment assets (liabilities)                     |       | $                                                            | 146,701,440 |   | $ | 176,084,131 |   | $ | (32,631,304 | ) | $ | — |   | $ | 290,154,267 |   |
| Segment capital expenditures, net of dispositions             |       | $                                                            | 95,081      |   | $ | 216,931 |   | $ | 4,305 |   | $ | — |   | $ | 316,317 |   |
| Segment goodwill                                              |       | $                                                            | 22,623,230  |   | $ | 106,493,715 |   | $ | — |   | $ | — |   | $ | 129,116,945 |   |

 

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The following table summarizescertain information for each of the reporting segments regularly provided toand reviewed by the chief operating decision maker as of and for the six monthsended March 31, 2009 and 2008:

 
| ** **                                                         | ** ** | **As of and for the Six Months Ended March 31, 2009** | ** **  |
|--------------------------------------------------------------------|------------|------------------------------------------------------------|-------------|
| ** **                                                         | ** ** | **IPA  Management**                                        | ** **  | **Hospital  Services** | ** ** | **Corporate** | ** ** | **Intersegment  Eliminations** | ** ** | **Consolidated** | ** ** |
| Revenues from external customers                                   |       | $                                                          | 96,290,351  |   | $ | 73,230,440 |   | $ | — |   | $ | — |   | $ | 169,520,791 |   |
| Intersegment revenues                                              |       | —                                                     |        | — |   | — |   | — |   | — |   |
| Total revenues                                                     |       | 96,290,351                                                 |        | 73,230,440 |   | — |   | — |   | 169,520,791 |   |
| Operating income (loss)                                            |       | 6,239,908                                                  |        | 20,182,863 |   | (4,879,250 | ) | — |   | 21,543,521 |   |
| Investment income                                                  |       | (30,643                                                    | )           | — |   | (37,102 | ) | — |   | (67,745 | ) |
| Interest expense and amortization of deferred financing costs |       | 19                                                         |        | 92,926 |   | 12,621,006 |   | — |   | 12,713,951 |   |
| Loss on interest rate swap arrangements                            |       | —                                                     |        | — |   | 8,712,824 |   | — |   | 8,712,824 |   |
| Income (loss) from continuing operations before income taxes       |       | $                                                          | 6,270,532   |   | $ | 20,089,937 |   | $ | (26,175,978 | ) | $ | — |   | $ | 184,491 |   |
| Identifiable segment assets (liabilities)                          |       | $                                                          | 161,714,515 |   | $ | 208,207,429 |   | $ | (74,486,348 | ) | $ | — |   | $ | 295,435,596 |   |
| Segment capital expenditures, net of dispositions                  |       | $                                                          | 61,661      |   | $ | 374,978 |   | $ | — |   | $ | — |   | $ | 436,639 |   |
| Segment goodwill                                                   |       | $                                                          | 22,338,519  |   | $ | 106,538,715 |   | $ | — |   | $ | — |   | $ | 128,877,234 |   |

 
| ** **                                                    | ** ** | **As of and for the Six Months Ended March 31, 2008** | ** **  |
|---------------------------------------------------------------|------------|------------------------------------------------------------|-------------|
| ** **                                                    | ** ** | **IPA  Management**                                        | ** **  | **Hospital  Services** | ** ** | **Corporate** | ** ** | **Intersegment  Eliminations** | ** ** | **Consolidated** | ** ** |
| Revenues from external customers                              |       | $                                                          | 101,249,529 |   | $ | 59,682,354 |   | $ | — |   | $ | — |   | $ | 160,931,883 |   |
| Intersegment revenues                                         |       | —                                                     |        | — |   | — |   | — |   | — |   |
| Total revenues                                                |       | 101,249,529                                                |        | 59,682,354 |   | — |   | — |   | 160,931,883 |   |
| Operating income (loss)                                       |       | 4,205,928                                                  |        | 13,113,481 |   | (6,405,842 | ) | — |   | 10,913,567 |   |
| Investment income                                             |       | (140,742                                                   | )           | — |   | (302,450 | ) | — |   | (443,192 | ) |
| Interest expense and amortization of deferred financing costs |       | —                                                     |        | 79,823 |   | 9,413,481 |   | — |   | 9,493,304 |   |
| Loss on interest rate swap arrangements                       |       | —                                                     |        | — |   | 876,680 |   | — |   | 876,680 |   |
| Income (loss) from continuing operations before income taxes  |       | $                                                          | 4,346,670   |   | $ | 13,033,658 |   | $ | (16,393,553 | ) | $ | — |   | 986,775 |   |
| Identifiable segment assets (liabilities)                     |       | $                                                          | 146,701,440 |   | $ | 176,084,131 |   | $ | (32,631,304 | ) | $ | — |   | $ | 290,154,267 |   |
| Segment capital expenditures, net of dispositions             |       | $                                                          | 215,220     |   | $ | 720,028 |   | $ | 16,901 |   | $ | — |   | $ | 952,149 |   |
| Segment goodwill                                              |       | $                                                          | 22,623,230  |   | $ | 106,493,715 |   | $ | — |   | $ | — |   | $ | 129,116,945 |   |

 

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| (1)    | Prospect Medical Holdings, Inc. files a consolidated tax  return and allocates costs for shared services and corporate overhead to each  of the reporting segments. All acquisition-related debt, including debt  related to the IPA Management and Hospital Services segment, is recorded at  the Parent entity level. As such, the Company does not allocate interest  expense, and gain or loss on interest rate swaps to the IPA Management and  Hospital Services segments.                                                                                                                                                                                         |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (2)    | Prospect Medical Group (which serves as a holding company for our affiliated  physician organizations and is itself an affiliated physician organization)  files a separate consolidated tax return.                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (3)    | During the six months ended March 31, 2008, the Company incurred  approximately $1,135,000 in costs related to the restatement of Alta’s  pre-acquisition financial statements, preparation of SEC filings and the  related special investigation by the Company’s audit committee, which was  completed in March 2008. These expenses are included in general and  administrative expenses of the Corporate Entity. Also included in general and  administrative expenses of the Corporate Entity were employee stock  compensation expense totaling approximately $582,000 and $58,000 for the six  months ended March 31, 2009 and 2008, respectively. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (4)    | Certain prior year amounts have been reclassified to conform to the  fiscal 2009 period presentation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |

 

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**10. Income Taxes**

 

On July 13, 2006, theFASB issued Interpretation No. 48, “*AccountingFor Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109*”(“FIN 48”). FIN 48 clarifies the accounting for uncertainty in incometaxes recognized in an entity’s financial statements in accordance with SFAS No. 109,“*Accounting for Income Taxes,*”and prescribes a recognition threshold and measurement attributes for financialstatement disclosure of tax positions taken or expected to be taken on a taxreturn. Under FIN 48, the impact of an uncertain income tax position onthe income tax return must be recognized at the largest amount that ismore-likely-than-not to be sustained upon audit by the relevant taxingauthority. An uncertain income tax position will not be recognized if it hasless than a 50% likelihood of being sustained. Additionally, FIN 48provides guidance on derecognition, classification, interest and penalties,accounting in interim periods, disclosure and transition. FIN 48 waseffective for fiscal years beginning after December 15, 2006.

 

In May 2007, the FASBpublished FASB Staff Position FIN 48-1 (“FSP FIN 48-1”), “*Definition of Settlement in FASB Interpretation No. 48*.”FSP FIN 48-1 is an amendment to FIN 48. It clarifies how anenterprise should determine whether a tax position is effectively settled forthe purpose of recognizing previously unrecognized tax benefits.

 

The Company adopted the provisionsof FIN 48 and FSP FIN 48-1 on October 1, 2007. There were nounrecognized tax benefits or interest and penalties recorded on income taxmatters as of the date of adoption. As a result of the implementation ofFIN 48 and FSP FIN 48-1, the Company recognized no decrease indeferred tax assets or changes in the valuation allowance. There are nounrecognized tax benefits included in the consolidated balance sheet thatwould, if recognized, affect the effective tax rate.

 

The Company’s practice is torecognize interest and/or penalties related to income tax matters in income taxexpense.

 

Consolidated and separateincome tax returns are filed with the U.S. Federal jurisdiction and in theState of California. The Company’s filed tax returns are subject to examinationby the IRS for tax years 2007, 2006 and 2005 and the State of California forfiscal years 2007, 2006, 2005 and 2004. Net operating losses that were incurredin prior years may still be adjusted by taxing authorities.

 

The Company recorded a tax  provision of approximately $2,496,000 and $76,000for the three months and six months ended March 31, 2009, at effective taxrates of 41% and 41%, respectively and a tax provision of approximately $456,000and $355,000 for the three months and six months ended march 31, 2008, at effective tax rates of 36% and 36%, respectively.The effective tax rates for the three months and six months ended March 31,2009, differ from the federal statutory rate of 34% and the rate for the sameperiod in fiscal 2008 primarily due to state income tax and permanentdifferences.

 

**11. Use of Estimates**

 

The preparation of Consolidatedfinancial statements in conformity with accounting principles generallyaccepted in the U.S. requires management to make estimates and assumptions thataffect the reported amounts of assets, liabilities, revenues and expenses, andthe disclosure of contingent assets and liabilities at the dates, and for theperiods, that the financial statements are prepared. Actual results couldmaterially differ from those estimates. Principal areas requiring the use ofestimates include third-party cost report settlements, risk-sharing programs,patient and medical related receivables, determination of allowances forcontractual discounts and uncollectible accounts, medical claims and accruals,impairment of goodwill, long-lived and intangible assets, valuation of interestrate swaps, share-based payments, professional and general liability claims,reserves for the outcome of litigation, liabilities for uncertain income taxpositions and valuation allowances for deferred tax assets.

 

During the six months ended March 31,2009 and 2008, the companyrecorded approximately $1,891,000 and $2,128,000 in favorable changes inestimates during the respective periods related to medical claims developmentfrom the prior periods.

 

**12. Fair Value Measurements**

 

Effective October 1,2008, the Company adopted SFAS No. 157, “*FairValue Measurements*,” (“SFAS No. 157”) for all financial assetsand liabilities measured at fair value on a recurring basis. SFAS 157defines fair value, establishes a framework for measuring fair value ingenerally accepted accounting principles, and expands disclosures about fairvalue measurements. In February 2008, the FASB staff issued Staff PositionNo. 157-2 “*Effective Date of FASBStatement No. 157,*” (“FSP SFAS 157-2”). FSPSFAS 157-2 delayed the effective date of FAS 157 for nonfinancialassets and nonfinancial liabilities, except for items that are recognized ordisclosed at fair value in the financial statements on a recurring basis (atleast annually). In accordance with the provisions of FSP SFAS 157-2, the 

 

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Company has elected to defer implementationof SFAS 157 until October 1, 2009 as it relates to its non-financialassets and non-financial liabilities that are not permitted or required to bemeasured at fair value on a recurring basis. Management is currently evaluatingthe impact, if any, SFAS No. 157 will have on those non-financial assetsand liabilities.

 

The FASB also issued FASBStaff Position No. 157-3, *Determiningthe Fair Value of a Financial Asset when the Market for that Asset is not Active*,(“FSP 157-3”) in October 2008. FSP 157-3 clarifies the application ofSFAS 157 in an inactive market and provides an example to illustrate keyconsiderations in determining the fair value of a financial asset when themarket for that financial asset is not active. FSP 157-3 is effectiveimmediately and was adopted by the Company as of October 1, 2008. Theimpact of adopting FSP 157-3 was not material to the Company’s consolidatedfinancial statements.

 

SFAS No. 157establishes a fair value hierarchy that prioritizes the inputs to valuationtechniques used to measure fair value. The hierarchy gives the highest priorityto unadjusted quoted prices in active markets for identical assets orliabilities (Level 1 measurements) and the lowest priority to unobservableinputs (Level 3 measurements). The three levels of the fair valuehierarchy under SFAS No. 157 are described below:

 

·                  Level 1—Unadjustedquoted prices in active markets that are accessible at the measurement date foridentical, unrestricted assets or liabilities;

 

·                  Level 2—Quotedprices in markets that are not active, or inputs that are observable, eitherdirectly or indirectly, for substantially the full term of the asset orliability; and

 

·                  Level 3—Pricesor valuation techniques that require inputs that are both significant to thefair value measurement and unobservable (supported by little or no marketactivity).

 

The following table setsforth the Company’s financial assets and liabilities measured at fair value ona recurring basis and where they are classified within the hierarchy as of March 31,2009:

 
| ** **                   | ** ** | **Total** | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
|------------------------------|------------|-----------|------------|------------------|------------|------------------|------------|------------------|------------|
| **Assets:**                  |       |      |       |             |       |             |       |             |       |
| Investments                  |       | $         | 664,172    |             | $          | 664,172          |       | $                | —     |   | $ | — |   |
| **Liabilities:**             |       |      |       |             |       |             |       |             |       |
| Interest rate swap liability |       | $         | 14,725,992 |             | $          | —           |       | $                | 14,725,992 |   | $ | — |   |

 

A financial asset orliability is categorized within the hierarchy based upon the lowest level ofinput that is significant to the fair value measurement. Following is adescription of the valuation methodologies used by the Company as well as thegeneral classification of such instruments pursuant to the hierarchy.

 

*Investments*

 

The Company’s investmentsare classified within Level 1 of the fair value hierarchy because they arevalued using quoted market prices. The investment instruments that are valuedbased on quoted market prices in active markets are primarily restrictedcertificates of deposit.

 

*Interest Rate Derivative Liabilities*

 

The Company has two interestrate swap agreements in place for an initial notional amount of$48 million and $97.75 million, respectively. These instrumentseffectively cause a portion of the Company’s floating rate debt to become fixedrate debt and are held with a major financial institution, which is expectedto, and is expecting the Company to, fully perform under the terms of theagreements. A mark-to-market valuation that takes into considerationanticipated cash flows from the transaction using quoted market prices, othereconomic data and assumptions, and pricing indications used by other marketparticipants is used to value the swaps. Given the degree of varyingassumptions used to value the swaps, they are deemed to be Level 2instruments.

 

In February 2007, theFASB issued FASB Statement No. 159, “*TheFair Value Option for Financial Assets and Financial Liabilities*” (“SFAS 159”).SFAS 159 permits entities to choose to measure many financial instrumentsand certain other items at fair value, with the objective of improvingfinancial reporting by mitigating volatility in reported earnings caused bymeasuring related assets and liabilities differently without having to applycomplex hedge accounting provisions. The provisions of SFAS 159 wereadopted October 1, 2008. The Company did not elect the Fair Value Optionfor any of its financial assets or liabilities, and therefore, the adoption ofSFAS 159 had no impact on the Company’s consolidated financial position,results of operations or cash flows.

 

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**13. Recent Accounting Pronouncements**

 

In December 2007, theFASB issued SFAS No. 141 (revised 2007), “*BusinessCombinations*” (“SFAS No. 141(R)”). SFAS No. 141(R) establishesnew principles and requirements for how the acquirer of a business recognizesand measures in its financial statements the identifiable assets acquired, theliabilities assumed, and any noncontrolling interest in the acquiree. SFAS No. 141(R) alsoprovides guidance for recognizing and measuring the goodwill acquired in thebusiness combination and determines what information to disclose to enableusers of the financial statements to evaluate the nature and financial effectsof the business combination. In general, SFAS No. 141(R) requires theacquiring entity to recognize all the assets acquired and liabilities assumedin the transaction and establishes the acquisition-date fair value as themeasurement objective. This standard will, among other things, impact thedetermination of acquisition-date fair value of consideration paid in abusiness combination, including recognition of contingent consideration andmost pre-acquisition loss and gain contingencies at their acquisition-date fairvalues. It will also require companies to expense, as incurred, transaction costs,and recognize changes in income tax valuation allowances and tax uncertaintyaccruals that result from a business combination as adjustments to income taxexpense. SFAS 141(R) will also place new restrictions on the abilityto capitalize acquisition-related restructuring costs. SFAS No. 141(R) appliesprospectively to business combinations for which the acquisition date is on orafter the beginning of the first annual reporting period beginning on or after December 15,2008. The Company will adopt SFAS No. 141(R) on October 1, 2009.Management is currently evaluating the potential impact of the adoption of SFASNo. 141(R) on its consolidated financial statements.

 

In December 2007, theFASB issued SFAS No. 160, *“NoncontrollingInterests in Consolidated Financial Statements—an Amendment of ARB No. 51”*(“SFAS No. 160”). SFAS No. 160 establishes accounting and reportingstandards for the noncontrolling interest in a subsidiary and for thedeconsolidation of a subsidiary. It clarifies that a non-controlling minorityinterest in a subsidiary is an ownership interest in the consolidated entitythat should be reported as equity in the accompanying Consolidated FinancialStatements separate from the parent company’s equity. Net income attributableto the non-controlling interest will be included in consolidated net income onthe face of the income statement. SFAS No. 160 is effective for fiscalyears, and interim periods within those fiscal years, beginning on or after December 15,2008. SFAS No. 160 requires retroactive adoption of the presentation andexpanded disclosure requirements for existing minority interests. All otherrequirements of SFAS No. 160 shall be applied prospectively. The Companywill adopt SFAS No. 160 on October 1, 2009 and is currently evaluatingthe potential impact of the adoption of SFAS No. 160 on its consolidatedfinancial statements.

 

In March 2008, the FASBissued SFAS No. 161, “*Disclosures aboutDerivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133*”(“SFAS No. 161”). SFAS No. 161 enhances required disclosuresregarding derivatives and hedging activities, including enhanced disclosuresregarding how: (a) an entity uses derivative instruments, (b) derivativeinstruments and related hedged items are accounted for under FASB Statement No. 133,*Accounting for Derivative Instruments andHedging Activities*, and (c) derivative instruments and relatedhedged items affect an entity’s financial position, financial performance andcash flows. SFAS No. 161 is effective for the fiscal years beginning afterNovember 15, 2008. Early adoption is permitted. The Company is currentlyreviewing the provisions of SFAS No. 161 and has not yet adopted thestatement. However, as the provisions of SFAS No. 161 are only related todisclosure of derivative and hedging activities, we do not believe the adoptionof SFAS No. 161 will have a material impact on our consolidated operatingresults, financial position, or cash flows.

 

In April 2008, the FASBissued FASB Staff Position SFAS No. 142-3, “*Determination of the Useful Life of Intangible Assets*” (“FSPSFAS No. 142-3”). FSP SFAS No. 142-3 amends the factors that shouldbe considered in developing renewal or extension assumptions used indetermining the useful life of a recognized intangible asset under Statement ofFinancial Accounting Standard No. 142, “*Goodwilland Other Intangible Assets*.” This new guidance appliesprospectively to intangible assets that are acquired individually or with agroup of other assets in business combinations and asset acquisitions. FSP SFASNo. 142-3 is effective for fiscal years beginning after December 15,2008, and early adoption is prohibited. The impact of FSP SFAS No. 142-3will depend upon the nature, terms, and size of the acquisitions the Company consummatesafter the effective date.

 

In May 2008, the FASBissued Staff Position (“FSP”) APB 14-1, “*Accountingfor Convertible Debt Instruments That May Be Settled in Cash uponConversion (Including Partial Cash Settlement*.” FSP APB 14-1clarifies that convertible debt instruments that may be settled in cash uponeither mandatory or optional conversion (including partial cash settlement) arenot addressed by paragraph 12 of APB Opinion No. 14, “*Accounting for Convertible Debt and Debt issued withStock Purchase Warrants*.” Additionally, FSP APB 14-1 specifiesthat issuers of such instruments should separately account for the liabilityand equity components in a manner that will reflect the entity’s nonconvertibledebt borrowing rate when interest cost is recognized in subsequent periods. FSPAPB 14-1 is effective for financial statements issued for fiscal yearsbeginning after December 15, 2008, and interim periods within those fiscalyears. The Company will adopt FSP APB 14-1 beginning in the first quarter offiscal 2010, and this standard must be applied on a retrospective basis. We areevaluating the impact the adoption of FSP APB 14-1 will have on ourconsolidated financial position and results of operations.

 

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In September 2008, theFASB issued FASB Staff Position No. 133-1, “*Disclosures about Credit Derivatives and Certain Guarantees: AnAmendment of FASB Statement No. 133”* (“FSP SFAS No. 133-1”)and FASB Interpretation No. 45-4, “*Clarificationof the Effective Date of FASB Statement No. 161*” (“FIN 45-4”).FSP SFAS No. 133-1 and FIN 45-4 amends FASB Statement No. 133 (“SFAS 133”),“*Accounting for Derivative Instruments andHedging Activities*,” to require disclosures by sellers of creditderivatives, including credit derivatives embedded in hybrid instruments. FSPSFAS 133-1 and FIN 45-4 also amend FASB Interpretation No. 45 (“FIN 45”),“*Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness toOthers*,” to require additional disclosure about the current statusof the payment/performance risk of a guarantee. The provisions of the FSP thatamend SFAS No. 133 and FIN 45 are effective for reporting periodsending after November 15, 2008. FSP SFAS No. 133-1 and FIN 45-4also clarifies the effective date in FASB Statement No. 161 (“SFAS No. 161”),“*Disclosures about Derivative Instrumentsand Hedging Activities*.” Disclosures required by SFAS No. 161are effective for financial statements issued for fiscal years and interimperiods beginning after November 15, 2008. Because FSP SFAS No. 133-1and FIN 45-4 only require additional disclosures, the adoption will notimpact the Company’s consolidated financial position, results of operations orcash flows.

 

In June 2008, the EITFreached a consensus in Issue No. 07-5, “*DeterminingWhether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock*”(“EITF 07-5”). This Issue addresses the determination of whether an instrument(or an embedded feature) is indexed to an entity’sown stock, which is the first part of the scope exception in paragraph 11(a) ofSFAS No. 133. EITF 07-5 is effective for fiscal years beginning after December 15,2008, and interim periods within those fiscal years. Early application is notpermitted. The Company will adopt EITF 07-5 on October 1, 2009 and iscurrently evaluating the potential impact of the adoption of EITF 07-5 on itsconsolidated financial statements.

 

**14. Litigation and Contingencies**

 

Many of the Company’s payerand provider contracts are complex in nature and may be subject to differinginterpretations regarding amounts due for the provision of medical services.Such differing interpretations may not come to light until a substantial periodof time has passed following contract implementation. Liabilities for claimsdisputes are recorded when the loss is probable and can be estimated. Anyadjustments to reserves are reflected in current operations.

 

The Company is subject to avariety of claims and suits that arise from time to time in the ordinary courseof its business. While management currently believes that resolving all ofthese matters, individually or in aggregate, will not have a material adverseimpact on the Company’s financial position or its results of operations, thelitigation and other claims that the Company faces are subject to inherentuncertainties and management’s view of these matters may change in the future.Should an unfavorable final outcome occur, there exists the possibility of amaterially adverse impact on the Company’s financial position, results ofoperations and cash flows for the period in which the effect becomes probableand reasonably estimable.

 

**15. Subsequent Event**

 

On April 14, 2009, theU.S. Bankruptcy Court confirmed and declared the Second Amended Chapter 11 Planof Reorganization (the “Plan”) of Brotman effective.  Effective on such date, the Company acquiredan additional 38.86% ownership interest in Brotman, which brought it to itscurrent total ownership of 71.96% of the outstanding common stock ofBrotman.  The Company’s ownershipinterest in Brotman continues to be held through its wholly-owned subsidiary,Prospect Hospital Advisory Services, Inc., a Delaware corporation.  Pursuant to the terms of the bankruptcy plan,the Company made an additional $1,800,000 investment in Brotman on January 13,2009, which amount was recorded in Deposits and Other Assets at March 31,2009, and has made a commitment to invest approximately an additional $700,000within six months after the effective date of the plan.

 

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As part of its bankruptcyplan, Brotman obtained a commitment from Gemino Healthcare Finance, LLC for athree-year, $6.0 million, senior credit facility secured by accounts receivableat an interest rate of LIBOR plus 7% per annum. In addition, the Los Angeles Jewish Home for the Aging (“JHA”) providedan aggregate of $22.25 million in financing through a $16.0 million loan (“TermA” loan) with a two-year term and a $6.25 million loan (“Term B” loan) with athree-year term.  The entire financing issecured by Brotman’s real estate and personal property.  The interest rate on the $16.0 million loanis 10% per annum during the first year of the loan and 7.5% thereafter.  Under the $6.25 million loan, the interestrate is 10% per annum during the life of the loan.  The proceeds of the JHA loans were used torepay all existing senior secured loans at Brotman, includingDebtor-In-Possession financing.  TheCompany has not guaranteed any portion of the Gemino or JHA financing.

 

As part of the JHAfinancing, Brotman has granted JHA an option to purchase certain Brotman-ownedland adjacent to the hospital, where JHA plans to construct a senior livingfacility, for a purchase price equal to the outstanding principal balance ofthe JHA Term A loan plus any prepaid amounts.

 

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

 

**Forward-Looking Statements**

 

The following discussion ofour financial condition and results of operations should be read in conjunctionwith the accompanying unaudited interim condensed consolidated financialstatements and the notes to those statements appearing elsewhere in this reportand the audited consolidated financial statements for the year ended September 30,2008 appearing in our annual report on Form 10-K filed with the Securitiesand Exchange Commission.

 

This discussion containsforward-looking statements that involve risks and uncertainties. Theseforward-looking statements are often accompanied by words such as “believe,” “should,”“anticipate,” “plan,” “expect,” “potential,” “scheduled,” “estimate,” “intend,”“seek,” “goal,” “may” and similar expressions. These statements include,without limitation, statements about our market opportunity, our growthstrategy, competition, expected activities and future acquisitions andinvestments and the adequacy of our available cash resources. Investors areurged to read these statements carefully, and are cautioned that matterssubject to forward-looking statements involve risks and uncertainties,including economic, regulatory, competitive and other factors that may affectour business. These statements are not guarantees of future performance and aresubject to risks, uncertainties and assumptions. Although we believe that theexpectations reflected in the forward-looking statements are reasonable, wecannot guarantee future results, levels of activity, performance, orachievements. Moreover, we do not assume any responsibility for the accuracyand completeness of such statements in the future. Subject to applicable law,we do not plan to update any of the forward-looking statements after the date ofthis report to conform such statements to actual results.

 

Forward-looking statementsinvolve known and unknown risks and uncertainties that may cause our actualresults 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:

 

·                  We are subjectto certain financial and administrative covenants under our loan agreements.Our lenders have asserted that we are not in compliance with certain administrativecovenants, which could result in the requirement to repay our loans in full,thus jeopardizing our ability to operate and raises substantial doubt about ourability to continue as a going concern.

 

·                  Changes in thefair market value of our interest rate swap arrangements are included inearnings. These amounts are unpredictable and likely to be significant.  Cumulative changes in the value of these swaparrangements have been significant and reflected as a liability in ourfinancial statements.  These swaps havecross-default provisions, whereby defaults under our loan agreements causedefaults under the swap agreements, which could potentially result in therecorded swap liability becoming immediately payable, and thus jeopardize ourability to operate and continue as a going concern.

 

·                  Our revenue andprofitability may be significantly reduced or eliminated if management isunable to successfully execute our turnaround plan to improve the operatingresults of our legacy IPA Management segment.

 

·                  Decreases inthe number of HMO enrollees using our provider networks reduce ourprofitability and inhibit future growth.

 

·                  A deficit inworking capital could adversely affect our ability to satisfy our obligationsas they come due and, accordingly, jeopardize our ability to operate as a goingconcern.

 

·                  If our goodwilland intangible assets become impaired, the impaired portion has to be writtenoff, which will materially reduce the value of our assets and reduce our netincome for the year in which the write-off occurs.

 

·                  We may not beable to make any additional acquisitions without first obtaining additionalfinancing and obtaining the consent of our lenders.

 

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·                  Substantiallyall of our IPA revenues are generated from contracts with a limited number ofHMOs, and if our affiliated physician organizations were to lose HMO contractsor to renew HMO contracts on less favorable terms, our revenues andprofitability could be significantly reduced.

 

·                  Ourprofitability may be reduced or eliminated if we are not able to managehealthcare costs of our affiliated physician organizations effectively.

 

·                  Our revenue andprofitability could be significantly reduced and could also fluctuatesignificantly from period to period under Medicare’s Risk Adjusted paymentmethodology.

 

·                  Our operatingresults could be adversely affected if our actual healthcare claims exceed ourreserves.

 

·                  We may beexposed to liability or fail to estimate IBNR claims accurately if we cannotprocess any increased volume of claims accurately and timely.

 

·                  Medicare,Medi-Cal and private third-party payer cost containment efforts and reductionsin reimbursement rates could reduce our hospital revenue and our cash flow.

 

·                  Risk-sharingarrangements that our affiliated physician organizations have with HMOs andhospitals could result in their costs exceeding the corresponding revenues,which could reduce or eliminate any shared risk profitability.

 

·                  If we do notsuccessfully integrate the operations of acquired physician organizations, ourcosts could increase, our business could be disrupted, and we may not be ableto realize the desired benefits from those acquisitions.

 

·                  The acquisitionof hospitals and subsequent integration with our business of managing physicianorganizations may prove to be difficult and may outweigh the associatedbenefits.

 

·                  Our hospitalwith a union contract could experience setbacks from unfavorable negotiationswith union members.

 

·                  Hospitaloperations are capital intensive and could prove to be a drain on cash.

 

·                  If we do notcontinually enhance our hospitals with the most recent technological advancesin diagnostic and surgical equipment, our ability to maintain and expand ourmarkets will be adversely affected.

 

·                  The continuedgrowth of uninsured and underinsured patients or further deterioration in thecollectibility of the accounts of such patients could harm our results ofoperations.

 

·                  Because we areobligated to provide care in certain circumstances regardless of whether wewill get paid for providing such care, if the number of uninsured patientstreated at our hospitals increases, our results of operations may be harmed.

 

·                  Controlsdesigned to reduce inpatient services may reduce our hospital revenue.

 

·                  Our hospitalrevenues and volume trends may be adversely affected by certain factors overwhich we have no control, including weather conditions, severity of annual fluseasons and other factors.

 

·                  An increasingportion of our IPA revenue is “at risk” and difficult to project, whichincreases uncertainty regarding future revenues, cash flow projections, andprofitability.

 

·                  If we areunable to identify suitable acquisition candidates or to negotiate or completeacquisitions on favorable terms, our prospects for growth could be limited.

 

·                  Anyacquisitions we complete in the future could potentially dilute the equityinterests of our current stockholders or could increase our indebtedness andcost of debt service, thereby reducing our profitability.

 

·                  Our acquisitioninitiatives may be put on hold until such time that we achieve a lowerfinancial leverage.

 

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·                  Our increasedownership stake in Brotman Medical Center, Inc. (“Brotman”) will requireus to consolidate Brotman in our financial statements, including all assets,liabilities, and results of operations. Brotman has, in its past, incurred significant operating losses.  Such netoperating losses may be significantly limited as to its utilizationunder section IRC 382 of the I.R.S. Tax Code.

 

·                  The Brotmanacquisition could potentially expose us to significant outlier liability, whichmay be subject to audit.

 

·                  We operate in ahighly competitive market.  Increasedcompetition could adversely affect our revenues.

 

·                  We are subjectto extensive government regulation regarding the conduct of our operations. Ifwe fail to comply with any existing or new regulations, we could suffer civilor criminal penalties or be required to make significant changes to ouroperations.

 

·                  Providers inthe hospital industry have been the subject of federal and state investigationsand we could become subject to such investigations in the future.

 

·                  The healthcareindustry is subject to many laws and regulations designed to deter and preventpractices deemed by the government to be fraudulent or abusive.

 

·                  We may besubjected to actions brought by the government under anti-fraud and abuseprovisions or by individuals on the government’s behalf under the False ClaimsAct’s “qui tam” or whistleblower provisions.

 

·                  Future reformsin healthcare legislation and regulation could reduce our revenues andprofitability.

 

·                  If ouraffiliated physician organizations are not able to satisfy CaliforniaDepartment of Managed Health Care financial solvency requirements, we couldbecome subject to sanctions and our ability to do business in this segment inCalifornia could be limited or ended.

 

·                  Ourprofitability could be adversely affected by any changes that would reducepayments to HMOs under government-sponsored healthcare programs.

 

·                  If any of ourhospitals lose their accreditation, such hospitals could become ineligible toreceive reimbursement under Medicare or Medi-Cal.

 

·                  Our revenuesand profits could be diminished if we lose the services of key physicians inour affiliated physician organizations.

 

·                  Our hospitalsface competition for medical support staff, including nurses, pharmacists,medical technicians and other personnel, which may increase our labor costs andharm our results of operations.

 

·                  If we were tolose the services of Sam Lee, our CEO, or other key members of management, wemight not be able to replace them in a timely manner with qualified personnel,which could disrupt our business and reduce our profitability and revenuegrowth.

 

·                  Because ourbusiness is currently limited to the Southern California area, any reduction inour revenues and profitability from a local economic downturn would not beoffset by operations in other geographic areas.

 

·                  We are requiredto upgrade and modify our management information systems to accommodate growthin our business and changes in technology and to satisfy new governmentregulations. As we seek to implement these changes, we may experiencecomplications, delays and increasing costs, which could disrupt our businessand reduce our profitability.

 

·                  Our ability tocontrol labor and employee benefit costs could be hindered by continuedacquisition activity.

 

·                  We and ourhospitals and affiliated physician organizations may become subject to claimsof medical malpractice or HMO bad-faith liability claims for which ourinsurance coverage may not be adequate. Such claims could materially increaseour costs and reduce our profitability.

 

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·                  Fluctuations inour quarterly operating results may make it difficult to predict our futureresults of operations, which could decrease the market value of our commonstock.

 

·                  If we are notable to develop or sustain an active trading market for our common stock, itmay be difficult for stockholders to dispose of their common stock.

 

·                  Even if anactive market develops for our common stock, the market price of our stock islikely to be volatile.

 

·                  If the currentweakness in the U.S. economy and job market continues unabated, revenue andprofitability within our Hospital Services and IPA Management segments could beadversely affected.

 

·                  While theCompany and its lenders remain in discussion to resolve the asserted defaults,there can be no assurance that the matter will be resolved on a basis favorableto the Company. The lenders may not grant waivers and could require fullrepayment of the loans, which would negatively impact the Company’s liquidity,ability to operate and its ability to continue as a going concern.

 

·                  If thedisruptions in the global financial and capital markets continue, debt orequity financing may not be available to us on acceptable terms, if at all. Ifwe are unable to fund future operations by way of financing, including publicor private offerings of equity or debt securities, our business, financialcondition and results of operations will be adversely impacted.

 

·                  We also faceother risks that could adversely affect our business, financial condition orresults of operations, which include: any requirement to restate financialresults in the event of inappropriate application of accounting principles; asignificant failure of our internal control over financial reporting; failureof our prevention and control systems related to employee compliance withinternal polices, including data security; failure to protect our proprietaryinformation; and failure of our corporate governance policies or procedures.

 

Investors should also referto our Form 10-K annual report filed with the Securities and ExchangeCommission on December 29, 2008 for a discussion of risk factors. A copyof the Form 10-K annual report can be found on the internet at *www.prospectmedicalholdings.com* or throughthe SEC’s electronic data system called EDGAR at *www.sec.gov*. Given these risks and uncertainties, we cangive no assurances that results projected in any forward-looking statementswill in fact occur and therefore caution investors not to place undue relianceon them.

 

**Overview**

 

Prior to the August 8,2007 acquisition of Alta, the Company was primarily a healthcare managementservices organization that developed integrated delivery systems and providesmedical management systems and services to affiliated medical organizations.With the acquisition of Alta, the Company now owns and operates fourcommunity-based hospitals in Southern California and its operations are noworganized into three reporting segments: IPA Management, Hospital Services andCorporate.

 

*IPA Management*

 

The IPA Management segmentis a healthcare management services organization that provides managementservices to affiliated physician organizations that operate as independentphysician associations (“IPAs”). The 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 contractwith physicians (primary care and specialist) and other healthcare providers toprovide all of their medical services.

 

Through our managementsubsidiaries—Prospect Medical Systems, Inc., Sierra Medical Management(through August 1, 2008) and ProMed Health Care Administrators, Inc.—wehave entered into long-term agreements to provide management services to eachof our affiliated physician organizations in exchange for a management fee. Themanagement services we provide include HMO contracting, physician recruiting,credentialing and contracting, human resources services, claims administration,financial services, provider relations, patient eligibility and other services,medical management including utilization management and quality assurance, datacollection, and management information systems.

 

Effective August 1,2008, the Company sold all of the issued and outstanding stock of SierraMedical Management (“SMM”), Sierra Primary Care Medical Group, Antelope ValleyMedical Associates, Inc. and Pegasus Medical Group, Inc., 

 

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(the “AV Entities”). As discussed inNote 4 to the accompanying unaudited interim condensed consolidatedfinancial statements, the assets, liabilities and operating results of the AVEntities have been classified as discontinued operations and are excluded fromthe disclosures below.

 

Our management subsidiariescurrently provide management services to twelve affiliated physicianorganizations, which include Prospect Medical Group, ten other affiliatedphysician organizations that Prospect Medical Group owns or controls, and oneaffiliated physician organization (AMVI/Prospect Health Network) that is anunconsolidated joint venture in which Prospect Medical Group owns a 50% interest.Prospect Medical Group, which was our first affiliated physician organization, hasacquired the ownership interest in all of our other affiliated physicianorganizations. Thus, while Prospect Medical Group is itself an affiliatedphysician organization that does the same business in its own service area asall of our other affiliated physician organizations do in theirs, ProspectMedical Group also serves as a holding company for our other affiliatedphysician organizations.

 

The twelve affiliated physicianorganizations provide medical services to a combined total of approximately183,200 HMO enrollees at March 31, 2009, including approximately 9,300AMVI Prospect Health Network enrollees that we manage for the economic benefitof an independent third party, and for which we earn management fee income.

 

Currently, our affiliatedphysician organizations have contracts with approximately 16 HMOs, from whichour revenue is primarily derived. HMOs offer a comprehensive healthcarebenefits package in exchange for a capitation fee per enrollee that does notvary through the contract period regardless of the quantity or cost of medicalservices required or used. HMOs enroll members by entering into contracts withemployer groups or directly with individuals to provide a broad range ofhealthcare services for a prepaid charge, with minimal deductibles orco-payments required of the members. All of the contracts between ouraffiliated physician organizations and the HMOs provide for the provision ofmedical services by the affiliated physician organization to the HMO enrolleesin consideration for the prepayment of the fixed monthly capitation fee perenrollee.

 

Our IPA Management businesshas grown through the acquisition of IPAs by Prospect Medical Group. We do notcurrently have plans to acquire any additional IPAs.

 

We have chosen toconcentrate our growth geographically by limiting our acquisitions to IPAs inOrange County, California, Los Angeles County, California and San BernardinoCounty, California.

 

Managed care revenuesconsist primarily of fees for medical services provided by our affiliatedphysician organizations under capitated contracts with various HMOs. Capitationrevenue under HMO contracts is prepaid monthly to the affiliates based on thenumber of enrollees electing any one of the affiliates as their healthcareprovider. Capitation revenue may be subsequently adjusted to reflect changes inenrollment as a result of retroactive terminations or additions. Theseadjustments have not had a material effect on capitation revenue. Capitationrevenue is also subject to risk adjustment. Beginning in calendar 2004,Medicare began a four year phase-in of a revised capitation model referred toas “Risk Adjustment.” Under this model, capitation with respect to Medicareenrollees is subject to subsequent adjustment for the acuity of the enrolleesto whom services were provided. Capitation for the current year is paid basedon data submitted for each enrollee for the preceding year. Capitation is paidat interim rates during the year and is adjusted in subsequent periods(generally in the fourth fiscal quarter) after the final data is compiled.Positive or negative capitation adjustments are made for seniors withconditions requiring more or less healthcare services than assumed in theinterim payments. Since we do not currently have the ability to reliablypredict these adjustments, periodic changes in capitation amounts earned as aresult of Risk Adjustment are recognized when those changes are communicated fromthe health plans, generally in the fourth quarter of the fiscal year to whichthe adjustments relate. Management fees primarily comprise amounts earned frommanaging the operations of AMVI, Inc., which is our joint venture partnerin the AMVI/Prospect Health Network joint venture. Management services havehistorically related only to Medi-Cal members. However, starting in fiscal2006, this was expanded to also include management services related to Medicaremembers enrolling in CalOPTIMA’s OneCare HMO, as well as management servicesprovided to Brotman Medical Center, an equity investee as of March 31, 2009 inwhich we held an initial 33.1% interest (increased to approximately 72% in April 2009).OneCare is a Medicare Advantage Special Needs Plan launched in August 2005by CalOPTIMA to serve dually-eligible members in Orange County who are entitledto Medicare benefits and are also Medi-Cal eligible. Management fee revenue isearned in the month the services are delivered.

 

Managed care revenues alsoinclude incentive payments from HMOs under “pay-for-performance” programs forquality medical care based on various criteria. These incentives are generallyreceived in the third and fourth quarters of our fiscal year and are recordedwhen such amounts are known since we do not have the information toindependently and reliably estimate these amounts.

 

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Wealso earn additional incentive revenue or incur penalties under HMO contractsby sharing in the risk for hospitalization based upon inpatient servicesutilized. These amounts are included in capitation revenue. Except for twominor contracts where we are contractually obligated for down-side risk, sharedrisk deficits are not payable until and unless we generate future risk sharingsurpluses. Risk pools are generally settled in the following year. Managementestimates risk pool incentives based on information received from the HMOs orhospitals with whom the risk-sharing arrangements are in place, and whotypically maintain the information and record keeping related to the risk poolarrangements. Differences between actual and estimated settlements are recordedwhen the final outcome is known. Risk pool and pay-for-performance incentivesare affected by many factors, some of which are beyond the Company’s control,and may vary significantly from year to year.

 

Revenues from continuingoperations of the IPA Management segment are comprised of the followingamounts:

 
| ** **      | ** ** | **Three Months Ended  March 31,** | ** ** | **% Increase** | ** ** | **Six Months Ended  March 31,** | ** ** | **% Increase** | ** ** |
|-----------------|------------|----------------------------------------|------------|----------------|------------|--------------------------------------|------------|----------------|------------|
| ** **      | ** ** | **2009**                               | ** ** | **2008(1)**    | ** ** | **(Decrease)**                       | ** ** | **2009**       | ** ** | **2008(1)** | ** ** | **(Decrease)** | ** ** |
| Capitation      |       | $                                      | 47,874,277 |           | $          | 50,464,854                           |       | (5.1           | )%         | $ | 95,636,452 |   | $ | 100,775,264 |   | (5.1 | )% |
| Management fees |       | 143,863                                |       | 146,767        |       | (2.0                                 | )%         | 288,195        |       | 254,395 |   | 13.3 | % |
| Other           |       | 140,962                                |       | 69,352         |       | 103.3                                | %          | 365,704        |       | 219,870 |   | 66.3 | % |
| Total           |       | $                                      | 48,159,102 |           | $          | 50,680,973                           |       | (5.0           | )%         | $ | 96,290,351 |   | $ | 101,249,529 |   | (4.9 | )% |

 

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| (1) | The above amounts exclude capitation revenue related to the AV  Entities, given their classification as discontinued operations in the  accompanying unaudited condensed consolidated financial statements |
|-----|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

We have increased ourmembership through acquisitions. These increases through acquisition are offsetby HMO enrollment declines at our affiliated physician organizations, similarto the general HMO enrollment trends in California in recent years. Thefollowing table sets forth the approximate number of members, by category:

 
| ** **                 | ** ** | **As of March 31,** | ** ** |
|----------------------------|------------|--------------------------|------------|
| **Member Category**        | ** ** | **2009**                 | ** ** | **2008(2)** | ** ** | **% Increase  (Decrease)** | ** ** |
| Commercial                 |       | 140,900                  |       | 161,100 |   | (12.5 | )% |
| Commercial—managed(1) |       | 1,300                    |       | 1,300 |   | 0.0 | % |
| Senior—owned          |       | 21,600                   |       | 22,100 |   | (2.3 | )% |
| Senior—managed(1)     |       | 100                      |       | 100 |   | 0.0 | % |
| Medi-Cal—owned        |       | 11,400                   |       | 16,100 |   | (29.2 | )% |
| Medi-Cal—managed(1)   |       | 7,900                    |       | 7,300 |   | 8.2 | % |
| Total                      |       | 183,200                  |       | 208,000 |   | (11.9 | )% |

 

----

| (1)    | Represent members of AMVI, Inc., our joint venture partner,  which we manage on their behalf in exchange for a fee.     |
|--------|------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                         |
| (2)    | The above amounts exclude HMO enrollment related to the AV Entities,  given their classification as discontinued operations. |

 

The following table detailstotal paid member months, by member category, for the three-month and six-monthperiods ended March 31, 2009 and 2008:

 
| ** **                 | ** ** | **Three Months Ended  March 31,** | ** ** | **% Increase** | ** ** | **Six Months Ended  March 31,** | ** ** | **% Increase** | ** ** |
|----------------------------|------------|----------------------------------------|------------|----------------|------------|--------------------------------------|------------|----------------|------------|
| ** **                 | ** ** | **2009**                               | ** ** | **2008(2)**    | ** ** | **(Decrease)**                       | ** ** | **2009**       | ** ** | **2008(2)** | ** ** | **(Decrease)** | ** ** |
| Commercial—owned      |       | 427,500                                |       | 487,800        |       | (12.4                                | )%         | 878,200        |       | 1,002,200 |   | (12.4 | )% |
| Commercial—managed(1) |       | 4,000                                  |       | 4,000          |       | 0.0                                  | %          | 8,100          |       | 7,900 |   | 2.5 | % |
| Senior—owned          |       | 64,800                                 |       | 66,800         |       | (3.0                                 | )%         | 129,700        |       | 133,400 |   | (2.8 | )% |
| Senior—managed(1)     |       | 400                                    |       | 400            |       | 0.0                                  | %          | 800            |       | 900 |   | (11.1 | )% |
| MediCal—owned         |       | 34,200                                 |       | 49,300         |       | (30.6                                | )%         | 68,000         |       | 98,100 |   | (30.7 | )% |
| MediCal—managed(1)    |       | 23,600                                 |       | 21,700         |       | 8.8                                  | %          | 46,800         |       | 41,300 |   | 13.3 | % |
|                       |       | 554,500                                |       | 630,000        |       | (12.0                                | )%         | 1,131,600      |       | 1,283,800 |   | (11.9 | )% |

 

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----

| (1)    | Represent members of AMVI, Inc., our joint venture partner,  which we manage on their behalf in exchange for a fee.     |
|--------|------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                         |
| (2)    | The above amounts exclude HMO enrollment related to the AV Entities,  given their classification as discontinued operations. |

 

Our operating expensesinclude expenses related to the provision of medical care services (managedcare cost of revenues) and general and administrative, or G&A, costs. Ourresults of operations depend on our ability to effectively manage expensesrelated to health benefits and accurately predict costs incurred.

 

Expenses related to medicalcare services include payments to contracted primary care physicians, paymentsto contracted specialists and the cost of employed physicians at the Company’smedical clinics (through August 1, 2008). In general, primary carephysicians are paid on a capitation basis, while specialists are paid on eithera capitation or a fee-for-service basis.

 

Capitation payments arefixed in advance of periods covered and are not subject to significantaccounting estimates. These payments are expensed in the period the providersare obligated to provide services. Fee-for-service payments are expensed in theperiod services are provided to our members. Medical care costs include actualhistorical claims experience and estimates of medical expenses incurred but notreported, or IBNR. Monthly, we estimate our IBNR based on a number of factors,including prior claims experience. As part of this review, we also considerestimates of amounts to cover uncertainties related to fluctuations in providerbilling patterns, claims payment patterns, membership and medical cost trends.These estimates are adjusted monthly as more information becomes available. Inaddition to our own IBNR estimation process, we obtain semi-annualcertifications of our IBNR liability from independent actuaries. We believethat our process for estimating IBNR is adequate, but there can be no assurancethat medical care costs will not exceed such estimates. In addition tocontractual reimbursements to providers, we also make discretionary incentivepayments to physicians, which are in large part based on thepay-for-performance, shared risk revenues and any favorable senior capitationrisk adjustment payments we receive. Since the Company records these revenuesgenerally in the third or fourth quarter of each fiscal year, when theincentives and capitation adjustments due from the health plans are known, the Companyalso historically adjusts interim accruals of discretionary physician bonusesin the same period. Because incentives and risk-adjustment revenues form thebasis for these discretionary bonuses, variability in earnings due tofluctuations in revenues are mitigated by reductions in bonuses awarded.

 

G&A costs are largelycomprised of wage and benefit costs related to our employee base and otheradministrative expenses. G&A functions include claims processing,information systems, provider relations, finance and accounting services, andlegal and regulatory services.

 

*Hospital Services*

* *

The Hospital Servicessegment owns and operates four urban acute-care community hospitals in thegreater Los Angeles area.  The four urbanacute-care community hospitals, operated by Alta, have a combined 339 licensedbeds served by 315 on-staff physicians at March 31, 2009. Each of thethree hospitals in Hollywood, Los Angeles and Norwalk offers a comprehensiverange of medical and surgical services, including inpatient, outpatient,skilled nursing and urgent care services. The hospital in Van Nuys providesacute inpatient and outpatient psychiatric services to patients admitted on avoluntary basis.  Admitting physiciansare primarily practitioners in the local area. The hospitals have paymentarrangements with Medicare, Medi-Cal and other third-party payers includingsome commercial insurance carriers, Health Maintenance Organizations (“HMOs”)and Preferred Provider Organizations (“PPOs”). The basis for such payments involvinginpatient and outpatient services rendered includes prospectively determinedrates per discharge and cost-reimbursed methodologies. The hospitals are alsoeligible to receive additional payment adjustments from Medicare and Medi-Calknown as Disproportionate Share Hospital (“DSH”) payments based on aprospective payment system for hospitals that serve large proportions oflow-income patients.

 

Operating revenue of ourHospital Services segment consists primarily of payments for services rendered,including estimated retroactive adjustments under reimbursement arrangementswith third-party payers. In some cases, reimbursement is based on formulas andreimbursable amounts are not considered final until cost reports are filed andaudited or otherwise settled by the various programs. The Company accrues foramounts that it believes will ultimately be due to or from Medicare and otherthird-party payers and reports such amounts as net patient revenues in theaccompanying financial statements. We closely monitor our historical collectionrates, as well as changes in applicable laws, rules and regulations andcontract terms, to assure that provisions are made using the most accurateinformation available. However, due to the complexities involved in these estimations,actual payments from payers may be materially different from the amounts weestimate and record. A summary of the payment arrangements with majorthird-party payers follows:

 

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Medicare: Medicare is afederal program that provides certain hospital and medical insurance benefitsto persons aged 65 and over, some disabled persons with end-stage renal diseaseand certain other beneficiary categories. Inpatient services rendered toMedicare program beneficiaries are paid at prospectively determined rates perdischarge, according to a patient classification system based on clinical,diagnostic, and other factors. Outpatient services are paid based on a blend ofprospectively determined rates and cost-reimbursed methodologies. The Companyis also reimbursed for various disproportionate share and Medicare bad debtcomponents at tentative rates, with final settlement determined aftersubmission of annual Medicare cost reports and audit thereof by the Medicarefiscal intermediary. Normal estimation differences between final settlementsand amounts accrued in previous years are reflected in net patient servicerevenue in the year of final settlement.

 

Medi-Cal: Medi-Cal is ajoint federal-state funded healthcare benefit program that is administered bythe state of California to provide benefits to qualifying individuals who areunable to afford care. As such, Medi-Cal constitutes the version of the federalMedicaid program that is applicable to California residents. Inpatient servicesrendered to Medi-Cal program beneficiaries are paid at contracted per diemrates. The per diem rates are not subject to retrospective adjustment.Outpatient services are paid based on prospectively determined rates perprocedure provided.

 

Managed Care: The Companyalso receives payment from certain commercial insurance carriers, HMOs, andPPOs, though generally does not enter into contracts with these entities. Thebasis for payment under these agreements includes the Company’s standardcharges for services.

 

Self Pay: Our hospitalsprovide services to individuals that do not have any form of healthcarecoverage. Such patients are evaluated, at the time of service or shortlythereafter, for their ability to pay based upon federal and state povertyguidelines, qualifications for Medi-Cal, as well as our local hospital’sindigent and charity care policy.

 

The following tables showthe approximate net patient revenue from each major payer category during thethree-month and six-month periods ended March 31, 2009 and 2008. Netpatient revenues are defined as revenues from all sources of patient care afterdeducting contractual allowances and discounts from established billing rates,which we derived from various sources of payment for the periods indicated.

 
| ** **   | ** ** | **Three Months Ended  March 31,** | ** ** | **% Increase** | ** ** | **Six Months Ended  March 31,** | ** ** | **%  Increase** | ** ** |
|--------------|------------|----------------------------------------|------------|----------------|------------|--------------------------------------|------------|-----------------|------------|
| ** **   | ** ** | **2009**                               | ** ** | **2008**       | ** ** | **(Decrease)**                       | ** ** | **2009**        | ** ** | **2008** | ** ** | **(Decrease)** | ** ** |
| Medicare     |       | $                                      | 17,899,611 |           | $          | 17,297,146                           |       | 3.5             | %          | $ | 34,758,052 |   | $ | 32,170,010 |   | 8.0 | % |
| Medi-Cal     |       | 17,464,590                             |       | 13,256,236     |       | 31.7                                 | %          | 33,578,348      |       | 24,067,014 |   | 39.5 | % |
| Managed care |       | 1,511,323                              |       | 954,193        |       | 58.4                                 | %          | 2,994,078       |       | 1,656,679 |   | 80.7 | % |
| Self pay     |       | 626,280                                |       | 512,318        |       | 22.2                                 | %          | 1,132,831       |       | 938,636 |   | 20.7 | % |
| Other        |       | 406,229                                |       | 376,233        |       | 8.0                                  | %          | 767,132         |       | 850,015 |   | (9.8 | )% |
| Total        |       | $                                      | 37,908,033 |           | $          | 32,396,126                           |       | 17.0            | %          | $ | 73,230,440 |   | $ | 59,682,354 |   | 22.7 | % |

 

Hospital revenues dependupon inpatient occupancy levels, the medical and ancillary services and therapyprograms ordered by physicians and provided to patients, the volume ofoutpatient procedures and the charges or negotiated payment rates for suchservices. Charges and reimbursement rates for inpatient routine services varydepending on the type of services provided (e.g., medical/surgical,intensive care or behavioral health) and the geographic location of thehospital. Inpatient occupancy levels fluctuate for various reasons, many ofwhich are beyond our control. The percentage of patient service revenueattributable to outpatient services has generally increased in recent years,primarily as a result of advances in medical technology that allow moreservices to be provided on an outpatient basis, as well as increased pressurefrom Medicare, Medi-Cal and private insurers to reduce hospital stays andprovide services, where possible, on a less expensive outpatient basis. Webelieve that our experience with respect to our increased outpatient levelsmirrors the general trend occurring in the healthcare industry and we areunable to predict the rate of growth and resulting impact on our futurerevenues.

 

Patients are generally notresponsible for any difference between customary hospital charges and amountsreimbursed for such services under Medicare, Medicaid, some private insuranceplans, and managed care plans, but are responsible for services not covered bysuch plans, exclusions, deductibles or co-insurance features of their coverage.The amount of such exclusions, deductibles and co-insurance has generally beenincreasing each year. Indications from recent federal and state legislation arethat this trend will continue. Collection of amounts due from individuals istypically more difficult than from governmental or business payers and wecontinue to experience an increase in uninsured and self-pay patients whichunfavorably impacts the collectability of our patient accounts, therebyincreasing our provision for doubtful accounts and charity care provided.

 

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The following table detailsoperating data of our hospital services facilities for the three-month andsix-month periods ended March 31, 2009 and 2008:

 
| ** **                                       | ** ** | **Three  Months Ended  March 31,** | ** **  | **%  Increase** | ** ** | **Six  Months Ended  March 31,** | ** ** | **%  Increase** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------|-------------|-----------------|------------|---------------------------------------|------------|-----------------|------------|
| ** **                                       | ** ** | **2009**                                | ** **  | **2008**        | ** ** | **(Decrease)**                        | ** ** | **2009**        | ** ** | **2008** | ** ** | **(Decrease)** | ** ** |
| Total net  Hospital services revenues            |       | $                                       | 37,908,033  |            | $          | 32,396,126                            |       | 17.0            | %          | $ | 73,230,440 |   | $ | 59,682,354 |   | 22.7 | % |
| Operating income  before income taxes            |       | $                                       | 11,065,118  |            | $          | 7,494,410                             |       | 47.6            | %          | $ | 20,182,863 |   | $ | 13,113,481 |   | 53.9 | % |
| Total assets as  of March 31, 2009 and 2008 |       | $                                       | 208,207,429 |            | $          | 176,084,131                           |       | 18.2            | %          | $ | 208,207,429 |   | $ | 176,084,131 |   | 18.2 | % |
| Average licensed  beds                           |       | 339                                     |        | 339             |       | 0.0                                   | %          | 339             |       | 339 |   | 0.0 | % |
| Average  available beds                          |       | 330                                     |        | 330             |       | 0.0                                   | %          | 330             |       | 330 |   | 0.0 | % |
| Inpatient  admissions                            |       | 3,639                                   |        | 3,742           |       | (2.8                                  | )%         | 7,224           |       | 7,031 |   | 2.7 | % |
| Average length  of patient stay (days)           |       | 6.0                                     |        | 5.5             |       | 9.1                                   | %          | 5.9             |       | 5.3 |   | 11.3 | % |
| Patient days                                     |       | 24,062                                  |        | 22,700          |       | 6.0                                   | %          | 47,529          |       | 41,620 |   | 14.2 | % |
| Occupancy rate  for licensed beds                |       | 78.9                                    | %           | 73.4            | %          | 7.5                                   | %          | 77.0            | %          | 67.1 | % | 14.8 | % |
| Occupancy rate  for available beds               |       | 81.0                                    | %           | 75.5            | %          | 7.3                                   | %          | 79.1            | %          | 68.9 | % | 14.8 | % |

 

Operating expenses of ourHospital Services segment include salaries, benefits and other compensationpaid to physicians and healthcare professionals that are employees of ourhospitals; medical supplies; consultant and professional services; andprovision for doubtful accounts.

 

General and administrativeexpenses of our Hospital Services segment includes salaries, benefits and othercompensation for our Hospital administrative employees, insurance, rent,operating supplies, legal, accounting and marketing.

 

*Corporate*

* *

Certain expenses incurred inProspect Medical Holdings, Inc. (the “Parent Entity”) not specificallyallocable to the IPA Management or Hospital Services segments are recorded inthe Corporate segment. These include certain salaries, benefits and othercompensation for our corporate employees, financing, insurance, rent, operatingsupplies, legal, accounting, SEC compliance, and Sarbanes-Oxley assessment andcompliance activities. We also do not allocate interest expense, debtextinguishment loss, gain or loss on interest rate swaps and income taxes tothe other reporting segments.

 

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** **

**Results of Operations**

 

***IPA Management***

*** ***

The following tablessummarize our net operating revenue, operating expenses and operating incomefrom continuing IPA Management operations and are used in the discussions belowfor the three-month and six-month periods ended March 31, 2009 and 2008.Effective August 1, 2008, we sold the AV Entities’ operations. Theoperating results of these operations are reflected as loss from discontinuedoperations, net of income tax and are excluded from the disclosures below foreach period presented.

 
| ** **                                | ** ** | **Three  Months Ended  March 31,** | ** ** | **Six  Months Ended  March 31,** | ** ** |
|-------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------|------------|
| ** **                                | ** ** | **2009**                                | ** ** | **2008**                              | ** ** | **Increase  (Decrease)** | ** ** | **%** | ** ** | **2009** | ** ** | **2008** | ** ** | **Increase  (Decrease)** | ** ** | **%** | ** ** |
| **Managed  care revenues:**               |       |                                    |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Capitation                                |       | $                                       | 47,874,277 |                                  | $          | 50,464,854 |   | $ | (2,590,576 | ) | (5.1 | )% | $ | 95,636,452 |   | $ | 100,775,264 |   | $ | (5,138,812 | ) | (5.1 | )% |
| Management fees                           |       | 143,863                                 |       | 146,767                               |       | (2,904 | ) | (2.0 | )% | 288,195 |   | 254,395 |   | 33,800 |   | 13.3 | % |
| Other operating  revenue                  |       | 140,962                                 |       | 69,352                                |       | 71,610 |   | 103.3 | % | 365,704 |   | 219,870 |   | 145,834 |   | 66.3 | % |
| **Total  managed care revenues**          |       | 48,159,102                              |       | 50,680,973                            |       | (2,521,871 | ) | (5.0 | )% | 96,290,351 |   | 101,249,529 |   | (4,959,178 | ) | (4.9 | )% |
| **Managed  care cost of revenues:**       |       |                                    |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| PCP capitation                            |       | 8,465,544                               |       | 9,464,369                             |       | (998,825 | ) | (10.6 | )% | 17,134,584 |   | 18,995,591 |   | (1,861,007 | ) | (9.8 | )% |
| Specialist  capitation                    |       | 11,128,335                              |       | 10,449,154                            |       | 679,181 |   | 6.5 | % | 22,146,827 |   | 20,962,690 |   | 1,184,137 |   | 5.6 | % |
| Claims expense                            |       | 17,470,089                              |       | 19,749,143                            |       | (2,279,054 | ) | (11.5 | )% | 35,162,731 |   | 40,786,780 |   | (5,624,049 | ) | (13.8 | )% |
| Physician  salaries                       |       | 286,578                                 |       | 318,154                               |       | (31,576 | ) | (9.9 | )% | 1,064,995 |   | 767,473 |   | 297,522 |   | 38.8 | % |
| Other cost of  revenues                   |       | (395,044                                | )          | 227,482                               |       | (622,526 | ) | (273.7 | )% | (941,706 | ) | (36,801 | ) | (904,905 | ) | 2458.9 | % |
| **Total  managed care cost of revenues**  |       | 36,955,502                              |       | 40,208,302                            |       | (3,252,800 | ) | (8.1 | )% | 74,567,431 |   | 81,475,733 |   | (6,908,302 | ) | (8.5 | )% |
| **Gross  margin**                         |       | 11,203,600                              |       | 10,472,671                            |       | 730,929 |   | 7.0 | % | 21,722,920 |   | 19,773,796 |   | 1,949,124 |   | 9.9 | % |
| General and  administrative expenses      |       | 7,479,468                               |       | 7,496,673                             |       | (17,205 | ) | (0.2 | )% | 14,675,358 |   | 15,006,977 |   | (331,619 | ) | (2.2 | )% |
| Depreciation and  amortization expense    |       | 883,929                                 |       | 877,344                               |       | 6,585 |   | 0.8 | % | 1,754,859 |   | 1,729,850 |   | 25,009 |   | 1.4 | % |
| Total non-medical  expenses               |       | 8,363,397                               |       | 8,374,018                             |       | (10,620 | ) | (0.1 | )% | 16,430,217 |   | 16,736,827 |   | (306,610 | ) | (1.8 | )% |
| Income from  unconsolidated joint venture |       | 594,623                                 |       | 694,219                               |       | (99,596 | ) | (14.3 | )% | 947,205 |   | 1,168,959 |   | (221,754 | ) | (19.0 | )% |
| **Operating  income**                     |       | $                                       | 3,434,826  |                                  | $          | 2,792,873 |   | $ | 641,953 |   | 23.0 | % | $ | 6,239,908 |   | $ | 4,205,928 |   | $ | 2,033,980 |   | 48.4 | % |

 

The following table setsforth selected operating items, expressed as a percentage of total revenue:

 
| ** **                               | ** ** | **Three Months Ended  March 31,** | ** ** | **Six Months Ended  March 31,** | ** ** |
|------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                               | ** ** | **2009**                               | ** ** | **2008**                             | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Managed care revenues:**               |       |                                   |       |                                 |       |   |   |   |   |
| Capitation revenue                       |       | 99.4                                   | %          | 99.6                                 | %          | 99.3 | % | 99.5 | % |
| Management fees                          |       | 0.3                                    | %          | 0.3                                  | %          | 0.3 | % | 0.3 | % |
| Other revenues                           |       | 0.3                                    | %          | 0.1                                  | %          | 0.4 | % | 0.2 | % |
| **Total managed care revenues**          |       | 100.0                                  | %          | 100.0                                | %          | 100.0 | % | 100.0 | % |
| **Managed care cost of revenues:**       |       |                                   |       |                                 |       |   |   |   |   |
| PCP capitation                           |       | 17.6                                   | %          | 18.7                                 | %          | 17.8 | % | 18.8 | % |
| Specialists capitation                   |       | 23.1                                   | %          | 20.6                                 | %          | 23.0 | % | 20.7 | % |
| Claims expense                           |       | 36.3                                   | %          | 39.0                                 | %          | 36.5 | % | 40.3 | % |
| Physician salaries                       |       | 0.6                                    | %          | 0.6                                  | %          | 1.1 | % | 0.8 | % |
| Other cost of revenues                   |       | (0.8                                   | )%         | 0.4                                  | %          | (1.0 | )% | 0.0 | % |
| **Total managed care cost of revenues**  |       | 76.8                                   | %          | 79.3                                 | %          | 77.4 | % | 80.6 | % |
| **Gross margin**                         |       | 23.2                                   | %          | 20.7                                 | %          | 22.6 | % | 19.4 | % |
| General and administrative expenses      |       | 15.5                                   | %          | 14.8                                 | %          | 15.2 | % | 14.8 | % |
| Depreciation and amortization expense    |       | 1.8                                    | %          | 1.7                                  | %          | 1.8 | % | 1.7 | % |
| Total non-medical expenses               |       | 17.3                                   | %          | 16.5                                 | %          | 17.1 | % | 16.5 | % |
| Income from unconsolidated joint venture |       | 1.2                                    | %          | 1.4                                  | %          | 1.0 | % | 1.2 | % |
| **Operating income**                     |       | 7.1                                    | %          | 5.6                                  | %          | 6.6 | % | 4.1 | % |

 

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** **

**Three Months Ended March 31, 2009 Compared toThree Months Ended March 31, 2008**

** **

*Capitation Revenue*

* *

Capitation revenue for thethree months ended March 31, 2009 was approximately $47,874,000,representing a decrease of approximately $2,591,000, or 5.1% from capitationrevenue for the three months ended March 31, 2008, of approximately$50,465,000.

 

The decrease was comprisedof two main factors: (i) member month declines in our IPA Managementoperations reduced capitation revenue by approximately $6,604,000 during thefiscal 2009 period, as compared to the fiscal 2008 period due to lower HMOenrollment, and (ii) higher capitation rates on our IPA Managementoperations increased capitation revenue by approximately $4,013,000 during thefiscal 2009 period, as compared to the fiscal 2008 period. The decrease inmember months was partly due to the loss of several of our primary carephysicians and our cancellation of certain unprofitable Medi-Cal contractswithin our ProMed operating unit.

 

*Management Fee Revenue*

* *

Management fee revenue forthe three months ended March 31, 2009 was approximately $144,000,representing a decrease of approximately $3,000 or 2.0% from management feerevenue for the three months ended March 31, 2008, of approximately$147,000.

 

The decrease was primarilydue to lower accrual of Brotman management fee within our IPA Managementoperation in the fiscal 2009 period as compared to the fiscal 2008 period,offset by an increase in management fee resulting from an increase in thenumber of members of AMVICare Health Network, Inc., which we manage ontheir behalf in exchange for a fee.

 

*Other Operating Revenue*

* *

Other operating revenue forthe three months ended March 31, 2009 was approximately $141,000,representing an increase of approximately $72,000 or 103.3% from otheroperating revenue for the three months ended March 31, 2008, ofapproximately $69,000.

 

Amounts include incentivepayments from HMOs under “pay-per-performance” programs for quality medicalcare based on various criteria. The incentives are recorded when such amountsare known. The increase in other operating revenue during the fiscal 2009period was primarily the result of timing of receipt of these incentives fromour contracted Health Plans.

 

*PCP Capitation Expense*

* *

Primary care physician (“PCP”)capitation expense for the three months ended March 31, 2009 wasapproximately $8,466,000, representing a decrease of approximately $999,000 or10.6% over PCP capitation expense for the three months ended March 31,2008, of approximately $9,464,000.

 

The decrease was comprisedof two main factors: (i) member months declines related to our IPAManagement operations, reduced our PCP capitation expense by approximately$1,239,000 during the fiscal 2009 period, as compared to the fiscal 2008 periodand (ii) higher capitation rates on our IPA Management operationsincreased PCP capitation expense by approximately $240,000 during the fiscal2009 period, as compared to the fiscal 2008 period.

 

*Specialist Capitation Expense*

* *

Specialist capitationexpense for the three months ended March 31, 2009 was approximately$11,128,000, representing an increase of $679,000, or 6.5%, over specialistcapitation expense for the three months ended March 31, 2008, of$10,449,000.

 

The increase was comprisedof two main factors: (i) higher capitation rates on our IPA Managementoperations increased specialist capitation expense by approximately $2,047,000during the fiscal 2009 period, as compared to the fiscal 2008 period. EffectiveNovember 1, 2008, we capitated radiology services for a significant numberof members in our Orange County area, which services had previously beenrendered on a fee-for-service basis; and (ii) member month declines in ourIPA Management operations reduced specialist capitation expense byapproximately $1,368,000 during the fiscal 2009 period, as compared to thefiscal 2008 period.

 

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*ClaimsExpense*

* *

Claims expense for the threemonths ended March 31, 2009 was approximately $17,470,000, representing adecrease of approximately $2,279,000 or 11.5% over claims expense for the threemonths ended March 31, 2008, of approximately $19,749,000.

 

The decrease was comprisedof two main factors: (i) member month declines in our IPA operationsreduced claims expense by approximately $2,585,000 in the fiscal 2009 period,as compared to the fiscal 2008 period. As indicated above, effective November 1,2008, we capitated radiology services for a significant number of our OrangeCounty members, saving costs and effectively moving the related cost fromclaims expense to specialist capitation expense and (ii) claims per memberrates on our IPA Management operations increased claims expense byapproximately $306,000 during the fiscal 2009 period as compared to the fiscal2008 period.

 

*Physician Salaries Expense*

* *

Physician salaries expensefor the three months ended March 31, 2009 was approximately $287,000,representing a decrease of approximately $32,000 or 9.9% over physiciansalaries expense for the three months ended March 31, 2008, ofapproximately $318,000.

 

The decrease was primarilydue to the conversion of certain physicians from salary to capitation basiseffective November 11, 2008, offset by a higher physician bonus accrualtotaling $100,000 in the fiscal 2009 period as compared to $2,000 in the fiscal2008 period.

 

*Other Cost of Revenues*

* *

Other cost of revenues forthe three months ended March 31, 2009 was a negative expense ofapproximately $395,000 as compared to an expense of approximately $227,000 forthe three months ended March 31, 2008.

 

The negative expense in thefiscal 2009 period represents stop-loss recoveries, which have been offsetagainst premiums paid and are recorded as a reduction of other medical costs.

 

*Gross Margin*

* *

Medical care costs as apercentage of medical revenues (the medical care ratio) largely determine ourgross margin. Our gross margin increased to 23.3% for the three months ended March 31,2009, from 20.7% for the three months ended March 31, 2008.

 

The increase in our grossmargin percentage between the fiscal 2009 period and the fiscal 2008 period wasprimarily the result of the decreasing fee for service claims due to newradiology specialty capitation service agreement, PCP capitation expense andclaims cost per member per month in the fiscal 2009 period, discussed above.

 

*General and Administrative*

* *

General and administrativeexpenses were approximately $7,479,000 for the three months ended March 31,2009, representing 15.5% of total IPA Management revenues, as compared withapproximately $7,497,000, or 14.8% of total IPA Management revenues, for thethree months ended March 31, 2008.

 

The decrease ofapproximately $17,000 in general and administrative expenses during the fiscal2009 period primarily related to the reduction in the use of outside consultingservices and temporary personnel within our IPA Management operation.

 

*Depreciation and Amortization*

* *

Depreciation andamortization expense for the three months ended March 31, 2009 increasedto approximately $884,000 from approximately $877,000 for the three months endedMarch 31, 2008. The increase of approximately $7,000 was due to additionaldepreciation expense for increased capital expenditures.

 

*Income from Unconsolidated Joint Venture*

* *

Income from unconsolidatedjoint venture for the three months ended March 31, 2009 decreased toapproximately $595,000 from approximately $694,000 for the three months ended March 31,2008. The decrease corresponds with membership levels and 

 

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costs associated with participation in theCalOptima OneCare program for Medicare/Medi-Cal eligible beneficiarieseffective January 1, 2006. 

 

*Operating Income*

* *

Our IPA Management segmentreported an operating income of approximately $3,435,000 for the three monthsended March 31, 2009, as compared to approximately $2,793,000 for thethree months ended March 31, 2008, which increase was the result of thechanges discussed above. The pre-tax operating results from the IPA Managementsegment include certain corporate expense allocations for insurance,professional services, and amortization of identifiable intangibles.

 

**Six Months Ended March 31, 2009 Compared to SixMonths Ended March 31, 2008**

** **

*Capitation Revenue*

* *

Capitation revenue for thesix months ended March 31, 2009 was approximately $95,636,000,representing a decrease of approximately $5,138,000, or 5.1% from capitationrevenue for the six months ended March 31, 2008, of approximately$100,775,000.

 

The decrease was comprisedof two main factors: (i) member month declines in our IPA Managementoperations reduced capitation revenue by approximately $13,180,000 during thefiscal 2009 period, as compared to the fiscal 2008 period due to lower HMO enrollment,and (ii) higher capitation rates on our IPA Management operationsincreased capitation revenue by approximately $8,042,000 during the fiscal 2009period, as compared to the fiscal 2008 period. The decrease in member monthswas partly due to the loss of several of our primary care physicians and ourcancellation of certain unprofitable Medi-Cal contracts within our ProMedoperating unit.

 

*Management Fee Revenue*

* *

Management fee revenue forsix months ended March 31, 2009 was approximately $288,000, representingan increase of approximately $34,000 or 13.3% from management fee revenue forthe six months ended March 31, 2008, of approximately $254,000.

 

The increase was primarilydue to an increase in the number of members of AMVICare Health Network, Inc.,which we manage on their behalf in exchange for a fee.

 

*Other Operating Revenue*

* *

Other operating revenue forthe six months ended March 31, 2009 was approximately $366,000,representing an increase of approximately $146,000 or 66.3% from other operatingrevenue for the six months ended March 31, 2008, of approximately$220,000.

 

Amounts include incentivepayments from HMOs under “pay-per-performance” programs for quality medicalcare based on various criteria. The incentives are recorded when such amountsare known. The increase in other operating revenue during the fiscal 2009period was primarily the result of timing of receipt of these incentives fromour contracted Health Plans and the settlement of claims under certain of ourHMO contracts.

 

*PCP Capitation Expense*

* *

PCP capitation expense forthe six months ended March 31, 2009 was approximately $17,135,000,representing a decrease of approximately $1,861,000 or 9.8% over PCP capitationexpense for the six months ended March 31, 2008, of approximately$18,996,000.

 

The decrease was comprisedof two main factors: (i) member months declines related to our IPAManagement operations, reduced our PCP capitation expense by approximately$2,484,000 during the fiscal 2009 period, as compared to the fiscal 2008 periodand (ii) higher capitation rates on our IPA Management operationsincreased PCP capitation expense by approximately $623,000 during the fiscal2009 period, as compared to the fiscal 2008 period.

 

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* *

*Specialist Capitation Expense*

* *

Specialist capitationexpense for the six months ended March 31, 2009 was approximately$22,147,000, representing an increase of $1,184,000, or 5.6%, over specialistcapitation expense for the six months ended March 31, 2008, of$20,963,000.

 

The increase was comprisedof two main factors: (i) higher capitation rates on our IPA Managementoperations increased specialist capitation expense by approximately $3,926,000during the fiscal 2009 period, as compared to the fiscal 2008 period. EffectiveNovember 1, 2008, we capitated radiology services for a significant numberof members in our Orange County area, which services had previously beenrendered on a fee-for-service basis; and (ii) member month declines in ourIPA Management operations, which reduced specialist capitation expense byapproximately $2,742,000 during the fiscal 2009 period, as compared to thefiscal 2008 period.

 

*Claims Expense*

* *

Claims expense for the sixmonths ended March 31, 2009 was approximately $35,162,000, representing adecrease of approximately $5,624,000 or 13.8% over claims expense for the sixmonths ended March 31, 2008, of approximately $40,787,000.

 

The decrease was comprisedof two main factors: (i) member month declines in our IPA operationsreduced claims expense by approximately $5,334,000 in the fiscal 2009 period,as compared to the fiscal 2008 period. As indicated above, effective November 1,2008, we capitated radiology services for a significant number of our OrangeCounty members, saving costs and effectively moving the related cost fromclaims expense to specialist capitation expense and (ii) claims per memberrates on our IPA Management operations decreased claims expense byapproximately $290,000 during the fiscal 2009 period as compared to the fiscal2008 period.

 

*Physician Salaries Expense*

* *

Physician salaries expensefor the six months ended March 31, 2009 was approximately $1,065,000,representing an increase of approximately $298,000 or 38.8% over physiciansalaries expense for the six months ended March 31, 2008, of approximately$767,000.

 

The increase was primarilydue to physician bonus accrual totaling $600,000 in the fiscal 2009 period ascompared to $8,000 in the fiscal 2008 period, offset by the reduction insalaries resulting from the conversion of certain physicians from salary tocapitation basis effective November 11, 2008.

 

*Other Cost of Revenues*

* *

Other cost of revenues forthe six months ended March 31, 2009 was a negative expense ofapproximately $942,000 as compared to a negative expense of approximately$37,000 for the six months ended March 31, 2008.

 

The negative expense in thefiscal 2009 and 2008 periods represent stop-loss recoveries, which have beenoffset against premiums paid and are recorded as a reduction of other medicalcosts.

 

*Gross Margin*

* *

Medical care costs as apercentage of medical revenues (the medical care ratio) largely determine ourgross margin. Our gross margin increased to 22.6% for the six months ended March 31,2009, from 19.5% for the six months ended March 31, 2008.

 

The increase in our grossmargin percentage between the fiscal 2009 period and the fiscal 2008 period wasprimarily the result of the decreasing fee for service claims due to newradiology specialty capitation service agreement, PCP capitation expense andclaims cost per member per month in the fiscal 2009 period, discussed above.

 

*General and Administrative*

* *

General and administrativeexpenses were approximately $14,675,000 for the six months ended March 31,2009, representing 15.2% of total IPA Management revenues, as compared withapproximately $15,007,000, or 14.8% of total IPA Management revenues, for thesix months ended March 31, 2009.

 

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The decrease ofapproximately $332,000 in general and administrative expenses during the fiscal2009 period primarily related to the reduction in the use of outside consultingservices and temporary personnel within our IPA Management operation.

 

*Depreciation and Amortization*

* *

Depreciation andamortization expense for the six months ended March 31, 2009 increased toapproximately $1,755,000 from approximately $1,730,000 for the six months endedMarch 31, 2008. The increase of approximately $25,000 was due toadditional depreciation expense for increased capital expenditures.

 

*Income from Unconsolidated Joint Venture*

* *

Income from unconsolidatedjoint venture for the six months ended March 31, 2009 decreased toapproximately $947,000 from approximately $1,169,000 for the six months ended March 31,2008. The decrease corresponds with membership levels and costs associated withparticipation in the CalOptima OneCare program for Medicare/Medi-Cal eligiblebeneficiaries effective January 1, 2006. We also reserved againstcollectability of certain amounts related to the Joint Venture in the currentperiod.

 

*Operating Income*

* *

Our IPA Management segmentreported an operating income of approximately $6,240,000 for the six monthsended March 31, 2009, as compared to approximately $4,206,000 for the sixmonths ended March 31, 2008, which increase was the result of the changesdiscussed above. The pre-tax operating results from the IPA Management segmentinclude certain corporate expense allocations for insurance, professionalservices, and amortization of identifiable intangibles.

 

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*** ***

***Hospital Services***

*** ***

The following table setsforth the results of operation for our Hospital Services segment and is used inthe discussion below for the three-month and six-month periods ended March 31,2009 and 2008.

 
| ** **                             | ** ** | **Three  Months Ended March 31,** | ** ** | **Six  Months Ended March 31,** | ** ** |
|----------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                             | ** ** | **2009**                               | ** ** | **2008**                             | ** ** | **Increase  (Decrease)** | ** ** | **%** | ** ** | **2009** | ** ** | **2008** | ** ** | **Increase  (Decrease)** | ** ** | **%** | ** ** |
| **Net  Hospital Services revenues:**   |       |                                   |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Medicare                               |       | $                                      | 17,899,611 |                                 | $          | 17,297,146 |   | 602,465 |   | 3.5 | % | $ | 34,758,035 |   | $ | 32,170,010 |   | 2,588,025 |   | 8.0 | % |
| Medi-Cal                               |       | 17,464,590                             |       | 13,256,236                           |       | 4,208,355 |   | 31.7 | % | 33,578,348 |   | 24,067,014 |   | 9,511,334 |   | 39.5 | % |
| Managed care                           |       | 1,511,323                              |       | 954,193                              |       | 557,130 |   | 58.4 | % | 2,994,078 |   | 1,656,679 |   | 1,337,399 |   | 80.7 | % |
| Self pay                               |       | 626,280                                |       | 512,318                              |       | 113,962 |   | 22.2 | % | 1,132,831 |   | 938,636 |   | 194,195 |   | 20.7 | % |
| Other                                  |       | 406,228                                |       | 376,233                              |       | 29,995 |   | 8.0 | % | 767,148 |   | 850,015 |   | (82,867 | ) | (9.8 | )% |
| **Total  Hospital Services revenues**  |       | 37,908,033                             |       | 32,396,126                           |       | 5,511,907 |   | 17.0 | % | 73,230,440 |   | 59,682,354 |   | 13,548,086 |   | 22.7 | % |
| **Hospital  operating expenses:**      |       |                                   |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Salaries, wages  and benefits          |       | 15,922,785                             |       | 15,063,696                           |       | 859,089 |   | 5.7 | % | 31,816,949 |   | 28,942,386 |   | 2,874,562 |   | 9.9 | % |
| Other operating  expenses              |       | 2,250,224                              |       | 1,868,772                            |       | 381,452 |   | 20.4 | % | 4,434,631 |   | 3,534,633 |   | 899,999 |   | 25.5 | % |
| Supplies expense                       |       | 2,184,130                              |       | 2,268,317                            |       | (84,187 | ) | (3.7 | )% | 4,377,284 |   | 4,177,582 |   | 199,702 |   | 4.8 | % |
| Provision for  doubtful accounts       |       | 2,216,414                              |       | 1,512,030                            |       | 704,384 |   | 46.6 | % | 3,708,943 |   | 1,860,809 |   | 1,848,134 |   | 99.3 | % |
| Lease and rental  expense              |       | 284,260                                |       | 254,162                              |       | 30,098 |   | 11.8 | % | 665,562 |   | 452,915 |   | 212,647 |   | 47.0 | % |
| **Total  Hospital operating expenses** |       | 22,857,813                             |       | 20,966,977                           |       | 1,890,836 |   | 9.0 | % | 45,003,369 |   | 38,968,325 |   | 6,035,044 |   | 15.5 | % |
| General and  administrative expenses   |       | 3,049,518                              |       | 2,911,418                            |       | 138,100 |   | 4.7 | % | 6,216,823 |   | 5,535,410 |   | 681,414 |   | 12.3 | % |
| Depreciation and  amortization expense |       | 935,583                                |       | 1,023,320                            |       | (87,736 | ) | (8.6 | )% | 1,827,385 |   | 2,065,138 |   | (237,755 | ) | (11.5 | )% |
| Total non-medical  expenses            |       | 3,985,101                              |       | 3,934,738                            |       | 50,363 |   | 1.3 | % | 8,044,208 |   | 7,600,548 |   | 443,660 |   | 5.8 | % |
| **Operating  income**                  |       | $                                      | 11,065,118 |                                 | $          | 7,494,411 |   | $ | 3,570,707 |   | 47.6 | % | $ | 20,182,863 |   | $ | 13,113,481 |   | $ | 7,069,382 |   | 53.9 | % |
|                                        |            |                                        |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The following table setsforth selected operating items, expressed as a percentage of total revenue:

 
| ** **                            | ** ** | **Three Months Ended  March 31,** | ** ** | **Six Months Ended  March 31,** | ** ** |
|---------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                            | ** ** | **2009**                               | ** ** | **2008**                             | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Net Hospital Services revenues:**   |       |                                   |       |                                 |       |   |   |   |   |
| Medicare                              |       | 47.2                                   | %          | 53.4                                 | %          | 47.5 | % | 53.9 | % |
| Medi-Cal                              |       | 46.1                                   | %          | 40.9                                 | %          | 45.8 | % | 40.3 | % |
| Managed care                          |       | 4.0                                    | %          | 2.9                                  | %          | 4.1 | % | 2.8 | % |
| Self pay                              |       | 1.7                                    | %          | 1.6                                  | %          | 1.5 | % | 1.6 | % |
| Other                                 |       | 1.1                                    | %          | 1.2                                  | %          | 1.1 | % | 1.4 | % |
| **Total Hospital Services revenues**  |       | 100.0                                  | %          | 100.0                                | %          | 100.0 | % | 100.0 | % |
| **Hospital operating expenses:**      |       |                                   |       |                                 |       |   |   |   |   |
| Salaries, wages and benefits          |       | 42.0                                   | %          | 46.5                                 | %          | 43.4 | % | 48.5 | % |
| Other operating expenses              |       | 5.9                                    | %          | 5.8                                  | %          | 6.1 | % | 5.9 | % |
| Supplies expense                      |       | 5.8                                    | %          | 7.0                                  | %          | 6.0 | % | 7.0 | % |
| Provision for doubtful accounts       |       | 5.8                                    | %          | 4.7                                  | %          | 5.1 | % | 3.1 | % |
| Lease and rental expense              |       | 0.7                                    | %          | 0.8                                  | %          | 0.9 | % | 0.8 | % |
| **Total Hospital operating expenses** |       | 60.2                                   | %          | 64.8                                 | %          | 61.5 | % | 65.3 | % |
| General and administrative expenses   |       | 8.0                                    | %          | 9.0                                  | %          | 8.5 | % | 9.3 | % |
| Depreciation and amortization expense |       | 2.5                                    | %          | 3.2                                  | %          | 2.5 | % | 3.5 | % |
| Total non-medical expenses            |       | 10.5                                   | %          | 12.2                                 | %          | 11.1 | % | 12.8 | % |
| **Operating income**                  |       | 29.3                                   | %          | 23.0                                 | %          | 27.4 | % | 21.9 | % |

 

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The following table showscertain selected historical operating statistics for our hospitals for thethree-month and six-month periods ended March 31, 2009 and 2008:

 
| ** **                                    | ** ** | **Three  Months Ended March 31,** | ** ** | **Six  Months Ended March 31,** | ** ** |
|-----------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                                    | ** ** | **2009**                               | ** ** | **2008**                             | ** ** | **Increase  (Decrease)** | ** ** | **2009** | ** ** | **2008** | ** ** | **Increase  (Decrease)** | ** ** |
| Net inpatient  revenues(1)                    |       | $                                      | 35,560,711 |                                 | $          | 30,159,537 |   | 17.9 | % | $ | 68,800,172 |   | $ | 55,250,624 |   | 24.5 | % |
| Net outpatient  revenues(1)                   |       | $                                      | 1,941,093  |                                 | $          | 1,860,356 |   | 4.3 | % | $ | 3,663,137 |   | $ | 3,581,715 |   | 2.3 | % |
| Number of  hospitals at end of period         |       | 4                                      |       | 4                                    |       | 0.0 | % | 4 |   | 4 |   | 0.0 | % |
| Licensed beds at  end of the period           |       | 339                                    |       | 339                                  |       | 0.0 | % | 339 |   | 339 |   | 0.0 | % |
| Average licensed  beds                        |       | 339                                    |       | 339                                  |       | 0.0 | % | 339 |   | 339 |   | 0.0 | % |
| Utilization of  licensed beds(2)              |       | 77.2                                   | %          | 72.8                                 | %          | 6.0 | % | 76.2 | % | 66.7 | % | 14.2 | % |
| Average available  beds                       |       | 330                                    |       | 330                                  |       | 0.0 | % | 330 |   | 330 |   | 0.0 | % |
| Admissions(3)                                 |       | 3,639                                  |       | 3,742                                |       | (2.8 | )% | 7,224 |   | 7,031 |   | 2.7 | % |
| Adjusted patient  admissions(4)               |       | 3,899                                  |       | 3,974                                |       | (1.9 | )% | 7,607 |   | 7,488 |   | 1.6 | % |
| Net inpatient  revenue per admission          |       | $                                      | 9,772      |                                 | $          | 8,060 |   | 21.2 | % | $ | 9,524 |   | 7,830 |   | 21.6 | % |
| Emergency  room visits                   |       | 3,687                                  |       | 3,696                                |       | (0.2 | )% | 6,927 |   | 6,954 |   | (0.4 | )% |
| Surgeries                                     |       | 697                                    |       | 722                                  |       | (3.5 | )% | 1,414 |   | 1,425 |   | (0.8 | )% |
| Patient days                                  |       | 24,062                                 |       | 22,700                               |       | 6.0 | % | 47,529 |   | 41,620 |   | 14.2 | % |
| Adjusted patient  days                        |       | 25,600                                 |       | 24,520                               |       | 4.4 | % | 50,553 |   | 45,202 |   | 11.8 | % |
| Average length of  patients’ stay (days) |       | 6.0                                    |       | 5.5                                  |       | 9.1 | % | 5.9 |   | 5.3 |   | 11.3 | % |
| Net inpatient  revenue per patient day        |       | $                                      | 1,478      |                                 | $          | 1,329 |   | 11.2 | % | $ | 1,448 |   | $ | 1,328 |   | 9.0 | % |
| Outpatient visits                             |       | 5,223                                  |       | 5,389                                |       | (3.1 | )% | 10,179 |   | 10,253 |   | (0.7 | )% |
| Net outpatient  revenue per visit             |       | $                                      | 372        |                                 | $          | 345 |   | 7.8 | % | $ | 360 |   | $ | 349 |   | 3.2 | % |
| Occupancy rate  for licensed beds(5)          |       | 78.9                                   | %          | 73.4                                 | %          | 7.2 | % | 77.0 | % | 67.1 | % | 14.8 | % |
| Occupancy rate  for available beds(5)         |       | 81.0                                   | %          | 75.4                                 | %          | 7.5 | % | 79.1 | % | 68.9 | % | 14.8 | % |

 

----

| (1)    | Net inpatient revenues and net outpatient revenues are components of  net patient revenues. Net inpatient revenues include self-pay revenues of $593,864  and $479,537, for the three months ended March 31, 2009 and 2008,  respectively, and 1,075,464 and $878,485, for the six months ended  March 31, 2009 and 2008, respectively. Net outpatient revenues include  self-pay revenues of $32,416 and $29,580 for the three months ended  March 31, 2009 and 2008, respectively, and $57,367 and $56,949, for the  six months ended March 31, 2009 and 2008, respectively. |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (2)    | Utilization of licensed beds represents patient days divided by  average licensed beds divided by number of days in the period.                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (3)    | Self-pay admissions represent 1.8% and 1.4% of total admissions for  the three months ended March 31, 2009 and 2008, respectively, and  represent 1.8% and 1.6% of total admissions for the six months ended  March 31, 2009 and 2008, respectively. Charity care admissions represent  0.5% and 0.3% of total admissions for the three months ended March 31,  2009 and 2008, respectively, and represent 0.6% and 0.3% of total admissions  for the six months ended March 31, 2009 and 2008, respectively.                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (4)    | Adjusted patient admissions are total admissions adjusted for  outpatient volume. Adjusted admissions are computed by multiplying admissions  (inpatient volume) by the sum of gross inpatient charges and gross outpatient  charges and then dividing the resulting amount by gross inpatient charges.                                                                                                                                                                                                                                                                                            |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (5)    | Occupancy rates are affected by many factors, including the  population size and general economic conditions within particular market  service areas, the degrees of variation in medical and surgical products,  outpatient use of hospital services, quality and treatment availability at  competing hospitals and seasonality.                                                                                                                                                                                                                                                                 |

 

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** **

**Three Months Ended March 31, 2009 Compared toThree Months Ended March 31, 2008**

** **

*Net Hospital Services Revenues*

* *

Our same-hospital netinpatient revenues for the three months ended March 31, 2009 wereapproximately $35,561,000, representing an increase of approximately $5,401,000or 17.9% from net inpatient revenues for the three months ended March 31,2008, of approximately $30,160,000.

 

The net increase wascomprised of the following main factors: (i) increases in both Medicareand Medi-Cal reimbursement rates, (ii) an increase a total patient days offsetby (iii) decreases in total admissions and in disproportionate share revenuesunder Medi-Cal programs.

 

Same-hospital admissions forthe three months ended March 31, 2009 decreased by 2.8% compared to thethree months ended March 31, 2008 primarily due to increased patient days,resulting in patients hitting facility maximum.

 

While outpatient visitsdecreased 3.1% in the fiscal 2009 period, same-hospital net outpatient revenuesincreased by 4.3% to approximately $1,941,000 during the three months ended March 31,2009 as compared to $1,860,000 during the three months ended March 31,2008. Outpatient visits decreased due to the elimination of certainunprofitable outpatient services.

 

*Salaries, Wages and Benefits*

* *

Salaries, wages and benefitsexpense as a percentage of net Hospital Services revenues for the three monthsended March 31, 2009 was 42.0%, representing a decrease of 9.7% comparedto 46.5% for the three months ended March 31, 2008. Salaries, wages andbenefits per adjusted patient day for the three months ended March 31,2009 was approximately $622, representing a decrease of 1.3% compared to $614for the three months ended March 31, 2008. The decrease is primarily dueto productivity gained through efficiencies, partially offset by merit increasesfor our employees.

 

As of March 31, 2009,less than 5% of the total employees at our Hospital Services operation wererepresented by labor unions. Labor relations at our hospital facilitiesgenerally have been satisfactory. In May 2008, we entered into a newcollective bargaining agreement between Service Employees International Union (“SEIU”)and Hollywood Community Hospital, which is one of the hospitals under theconsolidated group of Alta Hospitals System, LLC. The agreement, whichexpires on May 9, 2011, covers a small group of Hollywood CommunityHospital’s employees. We do not anticipate that the agreement we reached in2008 will have a material adverse effect on results of our Hospital Servicesoperations in fiscal 2009.

 

*Supplies*

* *

Supplies expense as apercentage of net Hospital Services revenue for the three months ended March 31,2009 was 5.8%, representing a decrease of 17.7%, compared to 7.0% for the threemonths ended March 31, 2008. Supplies expense per adjusted patient day forthe three months ended March 31, 2009 was approximately $85, representinga decrease of 7.8%, compared to approximately $93 for the three months ended March 31,2008. This decrease in supplies expense per adjusted patient day reflectsimproved efficiencies gained through continued focus on supply management. Westrive to control supplies expense through product standardization, bulkpurchases, contract compliance, improved utilization and operationalimprovements.

 

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* *

*Provision for Doubtful Accounts*

* *

The provision for doubtfulaccounts as a percentage of net Hospital services revenues was 5.8% for thethree months ended March 31, 2009 compared to 4.7% for three months ended March 31,2008.

 

The table below shows thenet accounts receivable and allowance for doubtful accounts by payor at March 31,2009 and September 30, 2008:

 
| ** **                | ** ** | **March 31, 2009**                                             | ** ** | **September 30, 2008**           | ** ** |
|---------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                | ** ** | **Accounts  Receivable  Before  Allowance  For Doubtful  Accounts** | ** ** | **Allowance  For Doubtful  Accounts** | ** ** | **Net** | ** ** | **Accounts  Receivable  Before  Allowance  For Doubtful  Accounts** | ** ** | **Allowance  For Doubtful  Accounts** | ** ** | **Net** | ** ** |
| Medicare                  |       | $                                                                   | 7,421,617  |                                  | $          | 982,570 |   | $ | 6,439,047 |   | $ | 5,939,172 |   | $ | 913,790 |   | $ | 5,025,382 |   |
| Medi-Cal                  |       | 12,411,206                                                          |       | 809,427                               |       | 11,601,779 |   | 10,214,125 |   | 345,426 |   | 9,868,699 |   |
| Commercial managed care   |       | 554,280                                                             |       | 78,806                                |       | 475,474 |   | 1,556,520 |   | 206,492 |   | 1,350,028 |   |
| Governmental managed care |       | 3,041,173                                                           |       | 581,667                               |       | 2,459,506 |   | 2,085,295 |   | 336,565 |   | 1,748,730 |   |
| Self-pay uninsured        |       | 1,946,416                                                           |       | 1,622,572                             |       | 323,844 |   | 2,106,889 |   | 1,828,267 |   | 278,622 |   |
| Self-pay                  |       | 360,252                                                             |       | 306,612                               |       | 53,640 |   | 260,647 |   | 243,498 |   | 17,149 |   |
| Other                     |       | 1,452,842                                                           |       | 235,323                               |       | 1,217,519 |   | 42,609 |   | 16,724 |   | 25,885 |   |
| Total                     |       | $                                                                   | 27,187,786 |                                  | $          | 4,616,977 |   | $ | 22,570,809 |   | $ | 22,205,257 |   | $ | 3,890,762 |   | $ | 18,314,495 |   |

 

Collection of accountsreceivable has been a key area of focus. Our current estimated collection rateon self-pay accounts is approximately 15.4%, including collections frompoint-of-service through collections by our in-house collection department orexternal collection vendors. This self-pay collection rate includes paymentsmade by patients, including co-payments and deductibles paid by patients withinsurance, prior to an account being classified and assigned to our in-houseself-pay collection group. The comparable self-pay collection percentage as of September 30,2008 was approximately 11.5%.

 

We continue working withmanaged care payers to obtain adequate and timely reimbursement for ourservices. Our current estimated collection rate on managed care accounts isapproximately 54.4%, which includes collections from point-of-service throughcollections by our in-house collection department or external collectionvendors. The comparable managed care collection percentage as of September 30,2008 was approximately 48.5%.

 

We manage our provision fordoubtful accounts using hospital-specific goals and benchmarks such as (1) totalcash collections, (2) point-of-service cash collections, (3) accountsreceivable days outstanding (“AR Days”), and (4) accounts receivableaging. The following tables present the approximate aging by payer of ourHospital Services operations’ net accounts receivable of $22.6 million and$18.3 million, excluding cost report settlements payable and valuationallowances of zero and zero, at March 31, 2009 and September 30,2008, respectively:

 
| ** **                | ** ** | **March 31,  2009** | ** ** | **September 30,  2008** | ** ** |
|---------------------------|------------|--------------------------|------------|------------------------------|------------|
| ** **                | ** ** | **Medicare**             | ** ** | **Medi-Cal**                 | ** ** | **Managed  Care** | ** ** | **Indemnity,  Self-Pay  and Other** | ** ** | **Total** | ** ** | **Medicare** | ** ** | **Medi-Cal** | ** ** | **Managed  Care** | ** ** | **Indemnity,  Self-Pay  and Other** | ** ** | **Total** | ** ** |
| 0 – 60 days     |       | 74.0                     | %          | 72.3                         | %          | 41.5 | % | 41.3 | % | 69.9 | % | 84.0 | % | 76.1 | % | 49.6 | % | 38.5 | % | 75.7 | % |
| 61 –  120 days  |       | 12.8                     | %          | 14.4                         | %          | 26.6 | % | 29.1 | % | 15.2 | % | 8.5 | % | 13.2 | % | 24.6 | % | 37.0 | % | 13.1 | % |
| 121 –  180 days |       | 8.7                      | %          | 6.4                          | %          | 24.1 | % | 18.2 | % | 8.5 | % | 3.7 | % | 7.3 | % | 16.1 | % | 14.0 | % | 7.0 | % |
| Over  180 days       |       | 4.5                      | %          | 6.9                          | %          | 7.8 | % | 11.4 | % | 6.4 | % | 3.8 | % | 3.4 | % | 9.7 | % | 10.5 | % | 4.2 | % |
| **Total**                 |       | 100                      | %          | 100                          | %          | 100 | % | 100 | % | 100 | % | 100 | % | 100 | % | 100 | % | 100 | % | 100 | % |

 

Our AR Days from HospitalServices operations were 53.4 days at March 31, 2009 compared to 53.0 daysat September 30, 2008. AR Days at March 31, 2009 and September 30,2008 are within our target of less than 75 days. AR Days are calculated asour accounts receivable from Hospital Services operations on the last date inthe relevant quarter divided by our net patient revenues for the quarter endedon that date divided by the number of days in the quarter.

 

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OtherOperating Expenses

 

Other operating expenses asa percentage of net Hospital Services revenues for the three months ended March 31,2009 were 5.9%, representing an increase of 2.9%, compared to 5.8% for thethree months ended March 31, 2008. Other operating expenses per adjustedpatient day increased approximately 15.3% to approximately $88 in the threemonths ended March 31, 2009 compared to approximately $76 for the sameperiod in fiscal 2008 primarily due to higher registry expense resulting fromincreased patient days, offset by a decrease in malpractice expense that isprimarily attributable to improved claims experience.

 

*Lease and Rental*

 

Lease and rental expenses asa percentage of net Hospital Services revenues for the three months ended March 31,2009 were 0.7%, compared to 0.8% for the three months ended March 31,2008. We own, through our subsidiary, Alta Hospitals Systems, LLC, all ofour hospital facilities. Included in lease and rental expenses were operatinglease arrangements for our administrative offices with terms expiring atvarious dates through 2015. The office space is shared with Prospect MedicalHoldings, Inc.

 

*General and Administrative*

 

General and administrativeexpenses as a percentage of net Hospital Services revenues for the three monthsended March 31, 2009 were 8.0%, representing a decrease of 10.5%, comparedto 9.0% for the three months ended March 31, 2008. Included in General andAdministrative expenses was consulting and outside services, supplies,insurance, utilities, taxes and licenses, and maintenance which accounted forapproximately 11.4% of the total expenses in the three months ended March 31,2009, as compared to 11.7% for the three months ended March 31, 2008.

 

*Depreciation and Amortization*

 

Depreciation andAmortization expenses as a percentage of net Hospital Services revenues for thethree months ended March 31, 2009 were 2.5%, representing a decrease of 21.9%,compared to 3.2% for the three months ended March 31, 2008. Included indepreciation and amortization expense was amortization of identifiableintangibles of approximately $317,000 and $317,000, in the three months ended March 31,2009 and 2008, respectively. During the three months ended March 31, 2009and 2008, total capital expenditures incurred of approximately $194,000 and$387,000 respectively, were within our budgeted expectations.

 

*Operating Income*

 

Our Hospital Servicessegment reported an operating income of approximately $11,065,000 and$7,494,000 for the three months ended March 31, 2009 and 2008,respectively, which increase was the result of the changes discussed above. Thepre-tax operating results from the Hospital Services segment include certaincorporate expense allocations for insurance, professional fees, andamortization of identifiable intangibles.

 

**Six Months Ended March 31, 2009 Compared to SixMonths Ended March 31, 2008**

 

*Net Hospital Services Revenues*

 

Our same-hospital netinpatient revenues for the six months ended March 31, 2009 wereapproximately $68,800,000, representing an increase of approximately$13,550,000 or 24.5% from net inpatient revenues for the six months ended March 31,2008, of approximately $55,251,000.

 

The increase was comprisedof three main factors: (i) an increase in disproportionate share revenuesunder Medi-Cal programs to approximately $6,164,000 in the fiscal 2009 periodfrom $5,674,000 in the fiscal 2008 period, (ii) increases in both Medicareand Medi-Cal reimbursement rates, and (iii) an increase in totaladmissions.

 

Same-hospital admissions forthe six months ended March 31, 2009 increased by 2.4% compared to the sixmonths ended March 31, 2008 primarily due to net volume increases in manyof the service lines emphasized by our targeted growth initiative.

 

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While outpatient visitsdecreased 0.7% in the fiscal 2009 period, same-hospital net outpatient revenuesincreased by 2.3% to approximately $3,663,000 during the six months ended March 31,2009 as compared to $3,582,000 during the six months ended March 31, 2008.Outpatient visits decreased due to the elimination of certain unprofitableoutpatient services.

 

*Salaries, Wages and Benefits*

 

Salaries, wages and benefitsexpense as a percentage of net Hospital Services revenues for the six monthsended March 31, 2009 was 43.4%, representing a decrease of 10.4% comparedto 48.5% for the six months ended March 31, 2008. Salaries, wages andbenefits per adjusted patient day for the six months ended March 31, 2009was approximately $629, representing a decrease of 1.7% compared to $640 forthe six months ended March 31, 2008. The decrease is primarily due toproductivity gained through efficiencies, partially offset by merit increasesfor our employees.

 

As of March 31, 2009,less than 5% of the total employees at our Hospital Services operation wererepresented by labor unions. Labor relations at our hospital facilitiesgenerally have been satisfactory. In May 2008, we entered into a newcollective bargaining agreement between Service Employees International Union (“SEIU”)and Hollywood Community Hospital, which is one of the hospitals under theconsolidated group of Alta Hospitals System, LLC. The agreement, whichexpires on May 9, 2011, covers a small group of Hollywood CommunityHospital’s employees. We do not anticipate that the agreement we reached in2008 will have a material adverse effect on results of our Hospital Servicesoperations in fiscal 2009.

 

*Supplies*

 

Supplies expense as apercentage of net Hospital Services revenue for the six months ended March 31,2009 was 6.0%, representing a decrease of 14.6%., compared to 7.0% for the sixmonths ended March 31, 2008. Supplies expense per adjusted patient day forthe six months ended March 31, 2009 was approximately $87, representing adecrease of 6.3%, compared to approximately $92 for the six months ended March 31,2008. This decrease in supplies expense per adjusted patient day reflectsimproved efficiencies gained through continued focus on supply management. Westrive to control supplies expense through product standardization, bulkpurchases, contract compliance, improved utilization and operationalimprovements.

 

*Provision for Doubtful Accounts*

 

The provision for doubtfulaccounts as a percentage of net Hospital Services revenues was 5.1% for the sixmonths ended March 31, 2009 compared to 3.1% for six months ended March 31,2008.

 

*Other Operating Expenses*

 

Other operating expenses asa percentage of net Hospital Services revenues for the six months ended March 31,2009 were 6.1%, representing an increase of 2.3%, compared to 5.9% for the sixmonths ended March 31, 2008. Other operating expenses per adjusted patientday increased approximately 12.2% to $88 in the six months ended March 31,2009 compared to $78 for the same period in fiscal 2008 primarily due to higherregistry expense resulting from increased patient days, offset by a decrease inmalpractice expense that is primarily attributable to improved claimsexperience.

 

*Lease and Rental*

 

Lease and rental expenses asa percentage of net Hospital Services revenues for the six months ended March 31,2009 were 0.9%, representing an increase of 19.8%, compared to 0.8% for the sixmonths ended March 31, 2008. We own, through our subsidiary, AltaHospitals Systems, LLC, all of our hospital facilities. Included in leaseand rental expenses were operating lease arrangements for our administrativeoffices with terms expiring at various dates through 2015. The office space isshared with Prospect Medical Holdings, Inc.

 

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*General and Administrative*

 

General and administrativeexpenses as a percentage of net Hospital Services revenues for the six monthsended March 31, 2009 were 8.5%, representing a decrease of 8.5%, comparedto 9.3% for the six months ended March 31, 2008. Included in General andAdministrative expenses was consulting and outside services, supplies,insurance, utilities, taxes and licenses, and maintenance which accounted forapproximately 11.7% of the total expenses in the six months ended March 31,2009, as compared to 11.9% for the six months ended March 31, 2008.

 

*Depreciation and Amortization*

 

Depreciation andAmortization expenses as a percentage of net Hospital Services revenues for thesix months ended March 31, 2009 were 2.5%, representing a decrease of 27.9%,compared to 3.5% for the six months ended March 31, 2008. Included indepreciation and amortization expense was amortization of identifiableintangibles of approximately $634,000 and $634,000, in the six months ended March 31,2009 and 2008, respectively. During the six months ended March 31, 2009and 2008, total capital expenditures incurred of approximately $375,000 and $720,000respectively, were within our budgeted expectations.

 

*Operating Income*

 

Our Hospital Servicessegment reported an operating income of approximately $20,183,000 and$13,113,000 for the six months ended March 31, 2009 and 2008,respectively, which increase was the result of the changes discussed above. Thepre-tax operating results from the Hospital Services segment include certaincorporate expense allocations for insurance, professional fees, andamortization of identifiable intangibles.

 

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***Corporate***

 

The following tablesummarizes our corporate expense for Prospect Medical Holdings, Inc., ourparent entity, and is used in the discussion below for the three-month andsix-month periods ended March 31, 2009 and 2008.

 
| ** **                                                     | ** ** | **Three  Months Ended March 31,** | ** ** | **Six  Months Ended March 31,** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                                                     | ** ** | **2009**                               | ** ** | **2008**                             | ** ** | **Increase  (Decrease)** | ** ** | **%** | ** ** | **2009** | ** ** | **2008** | ** ** | **Increase  (Decrease)** | ** ** | **%** | ** ** |
| **Operating  Expenses:**                                       |       |                                   |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| General and  administrative                                    |       | $                                      | 2,850,537  |                                 | $          | 3,872,901 |   | $ | (1,022,364 | ) | (26.4 | )% | $ | 4,872,846 |   | $ | 6,392,896 |   | $ | (1,520,050 | ) | (23.8 | )% |
| Depreciation and  amortization                                 |       | 3,203                                  |       | 6,747                                |       | (3,545 | ) | (52.5 | )% | 6,404 |   | 12,946 |   | (6,542 | ) | (50.5 | )% |
| **Total  Operating Expenses**                                  |       | 2,853,740                              |       | 3,879,648                            |       | (1,025,908 | ) | (26.4 | )% | 4,879,250 |   | 6,405,842 |   | (1,526,592 | ) | (23.8 | )% |
| **Other  (Income) Expense:**                                   |       |                                   |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Investment income                                              |       | (14,427                                | )          | (68,021                              | )          | (53,594 | ) | (78.8 | )% | (37,102 | ) | (302,450 | ) | (265,348 | ) | (87.7 | )% |
| Interest expense  and amortization of deferred financing Costs |       | 6,524,776                              |       | 5,252,571                            |       | 1,272,205 |   | 24.2 | % | 12,621,006 |   | 9,413,481 |   | 3,207,525 |   | 34.1 | % |
| (Gain) loss on  value of interest rate swap arrangements       |       | (955,201                               | )          | —                               |       | 955,201 |   | 100 | % | 8,712,824 |   | 876,680 |   | 7,836,144 |   | 893.8 | % |
| **Total  Other Expense**                                       |       | 5,555,148                              |       | 5,184,550                            |       | 370,598 |   | 7.1 | % | 21,296,728 |   | 9,987,711 |   | 11,309,017 |   | 113.2 | % |
| **Total  Corporate Expenses**                                  |       | $                                      | 8,408,888  |                                 | $          | 9,064,198 |   | $ | (655,310 | ) | (7.2 | )% | $ | 26,175,978 |   | $ | 16,393,553 |   | $ | 9,782,425 |   | 59.7 | % |

 

The following table setsforth selected operating items, expressed as a percentage of total consolidatedrevenues from continuing operations:

 
| ** **                                                    | ** ** | **Three Months Ended  March 31,** | ** ** | **Six Months Ended  March 31,** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                                                    | ** ** | **2009**                               | ** ** | **2008**                             | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Operating Expenses:**                                       |       |                                   |       |                                 |       |   |   |   |   |
| General and administrative                                    |       | 3.3                                    | %          | 4.7                                  | %          | 2.9 | % | 4.0 | % |
| Depreciation and amortization                                 |       | 0.0                                    | %          | 0.0                                  | %          | 0.0 | % | 0.0 | % |
| **Total Operating Expenses**                                  |       | 3.3                                    | %          | 4.7                                  | %          | 2.9 | % | 4.0 | % |
| **Other (Income) Expense:**                                   |       |                                   |       |                                 |       |   |   |   |   |
| Investment income                                             |       | 0.0                                    | %          | (0.1                                 | )%         | 0.0 | % | (0.2 | )% |
| Interest expense and amortization of deferred financing Costs |       | 7.6                                    | %          | 6.3                                  | %          | 7.4 | % | 5.8 | % |
| (Gain) loss on value of interest rate swap arrangements       |       | (1.1                                   | )%         | 0.0                                  | %          | 5.2 | % | 0.5 | % |
| **Total Other Expense**                                       |       | 6.5                                    | %          | 6.2                                  | %          | 12.6 | % | 6.1 | % |
| **Total Corporate Expenses**                                  |       | 9.8                                    | %          | 10.9                                 | %          | 15.5 | % | 10.1 | % |

 

**Three Months Ended March 31, 2009 Compared toThree Months Ended March 31, 2008**

 

*General and Administrative*

 

General and administrative expenses for the three months ended March 31,2009 were approximately $2,851,000, representing approximately 3.3% of totalrevenues from continuing operations, compared to approximately $3,873,000, orapproximately 4.7% of total revenues, for the three months ended March 31,2008, a decrease of approximately 29.8%. The decrease in general andadministrative expenses during the fiscal 2009 period primarily related to reduction in audit, legal, insurance andSarbanes-Oxley (“SOX”) compliance consulting expenditures, offset by additionalaccrued bonus and an increase in employee stock option grant and issue costs.

 

*Depreciation and Amortization*

 

Depreciation andamortization expense for the three months ended March 31, 2009 wasapproximately $3,000, compared to approximately $7,000, for the three monthsended March 31, 2008, a decrease of approximately 52.5%.  The decrease was primarily due to retirementof certain capital equipment.

 

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*Investment Income*

 

Investment income for thethree months ended March 31, 2009 was approximately $14,000, compared toapproximately $68,000 for the three months ended March 31, 2008, adecrease of approximately 78.8%. Following the amendment of our senior creditfacility agreement on May 15, 2008, we were required by Bank of America tomaintain substantially all of our cash in non-interest bearing accounts.

 

*Interest Expense and Amortization of DeferredFinancing Costs*

 

Interest expense andamortization of deferred financing costs for the three months ended March 31,2009 was approximately $6,525,000, representing approximately 7.6% of totalrevenues from continuing operations, compared to $5,253,000 or approximately6.3% of total revenues from continuing operations for the three months ended March 31,2008, an increase of approximately 24.2%. As discussed in Note 7 to theaccompanying unaudited interim condensed consolidated financial statements, wewere in default under our credit facilities and under the April 2008forbearance agreements, the applicable margins on the first and second lienterm loans were permanently increased to 750 and 1,175 basis points,respectively, and the range of applicable margins on the revolving line ofcredit was increased from 500 to 750 basis points effective April 10,2008. The agreements also provide that the LIBOR rate shall not be less than3.50% for the term of the credit facility. In May 2008, the debtagreements were further modified to add a 1% “payment-in-kind” (“PIK”) interestto the outstanding balance of the debt plus an additional 4% PIK interest tothe interest rate applicable to the second lien debt. The 4% accrues and isadded to the principal balance on a monthly basis. The 4% PIK could potentiallybe reduced in the future to the extent that the company reduces itsconsolidated leverage ratio. Additionally, as discussed in Note 7 to the accompanying unauditedinterim condensed consolidated financial statements, effective with the firstasserted default on March 19, 2009, our lenders have instituted defaultrates of 13.0% with respect to the first lien term loan, 17.25% with respect tothe second lien term loan, and 13.25% with respect to the revolving line ofcredit.

 

*(Gain) Loss in Value of Interest Rate SwapArrangements*

 

As discussed in Note 7to the accompanying unaudited interim condensed consolidated financialstatements, currently we have two interest rate swaps in place for initialnotional principal amounts of $48.0 million and $97.75 million,respectively. The interest rate swaps were designated as cash flow hedges ofour floating rate term debts, with the effective date of the $48.0 millionswap being December 31, 2007 and the effective date of the$97.75 million swap being September 6, 2007. As of April 1,2008, in anticipation of modifications to the terms of our credit agreements,the swaps were determined to no longer be effective in offsetting the hedgeditems. As a result, cash flow hedge accounting treatment was discontinued andall further changes in fair value of the swaps are included in earnings. Theseamounts are unpredictable and likely to be significant. In the three monthsended March 31, 2009, gain on interest rate swaps totaled approximately$955,000.

 

In the three months ended March 31,2008, all changes in fair value of the interest rate swaps were recorded inother comprehensive loss as the swaps were deemed effective.

 

**Six Months Ended March 31, 2009 Compared to SixMonths Ended March 31, 2008**

 

*General and Administrative*

 

General and administrative expenses for the six months ended March 31,2009 were approximately $4,873,000, representing approximately 2.9% of totalrevenues from continuing operations, compared to approximately $6,393,000, orapproximately 4.0% of total revenues from continuing operations, for the sixmonths ended March 31, 2008, a decrease of approximately 23.8%. Thedecrease in general and administrative expenses during the fiscal 2009 periodprimarily related to relatedto reduction in audit, legal, insurance and Sarbanes-Oxley (“SOX”) complianceconsulting expenditures, offset by additional accrued bonus and an increase inemployee stock option grant and issue costs.

 

*Depreciation and Amortization*

 

Depreciation andamortization expense for the six months ended March 31, 2009 wasapproximately $6,000, compared to approximately $13,000 for the six monthsended March 31, 2008, a decrease of approximately 50.5%.  The decrease was primarily due to retirementof certain capital equipment.

 

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*Investment Income*

 

Investment income for thesix months ended March 31, 2009 was approximately $37,000, compared toapproximately $302,000, for the six months ended March 31, 2008, adecrease of approximately 87.7%. Following the amendment of our senior creditfacility agreement on May 15, 2008, we were required by Bank of America tomaintain substantially all of our cash in non-interest bearing accounts.

 

*Interest Expense and Amortization of DeferredFinancing Costs*

 

Interest expense andamortization of deferred financing costs for the six months ended March 31,2009 was approximately $12,621,000, representing approximately 7.4% of totalrevenues from continuing operations, compared to $9,414,000 or approximately5.8% of total revenues from continuing operations for the six months ended March 31,2008, an increase of approximately 34.1%. As discussed in Note 7 to theaccompanying unaudited interim condensed consolidated financial statements, wewere in default under our credit facilities and under the April 2008forbearance agreements, the applicable margins on the first and second lienterm loans were permanently increased to 750 and 1,175 basis points,respectively, and the range of applicable margins on the revolving line ofcredit was increased from 500 to 750 basis points effective April 10,2008. The agreements also provide that the LIBOR rate shall not be less than3.50% for the term of the credit facility. In May 2008, the debtagreements were further modified to add a 1% “payment-in-kind” (“PIK”) interestto the outstanding balance of the debt plus an additional 4% PIK interest tothe interest rate applicable to the second lien debt. The 4% accrues and isadded to the principal balance on a monthly basis. The 4% PIK could potentiallybe reduced in the future to the extent that the company reduces itsconsolidated leverage ratio. Additionally, effective with the first asserted default on March 19,2009, our lenders have instituted default rates of 13.0% with respect to thefirst lien term loans, 17.25% with respect to the second lien term loan, and13.25% with respect to the revolving line of credit.

 

*Loss in Value of Interest Rate Swap Arrangements*

 

As discussed in Note 7to the accompanying unaudited interim condensed consolidated financialstatements, currently we have two interest rate swaps in place for initialnotional principal amounts of $48.0 million and $97.75 million,respectively. The interest rate swaps were designated as cash flow hedges ofour floating rate term debts, with the effective date of the $48.0 millionswap being December 31, 2007 and the effective date of the$97.75 million swap being September 6, 2007. As of April 1,2008, in anticipation of modifications to the terms of our credit agreements,the swaps were determined to no longer be effective in offsetting the hedgeditems. As a result, cash flow hedge accounting treatment was discontinued andall further changes in fair value of the swaps are included in earnings. Theseamounts are unpredictable and likely to be significant. In the six months endedMarch 31, 2009, loss on interest rate swaps totaled approximately$8.7 million.

 

In the six months ended March 31,2008, loss on interest rate swaps of approximately $877,000 represented thechange in fair value of the $48.0 million swap that was not yet subject tohedge accounting, which amount was charged to earnings.

 

***Consolidated***

 

**Three Months Ended March 31, 2009 Compared toThree Months Ended March 31, 2008**

 

*Provision for Income Taxes*

 

Income tax provision for thethree months ended March 31, 2009 was approximately $2,496,000 compared toapproximately $456,000 in the three months ended March 31, 2008. Theeffective tax rate was higher at 41.0% in the three months ended March 31,2009 compared to 36.0% in the three months ended March 31, 2008. Thehigher effective tax rate in the fiscal 2009 period was primarily due to stateincome tax and permanent differences.

 

*Net Income (Loss) from Continuing Operations*

 

Net income from continuingoperations attributable to common stockholders for the three months ended March 31,2009 was approximately $3,548,000, or $0.17 per diluted share, as compared to anet loss of $1,179,000, or $0.10 per diluted share, for the three months ended March 31,2008, which increase is the result of the changes discussed above.

 

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*Net Loss from Discontinued Operations*

 

Net loss from discontinuedoperations for the three months ended March 31, 2008 was approximately$76,000 or $0.01 per diluted share, as compared to none for the three monthsended March 31, 2009. As discussed in Note 4 to the unaudited interimcondensed consolidated financial statements, we sold the AV Entities’ effectiveAugust 1, 2008.

 

**Six Months Ended March 31, 2009 Compared to SixMonths Ended March 31, 2008**

 

*Provision for Income Taxes*

 

Income tax provision for thesix months ended March 31, 2009 was approximately $76,000 compared to approximately$355,000 in the six months ended March 31, 2008. The effective tax ratewas higher at 41.0% in the six months ended March 31, 2009 compared to36.0% in the six months ended March 31, 2008. The higher effective taxrate in the fiscal 2009 period was primarily due to state income tax andpermanent differences.

 

*Net Income (Loss) from Continuing Operations*

 

Net income from continuingoperations attributable to common stockholders for the six months ended March 31,2009 was approximately $104,000, or $0.01 per diluted share, as compared to anet loss of $3,242,000, or $0.28 per diluted share, for the six months ended March 31,2008, which increase is the result of the changes discussed above.

 

*Net Loss from Discontinued Operations*

 

Net loss from discontinuedoperations for the six months ended March 31, 2008 was approximately$392,000 or $0.03 per diluted share, as compared to none for the six monthsended March 31, 2009. As discussed in Note 4 to the unaudited interimcondensed consolidated financial statements, we sold the AV Entities’ effectiveAugust 1, 2008.

 

**Liquidity and Capital Resources**

 

Our primary sources of cashhave been funds provided by borrowings under our credit facilities, by theissuance of equity securities, by cash flow from operations and by proceedsfrom sales of assets related to discontinued operations. Prior to the August 8,2007 acquisition of Alta, our primary sources of cash from operations werehealthcare capitation revenues, fee-for-service revenues, risk pool paymentsand pay-for-performance incentives earned by our affiliated physicianorganizations. With the acquisition of Alta, our sources of cash fromoperations now include payments for hospital services rendered underreimbursement arrangements with third-party payers, which include the federalgovernment under the Medicare program, the state government under the Medi-Calprogram, private insurers, health maintenance organizations (“HMOs), preferredprovider organizations (“PPOs), and self-pay patients.

 

Our primary uses of cashinclude healthcare capitation and claims payments by our affiliated physicianorganizations, administrative expenses, debt service, acquisitions, costsassociated with the integration of acquired businesses, information systemsdevelopment costs and, with the acquisition of Alta, operating, capitalimprovement and administrative expenses related to our hospital operations. Ouraffiliated physician organizations generally receive capitation revenue inadvance of having to make capitation and claims payments to their providers.However, our hospitals receive payments for services rendered generally 30 to90 days after the medical care is rendered. For some accounts and payerprograms, the time lag between service and reimbursement can exceed one year.

 

Our investment strategiesare designed to provide safety and preservation of capital, sufficientliquidity to meet cash-flow needs, the integration of investment strategy withour business operations and objectives, and attainment of a competitive return.At March 31, 2009, we invested a portion of our cash in interest bearingmoney market accounts and, following the amendment of our senior creditfacility agreement on May 15, 2008, we were also required to maintainsubstantially all of our cash in non-interest bearing accounts with Bank ofAmerica. All of these amounts are classified as current assets and included incash and cash equivalents in the accompanying Condensed Consolidated BalanceSheets.

 

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*Cash Flow from Continuing Operations*

 

Net cash provided bycontinuing operations was approximately $5,048,000 for the six months ended March 31,2009 compared to net cash provided by continuing operations of approximately$1,415,000 for the six months ended March 31, 2008. The increase in netcash provided by continuing operations for the six months ended March 31,2009 as compared to the six months ended March 31, 2008 was due to variousfactors, including the following:

 

·                  earnings,excluding non-cash charges and credits were approximately $14,177,000 in thefiscal 2009 period compared to approximately $6,835,000 in the fiscal 2008period;

 

·                  changes inpatient, government program and other receivables, a use of approximately$7,524,000 in the fiscal 2009 period compared to a use of approximately$4,267,000 in the fiscal 2008 period. The increase in fiscal 2009 was primarilyrelated to our Hospital Services segment;

 

·                  changes inprepaid expenses and other, a use of approximately $438,000 in the fiscal 2009period compared to a use of approximately $1,196,000 in the fiscal 2008 period;

 

·                  changes inrefundable income tax and taxes payable a source of approximately $3,923,000 inthe fiscal 2009 period compared to a source of $1,527,000 in the fiscal 2008period;

 

·                  changes inmedical claims and related liabilities, a use of approximately $1,106,000 inthe fiscal 2009 period compared to a source of approximately $398,000 in thefiscal 2008 period; and

 

·                  changes inaccounts payable and other accrued liabilities, a use of approximately$2,790,000 in the fiscal 2009 period compared to a use of approximately$1,151,000 in the fiscal 2008 period due to a reduction in general andadministrative expenses in the fiscal 2009 period relating to legal, insuranceand SOX compliance consulting expenditures.

 

Net cash used in investingactivities totaled approximately $438,000 for the six months ended March 31,2009, compared to a use of approximately $936,000 for the six months ended March 31,2008, the largest component of which was purchases of property, improvementsand equipment, a use of approximately $437,000 in the fiscal 2009 periodcompared to a use of approximately $952,000 in the fiscal 2008 period.

 

Net cash used by financingactivities totaled approximately $6,660,000 for the six months ended March 31,2009, compared to a source of approximately $1,279,000 for the six months endedMarch 31, 2008. Net cash used in financing activities for the six monthsended March 31, 2009 was comprised primarily of the principal repayment ofthe first-lien term debt of approximately $6,465,000. Net cash provided byfinancing activities during the six months ended March 31, 2008 included a$10,750,000 borrowing on our line of credit and $1,200,000 received fromexercise of stock options, net of payment of $2,500,000 on our long-term debtand payment of $8,000,000 on our line of credit.

 

*Cash Flow from Discontinued Operations*

 

During the six months ended March 31,2008, net cash used in operating activities in our discontinued operations wasapproximately $573,000, compared to none for the six months ended March 31,2009, and net cash used in investing activities, was approximately $3,000compared to none for the six months ended March 31, 2009. As discussed inNote 4 to the unaudited interim condensed consolidated financialstatements, we sold the AV Entities effective August 1, 2008. We do notbelieve that the eventual exclusion of such amounts from our consolidated cashflows in future periods will have a material effect on our liquidity orfinancial position.

 

At March 31, 2009, wehad negative working capital of approximately $126,199,000 as compared topositive working capital of $12,373,000 at September 30, 2008, primarilyresulting from the reclassification of approximately $125.7 million oflong-term debt and $14.7 million for the swap liability as current due to ourdefault on the amended credit facility agreements for failure to meet certaintechnical requirements, including the sale of certain assets by a specifieddate and the acquisition of Brotman.

 

At March 31, 2009 and September 30,2008, cash, cash equivalents and investments were approximately $32,198,000 and$34,220,000, respectively.

 

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***Recent Operating Results and CreditFacility***

 

On June 1, 2007, weentered into a new three-year senior secured credit facility with Bank ofAmerica, in connection with the purchase of the ProMed Entities (seeNote 7 to the accompanying unaudited interim condensed consolidatedfinancial statements). The Bank of America facility totaled $53,000,000, andcomprised a $48,000,000 variable-rate term loan, and a $5,000,000 revolver(which was not drawn). $8,051,000 of the term loan proceeds were used to repayexisting debt and the balance was used to finance the ProMed acquisition. The$48,000,000 term loan was repaid on August 8, 2007, with proceeds from anew $155,000,000 syndicated senior secured credit facility arranged by Bank ofAmerica in connection with the acquisition of Alta, comprised of a $95,000,000seven-year first-lien term loan at LIBOR plus 400 basis points, with quarterlypayments of $1,250,000 and an annual principal payment of 50% of excess cashflow, as defined in the loan agreement; a $50,000,000 seven and one-half yearsecond-lien term loan at LIBOR plus 825 basis points, with all principal due atmaturity and a revolving credit facility of $10,000,000 bearing interest atprime plus a margin that ranges from 275 to 300 basis points based on theconsolidated leverage ratio. We could borrow, make repayments and re-borrowunder the revolver until August 8, 2012, at which time all outstandingamounts must be repaid.

 

We recorded an interestcharge of $895,914 to write off deferred financing costs upon theextinguishment of the $53 million credit facility and capitalizedapproximately $6.9 million in deferred financing costs on the$155 million credit facility in August 2007, which was beingamortized over the term of the related debt using the effective interestmethod.

 

We are subject to certainfinancial and administrative covenants, cross default provisions and otherconditions required by the loan agreements with the lenders, including amaximum senior debt/EBITDA ratio, a minimum fixed-charge coverage ratio and,effective May 15, 2008, a minimum EBITDA level, each computed quarterly(monthly, for the test periods April 30, 2008 through June 30, 2009)based on consolidated trailing twelve-month operating results, including thepre-acquisition operating results of acquired entities. There are also variousadministrative covenants and other restrictions with which we must comply,including, among others, restrictions on additional indebtedness, incurrence ofliens, engaging in business other than our primary business, paying dividends,acquisitions and asset sales. The credit facilities provide that an event ofdefault will occur if there is a change in control.

 

While we have met all debtservice requirements timely, we did not comply with certain financial andadministrative covenants as of September 30, 2007, December 31, 2007and March 31, 2008, as further discussed in Note 7 of theaccompanying unaudited interim condensed consolidated financial statements.Additionally, we did not make timely filings of our Form 10-K for the yearended September 30, 2007 and of our Forms 10-Q for the quarters endedDecember 31, 2007 and March 31, 2008; and as a result, trading of ourshares was suspended for the period from January 16, 2008 to June 18,2008.

 

On February 13, 2008, April 10,2008 and May 14, 2008, we and our lenders entered into forbearanceagreements, whereby our lenders agreed not to exercise their rights under thecredit facilities through May 15, 2008, subject to satisfaction ofspecified conditions. On May 15, 2008, we and our lenders entered intoagreements to waive past covenant violations and to amend the financialcovenant provisions prospectively. Effective May 15, 2008, the maximumsenior debt/EBITDA ratios were increased to levels ranging from 3.90 to 7.15for monthly reporting periods from April 30, 2008 through June 30,2009 and were increased to levels ranging from 3.30 to 3.75 beginning with the September 30,2009 quarterly reporting period through maturity of the term loan. The minimumfixed charge coverage ratios were reduced to levels ranging from 0.475 to 0.925for monthly reporting periods from April 30, 2008 through June 30,2009 and were reduced to levels ranging from 0.85 to 0.90 beginning with the September 30,2009 quarterly reporting period through maturity of the term loans. We are alsorequired to meet a minimum EBITDA for future monthly reporting periods from April 30,2008 through June 30, 2009 and the remaining quarterly periods throughmaturity of the term loan. In addition, we were required to, among otherconditions, file our Form 10-K for the year ended September 30, 2007and our Forms 10-Q for the quarters ended December 31, 2007 and March 31,2008 by June 16, 2008, which filing deadlines were met. Failure to performany obligation under the waivers and the amended credit facility agreementsconstitutes an additional event of default.

 

Under the April 2008forbearance agreements and the May 2008 credit facility amendments, theapplicable margin on the first and second lien term loans and the revolver werepermanently increased. During the forbearance periods, we had limited or noaccess to the line of credit. We also agreed to pay certain fees and expensesto the lenders.

 

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As discussed in Note 7to the accompanying unaudited interim condensed consolidated financialstatements, in fiscal 2008, we recorded an $8.3 million non-cash loss ondebt extinguishment, which was partially offset by a $3.1 million non-cashgain on interest rate swaps and in the fourth quarter of fiscal 2007, we recordeda non-cash impairment charge of approximately $27.5 million (exclusive of$11.3 million of impairment charges related to discontinued operations) towrite off goodwill and intangibles within the IPA Management segment, whichresulted in overall losses in our IPA operations. Any future improvement in ourIPA operations and the successful integration of our newly acquiredsubsidiaries will require significant investment and management attention. Wecontinue to review the company’s operations to improve profitability andefficiency and to reduce costs, which may include the divestiture ofnon-strategic assets.

 

During fiscal 2008 and 2007,we reported operating losses in our legacy IPA Management segment. We areattempting to improve the operating results of the legacy IPA Managementoperation, including measures to retain enrollment, increase health planreimbursements and reduce medical costs. Additionally, we may divestnon-strategic assets (such as the August 1, 2008 divestiture of the AVEntities), the proceeds from which will be used to reduce the first lien loan.

 

We were in compliance with the amended financial covenant provisions for the April 2008 through March 2009 monthly reporting periods. While we continue to meet all debt service requirements on a timely basis, on March 19, 2009, we received written notices from our lenders who have elected to begin charging interest based on the default interest rates (additional 2.0% per annum) set forth in the amended loan agreements because our lenders have deemed the Company in default of a credit facility requirement regarding the sale of certain of the Company’s assets by a specified date.  Additionally, on April 17, 2009, the Company received notices from its lenders asserting that the Company’s April 14, 2009 increase in ownership of Brotman Medical Center, Inc. violated certain provisions of the amended credit agreements.  The Company has contested both assertions.  Based on such notices, we have classified all scheduled payments due after twelve months as current at March 31, 2009. We have strongly disputed our lenders’ characterization of the matters, and we are currently in discussions with our lenders to seek resolution of the matters. While the discussions are continuing, there can be no assurance that this matter will be resolved on a basis favorable to us. Our lenders may not grant waivers and could require full repayment of the loans, which would negatively impact our liquidity, our ability to operate and our ability to continue as a going concern.

 

**Contractual Obligations**

 

In our annual report on Form 10-Kfiled on December 29, 2008, we reported on our contractual obligations asof that date. There have been no material changes to our contractualobligations since that report.

 

**Critical Accounting Policies**

 

In Part II, Item 7of our Form 10-K filed on December 29, 2008, under the heading “CriticalAccounting Policies,” we have provided a discussion of the critical accountingpolicies that management believes affect its more significant judgments andestimates used in the preparation of our consolidated financial statements.

 

When we prepare ourconsolidated financial statements, we use estimates and assumptions that mayaffect reported amounts and disclosures. The determination of our liability formedical claims and other healthcare costs payable is particularly important tothe determination of our financial position and results of operations andrequires the application of significant judgment by our management and, as aresult, is subject to an inherent degree of uncertainty.

 

Our medical care costsinclude actual historical claims experience and estimates for medical carecosts incurred but not reported to us (“IBNR”). We, together with ourindependent actuaries, estimate medical claims liabilities using actuarialmethods based upon historical data adjusted for payment patterns, cost trends,product mix, utilization of healthcare services and other relevant factors. Theestimation methods and the resulting reserves are frequently reviewed and updated,and adjustments, if necessary, are reflected in the period known. While webelieve our estimates are adequate, it is possible that future events couldrequire us to make significant adjustments or revisions to these estimates. Inassessing the adequacy of accruals for medical claims liabilities, we considerour historical experience, the terms of existing contracts, our knowledge oftrends in the industry, information provided by our customers and informationavailable from other sources as appropriate.

 

The most significantestimates involved in determining our claims liability concern thedetermination of claims payment completion factors and trended per member permonth cost estimates.

 

We consider historicalactivity for the current month, plus the prior 24 months, in our IBNRcalculation. For the five months of service prior to the reporting date andearlier, we estimate our outstanding claims liability based upon actual claims paid,adjusted for estimated completion factors. Completion factors seek to measurethe cumulative percentage of claims expense that will have been paid for agiven 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 March 31, 2009 that wouldhave resulted had we changed our completion factors for all applicable monthsof service included in our IBNR calculation (i.e., the preceding 5th through 25th months) by thepercentages indicated; and (ii) the change in our estimate of claimsliability as of March 31, 2009 that would have resulted had we changedtrended PMPM factors for all applicable months of service included in our IBNRcalculation (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.

 

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| **Increase (Decrease) in  Estimated Completion Factors** | ** ** | **Increase (Decrease) in  Accrued Medical Claims  Payable** | ** ** |
|----------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| (3)%                                                     |       | $                                                           | 4,047,000  |   |
| (2)%                                                     |       | $                                                           | 2,698,000  |   |
| (1)%                                                     |       | $                                                           | 1,349,000  |   |
| 1%                                                       |       | $                                                           | (1,349,000 | ) |
| 2%                                                       |       | $                                                           | (2,698,000 | ) |
| 3%                                                       |       | $                                                           | (4,047,000 | ) |

 
| **Increase (Decrease) in  Trended PMPM Factors** | ** ** | **Increase (Decrease) in  Accrued Medical Claims  Payable** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------------------|------------|
| (3)%                                             |       | $                                                           | (782,000   | ) |
| (2)%                                             |       | $                                                           | (521,000   | ) |
| (1)%                                             |       | $                                                           | (261,000   | ) |
| 1%                                               |       | $                                                           | 261,000    |   |
| 2%                                               |       | $                                                           | 521,000    |   |
| 3%                                               |       | $                                                           | 782,000    |   |

 

Additionally, for each 1%(hypothetical) difference between our March 31, 2009 estimated claimsliability of $19,374,177 and the actual claims incurred run-out, pre-tax lossfor the six months ended March 31, 2009 would increase or decrease byapproximately $194,000 or approximately $0.01 per diluted share.

 

The following table showsthe components of the change in medical claims and benefits payable for the sixmonths ended March 31, 2009 and 2008:

 
| ** **                                           | ** ** | **Six Months Ended  March 31,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                           | ** ** | **2009**                             | ** ** | **2008(1)** | ** ** |
| IBNR as of beginning of period                       |       | $                                    | 20,480,380 |   | $ | 21,405,960 |   |
| Healthcare claims expense incurred during the period |       |                                 |       |   |   |
| Related to current year                              |       | 37,054,197                           |       | 42,914,646 |   |
| Related to prior years                               |       | (1,891,465                           | )          | (2,127,866 | ) |
| Total incurred                                       |       | 35,162,732                           |       | 40,786,780 |   |
| Healthcare claims paid during the period             |       |                                 |       |   |   |
| Related to current year                              |       | (20,074,687                          | )          | (23,189,927 | ) |
| Related to prior years                               |       | (16,194,247                          | )          | (17,198,434 | ) |
| Total paid                                           |       | (36,268,934                          | )          | (40,388,361 | ) |
| IBNR as of end or period                             |       | $                                    | 19,374,178 |   | $ | 21,804,379 |   |

 

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(1)                    Amounts exclude changes inmedical claims and benefits payable related to the AV Entities which arereported in discontinued operations.

 

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A negative amount reportedfor healthcare claims expense incurred related to prior years, results fromclaims being ultimately settled for amounts less than originally estimated (afavorable development). A positive amount results from claims ultimately beingsettled for amounts greater than originally estimated (an unfavorabledevelopment).

 

Through March 31, 2009,the $1,891,465 change in estimate related to IBNR as of September 30, 2008represented approximately 9.2% of the IBNR balance as of September 30,2008, approximately 2.5% of fiscal 2008 claims expense, and after considerationof tax effect, approximately 45% of net loss from continuing operation for theyear then ended.

 

Through March 31, 2008,the $2,127,866 change in estimate related to IBNR as of September 30, 2007represented approximately 9.9% of the IBNR balance as of September 30,2007, approximately 3.4% of claims expense and after consideration of taxeffect, approximately 9.1% of net loss from continuing operation for the yearthen ended.

 

Past fluctuations in theIBNR estimates might also be a useful indicator of the potential magnitude offuture changes in these estimates. Quarterly IBNR estimates include provisionsfor adverse development based on historical volatility. We maintain similarprovisions at each quarter end.

 

**Inflation**

 

According to U.S. Bureau ofLabor Statistics Data, the national healthcare cost inflation rate has exceededthe general inflation rate for the last four years. We use various strategiesto mitigate the negative effects of healthcare cost inflation. Specifically, wetry to control medical and hospital costs through contracts with independentproviders of healthcare services. Through these contracted providers, weemphasize preventive healthcare and appropriate use of specialty and hospitalservices.

 

While we currently believeour strategies to mitigate healthcare cost inflation will continue to besuccessful, competitive pressures, new healthcare and pharmaceutical productintroductions, demands from healthcare providers and customers, applicableregulations or other factors may affect our ability to control healthcarecosts.

 

**Item 3. Quantitative and Qualitative Disclosures about Market Risk.**

 

Not applicable

 

**Item 4T. Controls and Procedures.**

 

***Evaluation of Disclosure Controls and Procedures***

 

We carried out an evaluationas of March 31, 2009, under the supervision and with the participation ofour management, including our Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of the design and operation of our disclosurecontrols and procedures as defined in Rule 13a-15(e) of theSecurities Exchange Act of 1934. Based upon that evaluation, the ChiefExecutive Officer and Chief Financial Officer concluded that our disclosurecontrols and procedures were effective as of that date in ensuring thatinformation required to be disclosed in the reports that we file with, orsubmit to, the Securities and Exchange Commission (the “SEC”) under theSecurities Exchange Act of 1934 is recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and forms. Inaddition, based on that evaluation, the Chief Executive Officer and ChiefFinancial Officer concluded that our disclosure controls and procedures wereeffective as of March 31, 2009 in ensuring that information required to bedisclosed by us in the reports that we file or submit under the SecuritiesExchange Act of 1934 is accumulated and communicated to our management,including the Chief Executive Officer and Chief Financial Officer, asappropriate to allow timely decisions regarding required disclosures.

 

***Changes in Internal Control over Financial Reporting***

 

There were no changes in ourinternal control over financial reporting that occurred during the three monthsended March 31, 2009 that have materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting.

 

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**PART II—OTHER INFORMATION**

** **

**Item 1. Legal Proceedings.**

** **

Weand our affiliated physician organizations are parties to legal actions arisingin the ordinary course of business. We believe that liability, if any, underthese claims will not have a material adverse effect on our consolidatedfinancial position or results of operations.

 

**Item 1A. Risk Factors.**

** **

Notapplicable.

 

**Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.**

** **

None.

 

**Item 3. Defaults Upon Senior Securities.**

** **

TheCompany is subject to certain financial and administrative covenants, crossdefault provisions and other conditions required by the loan agreements withits lenders, including a maximum senior debt/EBITDA ratio, a minimumfixed-charge coverage ratio and, effective May 15, 2008, a minimum EBITDAlevel, each computed quarterly (monthly, for test periods from April 30,2008 through June 30, 2009) based on consolidated trailing twelve-monthresults, including the pre-acquisition results of any acquired entities. Theadministrative covenants and other restrictions with which the Company mustcomply include, among others, restrictions on additional indebtedness,incurrence of liens, engaging in business other than the Company’s primarybusiness, paying certain dividends, acquisitions and asset sales. The creditfacilities provide that an event of default will occur if there is a change incontrol of the Company. The payment of principal and interest under the creditfacilities is fully and unconditionally guaranteed, jointly and severally bythe Company and most of its existing wholly-owned subsidiaries. Substantiallyall of the Company’s assets are pledged to secure the credit facilities. TheCompany exceeded the maximum senior debt/EBITDA ratio of 3.75 as of September 30,2007. The Company also exceeded the maximum senior debt/EBITDA ratio of 3.75and failed to meet the minimum fixed charge coverage ratio of 1.25 as of andfor the rolling twelve-month periods ended December 31, 2007 and March 31,2008. In addition, the Company did not comply with certain administrativecovenants including timely filing of its Form 10-K for the year ended September 30,2007 and its Forms 10-Q for the quarters ended December 31, 2007 and March 31,2008.

 

OnFebruary 13, 2008, April 10, 2008 and May 14, 2008, the Companyand its lenders entered into forbearance agreements, whereby the lenders agreednot to exercise their rights under the credit facility through May 15,2008, subject to satisfaction of specified conditions. For the period January 28,2008 through April 10, 2008, interest was assessed at default rates of11.4% with respect to the first lien term loan and 15.4% with respect to thesecond-lien term loan. Under the April 2008 forbearance agreements, theapplicable margin on the first and second lien term loans were permanentlyincreased to 750 and 1,175 basis points, respectively, and the range ofapplicable margins on the revolving line of credit was increased to 500 to 750basis points. The agreements also provide that the LIBOR rate shall not be lessthan 3.5% over the term of the credit facilities. During the forbearanceperiods, the Company had limited or no access to the line of credit. TheCompany also agreed to pay certain fees and expenses to the lenders and theiradvisors as described below.

 

OnMay 15, 2008, the Company and its lenders entered into agreements to waive pastcovenant violations and amended the financial covenant provisions prospectivelystarting in April 2008 to modify the required ratios and to increase thefrequency of compliance reporting from quarterly to monthly for a specifiedperiod. Effective May 15, 2008, the maximum senior debt/EBITDA ratios wereincreased to levels ranging from 3.90 to 7.15 for monthly reporting periodsfrom April 30, 2008 through June 30, 2009 and were increased to levels rangingfrom 3.30 to 3.75 beginning with the September 30, 2009 quarterly reportingperiod through maturity of the term loan. The minimum fixed charge coverageratios were reduced to levels ranging from 0.475 to 0.925 for monthly reportingperiods from April 30, 2008 through June 30, 2009 and were reduced to levelsranging from 0.85 to 0.90 beginning with the September 30, 2009 quarterlyreporting periods through maturity of the term loan. The Company is alsorequired to meet a new minimum EBITDA requirement for future monthly reportingperiods from April 30, 2008 through June 30, 2009 and the remaining quarterlyreporting periods through maturity of the term loan. In addition, the Companywas required to, among other conditions, file its Form 10-K for the year ended September30, 2007 and the Forms 10-Q for the quarters ended December 31, 2007 and June 30,2008 by June 16, 2008. Failure to perform any obligations under the wavier andthe amended credit facility agreement constitutes additional events of default.The Company filed its Form 10-K on June 2, 2008 and its Forms 10-Q for thequarters ended December 31, 2007 and March 31, 2008 on June 9, 2008 and June 16,2008, respectively and has met all debt service requirements on a timely basis.

 

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Inconnection with obtaining the forbearance and waivers, during the second andthird quarters of 2008, the Company paid $450,000 in fees to Bank of America,which was included in general and administrative expenses and $1,525,000 inforbearance fees to the lenders, which was included in interest expense. Inaddition, the Company incurred $860,000 in legal and consulting fees to thelenders’ advisors related to the forbearance activities, which was included ingeneral and administrative expenses. Pursuant to the amended senior creditfacility agreement, the Company was required to pay an amendment fee of$758,000 in cash and add 1% to the principal balance of the first andsecond-lien debt and the revolving line of credit totaling $1,514,000. The Companywas also required to incur an additional 4% “payment-in-kind” interest expenseon the second lien debt, which accrues and is added to the principal balance ona monthly basis. The 4% may be reduced on a quarterly basis by 0.50% for each0.25% reduction in the Company’s consolidated leverage ratio. In connectionwith the modifications of the first and second-lien term debt and the revolvingline of credit, the Company wrote off the remaining unamortized discount anddebt issuance costs relating to the early extinguishment of the Company’sexisting debt totaling of $6,036,000, and expensed as debt extinguishment coststhe amendment fees of $758,000 paid to lenders and the $1,514,000 “payment-in-kind”interest added to the new debt, resulting in a total charge of $8,308,000 inconnection with this debt extinguishment. Additionally, the Company capitalized$327,000 of legal and consulting fees to the lenders’ advisors related to thenew credit agreements.

 

                    The Company was in compliance with the amended financial covenant provisions for the April 2008 through March 2009 monthly reporting periods. While the Company continues to meet all debt service requirements on a timely basis, on March 19, 2009, it received written notices from the lenders who have elected to begin charging interest based on the default interest rates set forth in the amended loan agreements because the lenders have deemed the Company in default of a credit facility requirement regarding the sale of certain of the Company’s assets by a specified date.  Additionally, on April 17, 2009, the Company received notices from its lenders asserting that the Company’s April 14, 2009 increase in ownership of Brotman Medical Center, Inc. violated certain provisions of the amended credit agreements.  The Company has contested both assertions.  Based on such notices, the Company has classified all scheduled payments due after twelve months as current at March 31, 2009. Also, due to cross default provisions, the swap liability was classified as current as of March 31, 2009.  The Company has strongly disputed the lenders’ characterization of the matters and is currently in discussions with the lenders to seek resolution of these matters. While the parties’ discussions are continuing, there can be no assurance that the matters will be resolved on a basis favorable to the Company. The lenders may not grant waivers and could require full repayment of the loans, which would negatively impact the Company’s liquidity, ability to operate and raises substantial doubt about its ability to continue as a going concern.

 

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

** **

None

 

**Item 5. Other Information**

** **

EffectiveMay 12, 2009, the Company and Samuel S. Lee (our Chief Executive Officer andChairman of our Board of Directors) entered into an Amended and RestatedExecutive Employment Agreement (“Agreement”). The Agreement amends and restates the Original Agreement (as amended bythe First, Second, and Third Amendments) in its entirety, and provides for anincreased annual base salary for Mr. Lee during fiscal year 2009 in the amountof $950,000 (retroactive to April 1, 2009). It also provides that Mr. Lee will be eligible for an annual bonus tiedto the Company’s attainment of certain EBITDA targets.  Lastly, the Agreement allows the CompensationCommittee of the Company’s Board of Directors to grant discretionary bonuses asit determines appropriate.

 

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** **

**Item 6. Exhibits.**

** **

Thefollowing documents are being filed as exhibits to this report:

 
| **Exhibit No.** | ** ** | **Title**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1*                |       | **Letter  agreement dated April 10, 2008, pertaining to the Amended and Restated  Forbearance Agreement dated April 10, 2008, among Prospect Medical  Holdings, Inc., Prospect Medical Group, Inc., and Bank of America,  N.A., as Administrative Agent on behalf of itself and the lenders named in  the First Lien Credit Agreement.**                                                                                                                                                                                                                                                                                                                |
| 10.2*                |       | **Letter  agreement dated April 10, 2008, pertaining to the Amended and Restated  Forbearance Agreement dated April 10, 2008, among Prospect Medical  Holdings, Inc., Prospect Medical Group, Inc., and Bank of America,  N.A., as Administrative Agent on behalf of itself and the lenders named in  the Second Lien Credit Agreement.**                                                                                                                                                                                                                                                                                                               |
| 10.3*                |       | **Letter  agreement dated May 15, 2008, pertaining to the First Lien Credit  Agreement, among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc.,  and Bank of America, N.A., as Administrative Agent on behalf of itself and  the lenders named in the First Lien Credit Agreement.**                                                                                                                                                                                                                                                                                                                                                            |
| 10.4*                |       | **Letter  agreement dated May 15, 2008, pertaining to the Second Lien Credit  Agreement, among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc.,  and Bank of America, N.A., as Administrative Agent on behalf of itself and  the lenders named in the Second Lien Credit Agreement.**                                                                                                                                                                                                                                                                                                                                                          |
| 10.5*                |       | **Letter  agreement dated December 31, 2008, pertaining to the First Lien Credit  Agreement, among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc.,  Bank of America, N.A., as Administrative Agent on behalf of itself and the  lenders named in the First Lien Credit Agreement, and the other parties whose  signatures are set forth on the signature pages to the letter agreement  dated December 31, 2008. (Certain portions of this exhibit have been  omitted pursuant to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange Act of  1934.)**   |
| 10.6*                |       | **Letter  agreement dated December 31, 2008, pertaining to the Second Lien Credit  Agreement, among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc.,  Bank of America, N.A., as Administrative Agent on behalf of itself and the  lenders named in the Second Lien Credit Agreement, and the other parties  whose signatures are set forth on the signature pages to the letter  agreement dated December 31, 2008. (Certain portions of this exhibit  have been omitted pursuant to an application for confidential treatment filed  with the Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934.)** |
| 10.7*                |       | **Letter  agreement dated January 30, 2009, pertaining to the First Lien Credit  Agreement, among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc.,  Bank of America, N.A., as Administrative Agent on behalf of itself and the  lenders named in the First Lien Credit Agreement, and the other parties whose  signatures are set forth on the signature pages to the letter agreement  dated January 30, 2009. (Certain portions of this exhibit have been omitted  pursuant to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange Act of  1934.)**     |
| 10.8*                |       | **Letter  agreement dated January 30, 2009, pertaining to the Second Lien Credit  Agreement, among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc.,  Bank of America, N.A., as Administrative Agent on behalf of itself and the  lenders named in the Second Lien Credit Agreement, and the other parties  whose signatures are set forth on the signature pages to the letter  agreement dated January 30, 2009. (Certain portions of this exhibit have  been omitted pursuant to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities Exchange Act  of 1934.)**   |
| 10.9*                |       | **Letter  agreement dated February 27, 2009, pertaining to the First Lien Credit  Agreement, among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc.,  Bank of America, N.A., as Administrative Agent on behalf of itself and the  lenders named in the First Lien Credit Agreement, and the other parties whose  signatures are set forth on the signature pages to the letter agreement  dated February 27, 2009. (Certain portions of this exhibit have been  omitted pursuant to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange Act of  1934.)**   |
| 10.10*               |       | **Letter  agreement dated February 27, 2009, pertaining to the Second Lien Credit  Agreement, among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc.,  Bank of America, N.A., as Administrative Agent on behalf of itself and the  lenders named in the Second Lien Credit Agreement, and the other parties  whose signatures are set forth on the signature pages to the letter  agreement dated February 27, 2009. (Certain portions of this exhibit  have been omitted pursuant to an application for confidential treatment filed  with the Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934.)** |

 

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| **Exhibit No.** | ** ** | **Title**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.11*               |       | **Letter  agreement dated March 6, 2009, pertaining to the First Lien Credit  Agreement, among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc.,  Bank of America, N.A., as Administrative Agent on behalf of itself and the  lenders named in the First Lien Credit Agreement, and the other parties whose  signatures are set forth on the signature pages to the letter agreement  dated March 6, 2009. (Certain portions of this exhibit have been omitted  pursuant to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange Act of  1934.)**     |
| 10.12*               |       | **Letter  agreement dated March 6, 2009, pertaining to the Second Lien Credit  Agreement, among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc.,  Bank of America, N.A., as Administrative Agent on behalf of itself and the  lenders named in the Second Lien Credit Agreement, and the other parties  whose signatures are set forth on the signature pages to the letter  agreement dated March 6, 2009. (Certain portions of this exhibit have  been omitted pursuant to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities Exchange Act  of 1934.)**   |
| 10.13*               |       | **Letter  agreement dated March 12, 2009, pertaining to the First Lien Credit  Agreement, among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc.,  Bank of America, N.A., as Administrative Agent on behalf of itself and the  lenders named in the First Lien Credit Agreement, and the other parties whose  signatures are set forth on the signature pages to the letter agreement  dated March 12, 2009. (Certain portions of this exhibit have been  omitted pursuant to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange Act of  1934.)**   |
| 10.14*               |       | **Letter  agreement dated March 12, 2009, pertaining to the Second Lien Credit  Agreement, among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc.,  Bank of America, N.A., as Administrative Agent on behalf of itself and the  lenders named in the Second Lien Credit Agreement, and the other parties  whose signatures are set forth on the signature pages to the letter  agreement dated March 12, 2009. (Certain portions of this exhibit have  been omitted pursuant to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities Exchange Act  of 1934.)** |
| 10.15**              |       | Amended and Restated Employment Agreement dated as of May 12,  2009 between Prospect Medical Holdings, Inc. and Samuel S. Lee.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |

 

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*                                         Filed by theCompany with the Securities and Exchange Commission on April 3, 2009 as anexhibit to the Company’s Current Report on Form 8-K/A and incorporated hereinby reference.

 

**                                  Filed with thisQuarterly Report on Form 10-Q.

 

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** **

**SIGNATURES**

** **

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|              | PROSPECT MEDICAL  HOLDINGS, INC. |
|-------------------|---------------------------------------|
|              | (Registrant)                          |
|              |                                  |
| May 15, 2009 | **/**s**/**SAMUEL S. LEE              |
|              | **Samuel S.  Lee**                    |
|              | **Chief  Executive Officer**          |
|              | **(Principal  Executive Officer)**    |
|              | ** **                            |
| May 15, 2009 | **/**s**/**MIKE HEATHER               |
|              | **Mike  Heather**                     |
|              | **Chief Financial  Officer**          |
|              | **(Principal  Financial Officer)**    |

 

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