**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**Form 10-Q**

 

**ý****                              ****Quarterly reportpursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934**

 

**For the quarterly period ended March 31, 2006**

 

**or**

 

**o****                              ****Transition reportpursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934**

 

**Commissionfile number: 1-32203**

 

**ProspectMedical Holdings, Inc.**

(Exactname of registrant as specified in its charter)

 

| **Delaware**                                                           | ** ** | **33-0564370**                               |
|------------------------------------------------------------------------|------------|----------------------------------------------|
| (State  or other jurisdiction of  incorporation  or organization) |       | (I.R.S.  Employer  Identification  No.) |
| ** **                                                             | ** ** | ** **                                   |
| **400 Corporate Pointe, Suite 525**  **Culver City,  California** | ** ** | **90230**                                    |
| (Address of principal executive offices)                               |       | (Zip Code)                                   |

 

**(310)338-8677**

(Registrant’stelephone number, including area code)

 

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

 

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

 

| Large  accelerated filer  o |   | Accelerated filer  o |   | Non-accelerated filer  ý |
|---------------------------------------|--------|--------------------------------|--------|-----------------------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act):

 
| Yes  o   No  ý |
|--------------------------------------------------------|

 

The number of shares of the issuer’s Common Stock,par value $0.01 per share, outstanding as of May 8, was 6,922,828.

 

 

----

 

**PROSPECTMEDICAL HOLDINGS, INC.**

 

**Index**

 
|             | **Part I – Financial Information**                                                                                           |       |
|------------------|-----------------------------------------------------------------------------------------------------------------------------------|------------|
|             | ** **                                                                                                                        |       |
| **Item 1.**      | **Financial Statements**                                                                                                          |       |
| ** **       |                                                                                                                              |       |
|             | Condensed Consolidated Balance  Sheets as of March 31, 2006 (unaudited) and September 30, 2005                                    |       |
|             |                                                                                                                              |       |
|             | Condensed Consolidated  Statements of Income for the three-month and six-month periods ended March  31, 2006 and 2005 (unaudited) |       |
|             |                                                                                                                              |       |
|             | Condensed Consolidated  Statements of Cash Flows for the six-month periods ended March 31, 2006 and  2005 (unaudited)             |       |
|             |                                                                                                                              |       |
|             | Notes to Condensed  Consolidated Financial Statements (unaudited)                                                            |       |
|             |                                                                                                                              |       |
| **Item 2.**      | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations**                                   |       |
| ** **       | ** **                                                                                                                        |       |
| **Item 3.**      | **Quantitative  and Qualitative Disclosures About Market Risk**                                                                   |       |
| ** **       | ** **                                                                                                                        |       |
| **Item 4.**      | **Controls and  Procedures**                                                                                                      |       |
| ** **       | ** **                                                                                                                        |       |
|             | **Part II -  Other Information**                                                                                                  | ** ** |
|             | ** **                                                                                                                        | ** ** |
| **Item 1.**      | **Legal Proceedings**                                                                                                             |       |
| ** **       | ** **                                                                                                                        |       |
| **Item 2.**      | **Unregistered  Sales of Equity Securities and Use of Proceeds**                                                                  |       |
| ** **       | ** **                                                                                                                        |       |
| **Item 3.**      | **Defaults Upon Senior Securities**                                                                                               |       |
| ** **       |                                                                                                                              |       |
| **Item 4.**      | **Submission of Matters to a Vote of Security Holders**                                                                           |       |
| ** **       |                                                                                                                              |       |
| **Item 5.**      | **Other  information**                                                                                                            |       |
| ** **       |                                                                                                                              |       |
| **Item 6.** | **Exhibits**                                                                                                                      |       |
|             |                                                                                                                              |       |
| **Signatures**   |                                                                                                                              |

 

2

----

 

**PART I -FINANCIAL INFORMATION**

 

**Item 1. Financial Statements.**

 

**PROSPECTMEDICAL HOLDINGS, INC.**

 

**CONDENSED CONSOLIDATEDBALANCE SHEETS**

 
| ** **                                                                                                                                                    | ** ** | **March 31,   2006** | ** ** | **September 30   2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                                                                    | ** ** | **(Unaudited)**                | ** ** | ** **                        | ** ** |
| **ASSETS**                                                                                                                                                    |       |                           |       |                              |       |
| **Current assets:**                                                                                                                                           |       |                           |       |                              |       |
| Cash and cash equivalents                                                                                                                                     |       | $                              | 16,033,876 |                              | $          | 16,949,304 |   |
| Investments, primarily restricted  certificates of deposit                                                                                                    |       | 835,153                        |       | 1,100,000                         |       |
| Risk pool receivables                                                                                                                                         |       | 450,000                        |       | 57,267                            |       |
| Other receivables, net of allowances of  $667,000 and $802,000 at March 31, 2006 and September 30, 2005                                                       |       | 866,159                        |       | 1,940,536                         |       |
| Notes receivable, current portion                                                                                                                             |       | 49,676                         |       | 52,160                            |       |
| Prepaid expenses and other                                                                                                                                    |       | 735,115                        |       | 646,932                           |       |
| Refundable income taxes                                                                                                                                       |       | 1,393,252                      |       | —                            |       |
| Deferred income taxes, net                                                                                                                                    |       | 1,537,970                      |       | 1,904,137                         |       |
| Total current assets                                                                                                                                          |       | 21,901,201                     |       |                              | 22,650,336 |   |
|                                                                                                                                                          |       |                           |       |                              |       |
| Property, improvements and equipment:                                                                                                                         |       |                           |       |                              |       |
| Land                                                                                                                                                          |       | 40,620                         |       | 40,620                            |       |
| Leasehold improvements                                                                                                                                        |       | 986,827                        |       | 726,973                           |       |
| Equipment                                                                                                                                                     |       | 3,311,815                      |       | 3,342,385                         |       |
| Furniture and fixtures                                                                                                                                        |       | 561,134                        |       | 546,523                           |       |
|                                                                                                                                                          |       | 4,900,396                      |       | 4,656,501                         |       |
| Less accumulated depreciation and  amortization                                                                                                               |       | (3,713,051                     | )          | (3,454,282                        | )          |
| Property, improvements and equipment, net                                                                                                                     |       | 1,187,345                      |       | 1,202,219                         |       |
|                                                                                                                                                          |       |                           |       |                              |       |
| Notes receivable, long term portion                                                                                                                           |       | 558,034                        |       | 572,979                           |       |
| Deposits                                                                                                                                                      |       | 546,438                        |       | 583,226                           |       |
| Goodwill                                                                                                                                                      |       | 38,623,322                     |       | 31,404,328                        |       |
| Other intangible assets, net                                                                                                                                  |       | 1,726,164                      |       | 1,317,614                         |       |
| Total assets                                                                                                                                                  |       | $                              | 64,542,504 |                              | $          | 57,730,702 |   |
|                                                                                                                                                          |       |                           |       |                              |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                 |       |                           |       |                              |       |
| **Current liabilities:**                                                                                                                                      |       |                           |       |                              |       |
| Accrued medical claims and other health  care costs payable                                                                                                   |       | $                              | 11,695,000 |                              | $          | 11,532,328 |   |
| Accounts payable and other accrued  liabilities                                                                                                               |       | 8,389,769                      |       | 9,799,968                         |       |
| Current maturities of long-term debt and  capital leases                                                                                                      |       | 4,800,000                      |       | 2,000,000                         |       |
| Total current liabilities                                                                                                                                     |       | 24,884,769                     |       | 23,332,296                        |       |
|                                                                                                                                                          |       |                           |       |                              |       |
| Long-term debt, less current maturities                                                                                                                       |       | 8,100,000                      |       | 6,166,667                         |       |
| Deferred income taxes                                                                                                                                         |       | 1,066,930                      |       | 1,045,696                         |       |
| Other long-term liabilities                                                                                                                                   |       | 185,000                        |       | 185,000                           |       |
| Total liabilities                                                                                                                                             |       | 34,236,699                     |       | 30,729,659                        |       |
| **Minority interest**                                                                                                                                         |       | 71,389                         |       | 65,405                            |       |
|                                                                                                                                                          |       |                           |       |                              |       |
| **Shareholders’ equity:**                                                                                                                                |       |                           |       |                              |       |
| Common stock, $0.01 par value; 40,000,000  shares authorized; 6,922,828 and 6,640,362 shares issued and outstanding at  March 31, 2006 and September 30, 2005 |       | 69,228                         |       | 66,403                            |       |
| Additional paid-in capital                                                                                                                                    |       | 19,337,428                     |       | 18,373,487                        |       |
| Retained earnings                                                                                                                                             |       | 10,827,760                     |       | 8,495,748                         |       |
| Total shareholders’ equity                                                                                                                               |       | 30,234,416                     |       | 26,935,638                        |       |
|                                                                                                                                                          |       |                           |       |                              |       |
| Total liabilities and shareholders’ equity                                                                                                               |       | $                              | 64,542,504 |                              | $          | 57,730,702 |   |

 

See accompanying notes.

 

3

----

 

**PROSPECTMEDICAL HOLDINGS, INC.**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF INCOME**

**(Unaudited)**

 
| ** **                                                 | ** ** | **Three months ended   March 31,** | ** ** | **Six months ended   March 31,** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                 | ** ** | **2006**                                               | ** ** | **2005**                                             | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                       |       |                                                   |       |                                                 |       |   |   |   |   |
| Revenues                                                   |       | $                                                      | 34,572,146 |                                                 | $          | 32,330,622 |   | $ | 68,036,905 |   | $ | 65,611,458 |   |
| Cost of revenues                                           |       | 23,963,663                                             |       | 23,656,214                                           |       | 48,449,879 |   | 48,456,826 |   |
|                                                       |       |                                                   |       |                                                 |       |   |   |   |   |
| Gross margin                                               |       | 10,608,483                                             |       | 8,674,408                                            |       | 19,587,026 |   | 17,154,632 |   |
|                                                       |       |                                                   |       |                                                 |       |   |   |   |   |
| Operating expenses:                                        |       |                                                   |       |                                                 |       |   |   |   |   |
| General and administrative                                 |       | 8,461,134                                              |       | 6,550,266                                            |       | 15,592,208 |   | 13,123,077 |   |
| Depreciation and amortization                              |       | 335,573                                                |       | 263,680                                              |       | 657,589 |   | 496,910 |   |
| Total operating expenses                                   |       | 8,796,707                                              |       | 6,813,946                                            |       | 16,249,797 |   | 13,619,987 |   |
|                                                       |       |                                                   |       |                                                 |       |   |   |   |   |
| Operating income (loss) from unconsolidated  joint venture |       | 330,732                                                |       | (143,396                                             | )          | 676,893 |   | 97,682 |   |
|                                                       |       |                                                   |       |                                                 |       |   |   |   |   |
| Operating income                                           |       | 2,142,508                                              |       | 1,717,066                                            |       | 4,014,122 |   | 3,632,327 |   |
|                                                       |       |                                                   |       |                                                 |       |   |   |   |   |
| Other (income) expense:                                    |       |                                                   |       |                                                 |       |   |   |   |   |
| Investment income                                          |       | (204,722                                               | )          | (99,407                                              | )          | (439,189 | ) | (177,388 | ) |
| Interest expense                                           |       | 288,229                                                |       | 271,414                                              |       | 545,740 |   | 449,416 |   |
| Total other (income) expense, net                          |       | 83,507                                                 |       | 172,007                                              |       | 106,551 |   | 272,028 |   |
|                                                       |       |                                                   |       |                                                 |       |   |   |   |   |
| Income before income taxes                                 |       | 2,059,001                                              |       | 1,545,059                                            |       | 3,907,571 |   | 3,360,299 |   |
| Provision for income taxes                                 |       | 825,392                                                |       | 618,650                                              |       | 1,569,575 |   | 1,346,809 |   |
|                                                       |       |                                                   |       |                                                 |       |   |   |   |   |
| Net income before minority interest                        |       | 1,233,609                                              |       | 926,409                                              |       | 2,337,996 |   | 2,013,490 |   |
|                                                       |       |                                                   |       |                                                 |       |   |   |   |   |
| Minority interest                                          |       | 4,386                                                  |       | 4,561                                                |       | 5,984 |   | 4,945 |   |
|                                                       |       |                                                   |       |                                                 |       |   |   |   |   |
| Net income                                                 |       | $                                                      | 1,229,223  |                                                 | $          | 921,848 |   | $ | 2,332,012 |   | $ | 2,008,545 |   |
|                                                       |       |                                                   |       |                                                 |       |   |   |   |   |
| Net income per common share:                               |       |                                                   |       |                                                 |       |   |   |   |   |
| Basic                                                      |       | $                                                      | 0.18       |                                                 | $          | 0.20 |   | $ | 0.34 |   | $ | 0.45 |   |
| Diluted                                                    |       | $                                                      | 0.15       |                                                 | $          | 0.11 |   | $ | 0.29 |   | $ | 0.23 |   |
| Weighted average shares outstanding:                       |       |                                                   |       |                                                 |       |   |   |   |   |
| Basic                                                      |       | 6,887,286                                              |       | 4,549,828                                            |       | 6,792,907 |   | 4,446,048 |   |
| Diluted                                                    |       | 8,233,916                                              |       | 8,757,795                                            |       | 7,994,380 |   | 8,716,551 |   |

 

See accompanying notes. 

 

4

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**PROSPECTMEDICAL HOLDINGS, INC.**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                     | ** ** | **Six months ended   March 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                     | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| **Operating activities**                                                       |       |                                                 |       |   |   |
| Net income                                                                     |       | $                                                    | 2,332,012  |   | $ | 2,008,545 |   |
| Adjustments to reconcile net income to net  cash used in operating activities: |       |                                                 |       |   |   |
| Depreciation and amortization                                                  |       | 657,589                                              |       | 496,910 |   |
| Provision for bad debts                                                        |       | 119,492                                              |       | 15,555 |   |
| Loss on disposal of assets                                                     |       | 151                                                  |       | — |   |
| Deferred income taxes, net                                                     |       | 387,401                                              |       | 257,862 |   |
| Change in deferred compensation                                                |       | —                                               |       | 58,779 |   |
| Changes in operating assets and  liabilities:                                  |       |                                                 |       |   |   |
| Risk pool receivables                                                          |       | (392,733                                             | )          | (137,608 | ) |
| Other receivables                                                              |       | 959,383                                              |       | (93,859 | ) |
| Prepaid expenses and other                                                     |       | (86,136                                              | )          | (679,906 | ) |
| Recoverable income taxes                                                       |       | (2,868,865                                           | )          | (1,089,046 | ) |
| Deposits and other assets                                                      |       | 38,836                                               |       | — |   |
| Accrued medical claims and other health  care costs payable                    |       | (835,191                                             | )          | (69,017 | ) |
| Accounts payable and other accrued  liabilities                                |       | (618,724                                             | )          | (2,873,452 | ) |
| Net cash used in operating activities                                          |       | (306,785                                             | )          | (2,105,237 | ) |
|                                                                           |       |                                                 |       |   |   |
| **Investing activities**                                                       |       |                                                 |       |   |   |
| Purchases of property, improvements and  equipment                             |       | (251,416                                             | )          | (154,443 | ) |
| Collections on note receivable                                                 |       | 17,429                                               |       | 220,051 |   |
| Cash paid for acquisitions, net of cash  received                              |       | (6,596,080                                           | )          | — |   |
| Decrease (increase) in restricted  certificates of deposit                     |       | 294,364                                              |       | (638,115 | ) |
| Capitalized expenses related to acquisitions                                   |       | —                                               |       | (5,250 | ) |
| Other investing activities                                                     |       | 5,984                                                |       | 4,945 |   |
| Net cash used in investing activities                                          |       | (6,529,719                                           | )          | (572,812 | ) |
|                                                                           |       |                                                 |       |   |   |
| **Financing activities**                                                       |       |                                                 |       |   |   |
| Borrowings from term loan                                                      |       | 4,000,000                                            |       | — |   |
| Net proceeds (repayments) on line of credit                                    |       | 2,000,000                                            |       | (5,000,000 | ) |
| Reduction of note payable and capital  leases                                  |       | (1,266,667                                           | )          | (841,888 | ) |
| Proceeds (expenses) from issuance of common  and preferred stock               |       | 918,232                                              |       | (201,663 | ) |
| Tax benefit from options exercised                                             |       | 269,511                                              |       | — |   |
| Net cash provided by (used in) financing  activities                           |       | 5,921,076                                            |       | (6,043,551 | ) |
|                                                                           |       |                                                 |       |   |   |
| Net decrease in cash and cash equivalents                                      |       | (915,428                                             | )          | (8,721,600 | ) |
|                                                                           |       |                                                 |       |   |   |
| Cash and cash equivalents at beginning of  period                              |       | 16,949,304                                           |       | 20,330,754 |   |
|                                                                           |       |                                                 |       |   |   |
| Cash and cash equivalents at end of period                                     |       | $                                                    | 16,033,876 |   | $ | 11,609,154 |   |
|                                                                           |       |                                                 |       |   |   |
| **Supplemental cash flow information**                                         |       |                                                 |       |   |   |
| Cash paid during the period for:                                               |       |                                                 |       |   |   |
| Income taxes                                                                   |       | $                                                    | 2,756,000  |   | $ | 3,513,124 |   |
| Interest                                                                       |       | $                                                    | 513,367    |   | $ | 376,846 |   |
|                                                                           |       |                                                 |       |   |   |
| Details of businesses acquired:                                                |       |                                                 |       |   |   |
| Fair value of assets acquired                                                  |       | $                                                    | 9,496,212  |   | $ | — |   |
| Liabilities assumed or created                                                 |       | (1,461,024                                           | )          | — |   |
| Less cash acquired                                                             |       | (1,439,108                                           | )          | — |   |
| Net cash paid for acquisition                                                  |       | $                                                    | 6,596,080  |   | $ | — |   |

 

5

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**PROSPECTMEDICAL HOLDINGS, INC.**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**March 31,2006**

**(Unaudited)**

 

**1. Reporting Entity**

 

Prospect Medical Holdings, Inc.(Prospect or the Company) a Delaware corporation, was incorporated onMay 12, 1993. The Company is a health care management servicesorganization that develops integrated delivery systems, and provides medicalmanagement systems and services to affiliated medical organizations. Theaffiliated medical organizations employ and/or contract with physicians andprofessional medical corporations, and contract with managed care payors.Prospect manages the provision of prepaid health care services for itsaffiliated medical organizations in Southern California.

 

**2. Basis of Presentation**

 

The unaudited condensed consolidated interimfinancial statements have been prepared under the assumption that users of theinterim financial data have either read or have access to our auditedconsolidated financial statements for the latest fiscal year ended September30, 2005. Accordingly, certain note disclosures that would substantiallyduplicate the disclosures contained in the September 30, 2005 audited financialstatements have been omitted. These unaudited condensed consolidated interimfinancial statements should be read in conjunction with our September 30, 2005audited financial statements.

 

The unaudited condensed consolidated financialstatements include the accounts of the Company and all majority ownedsubsidiaries and controlled entities under Emerging Issues Task Force (EITF)No. 97-2, “*Application of FASB Statement No. 94 and APBOpinion No. 16 to Physician Practice Management Entities and Certain OtherEntities with Contractual Management Arrangements.”* In the opinionof management, all adjustments considered necessary for a fair presentation ofthe results as of the date and for the interim periods presented, which consistsolely of normal recurring adjustments, have been included. All significantinter-company balances and transactions have been eliminated in consolidation.The consolidated results of operations for the current interim period are notnecessarily indicative of the results that may be expected for the entire yearending September 30, 2006.

 

Revenues are comprised of the followingamounts:

 
| ** **      | ** ** | **Three Months Ended March 31,** | ** ** | **Six Months Ended March 31,** | ** ** |
|-----------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **      | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Capitation      |       | $                                | 33,653,872 |                           | $          | 31,411,215 |   | $ | 66,271,978 |   | $ | 63,929,977 |   |
| Fee for service |       | 558,015                          |       | 563,323                        |       | 1,123,765 |   | 1,063,604 |   |
| Management fees |       | 356,700                          |       | 214,171                        |       | 631,767 |   | 426,934 |   |
| Other           |       | 3,559                            |       | 141,913                        |       | 9,395 |   | 190,943 |   |
| Total revenues  |       | $                                | 34,572,146 |                           | $          | 32,330,622 |   | $ | 68,036,905 |   | $ | 65,611,458 |   |

 

**3. Stock Based Compensation**

 

The Company has stockoption agreements with certain directors, officers and employees. On October 1,2005, the Company adopted Statement of Financial Accounting Standards (SFAS)No. 123(R), “*Share-Based Payment*,”by applying the modified prospective method. SFAS 123(R) requirescompensation cost for all share-based payments (including employee stockoptions) to be measured at fair value and eliminates the intrinsic value methodpreviously permitted under Accounting Principles Board (APB) Opinion 25, “*Accounting for Stock Issued to Employees*” and SFAS No. 123 “*Accounting for Stock-Based Compensation*.” Under APB No. 25,compensation costs were recognized only to the extent the market price of theunderlying stock exceeded the exercise price on the date of grant. Since theCompany generally issues shared-based awards at or above the market price ofthe underlying stock, these equity awards have not historically resulted incompensation expense.

 

Under the modifiedprospective method, compensation cost is recognized for all awards granted,modified or settled subsequent to the adoption date, or where the requisiteservice period has not been completed prior to the date of adoption.Compensation cost for awards granted prior to, but not vested as of theadoption date would be based on the same estimated

 

6

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grant-date fair valuepreviously used for pro forma disclosure purposes under SFAS No. 123.Compensation costs for awards granted, modified, or settled after the adoptiondate are measured and recognized in the financial statements, net of estimatedforfeitures over the awards’ service period, in accordance with SFAS No.123(R). The Company will continue to use the Black-Scholes option pricing modelto estimate the fair value of options granted. The adoption of SFAS No. 123Rdid not result in adjustments that are required to be reported as thecumulative effect of a change in accounting principle. Equity-basedcompensation, if any, is classified within the same line items as cashcompensation paid to employees. Cash retained as a result of excess taxbenefits relating to share-based payments are presented in the statement ofcash flows as a financing cash inflow. Previously, the cash retained fromexcess tax benefits was presented in operating cash flows.

 

The Company fully vestedall remaining unvested portions of previously issued stock options in September2005. Because none of the stock options whose vesting was accelerated hadexercise prices below the market value of the Company’s stock, no expense wasrecognized upon the acceleration of vesting. The Company did not make otherchanges to the terms of the options, which generally vest pro-rata over 2 yearsand expire after 5 years from the date of grant.

 

Thepro forma effects of recognizing the estimated fair value of stock-based compensationfor the three and six months ended March 31, 2005 has been disclosed previouslyin our footnotes under provisions of Statement of Financial AccountingStandards No. 123 (“FAS 123”), *Accountingfor Stock-Based Compensation.*The previously-disclosed pro formainformation is presented below.

 
| ** **                                                                                                                 | ** ** | **3 Months Ended  March 31, 2005** | ** ** | **6 Months Ended  March 31, 2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|------------------------------------|------------|
| Net income, as reported                                                                                                    |       | $                                  | 921,848    |                               | $          | 2,008,545 |   |
| Reconciling items (net of related tax  effects):                                                                           |       |                               |       |                               |       |
| Add: Stock-based employee compensation  expense determined under the intrinsic-value based method, included in net  income |       | 29,389                             |       | 58,779                             |       |
| Deduct: Stock-based employee compensation  expense determined under the fair-value based method                            |       | (41,496                            | )          | (319,439                           | )          |
| Net adjustment                                                                                                             |       | (12,107                            | )          | (260,660                           | )          |
| Pro forma net income                                                                                                       |       | $                                  | 909,741    |                               | $          | 1,747,885 |   |
|                                                                                                                       |       |                               |       |                               |       |
| Earnings per share:                                                                                                        |       |                               |       |                               |       |
| Basic—as reported                                                                                                     |       | $                                  | 0.20       |                               | $          | 0.45 |   |
| Basic—pro forma                                                                                                       |       | $                                  | 0.20       |                               | $          | 0.39 |   |
| Diluted—as reported                                                                                                   |       | $                                  | 0.11       |                               | $          | 0.23 |   |
| Diluted—pro forma                                                                                                     |       | $                                  | 0.10       |                               | $          | 0.20 |   |

 

During the six months endedMarch 31, 2006, options for 282,466 common shares were exercised for netproceeds of approximately $696,000 and 7,721 options were forfeited. TheCompany realized net tax benefits of $269,511 from these exercises. The taxbenefits reduced income tax payable and increased additional paid-in capital.

 

During the six-monthperiod ended March 31, 2006, the Company granted 500 fully vested options and recognizedcompensation expense of $1,745 which represents the grant date fair value ofthese share option awards.  The optionshave an exercise price of $6.75, which equals the fair value of the underlyingCommon Stock on the date of the grant.

 

The fair value of the options granted prior to theCompany becoming a public reporting entity was estimated at the date of grantusing the Minimum Value option model. The fair value of the options grantedafter the Company became a public reporting entity was estimated at the date ofthe grant using the Black-Scholes pricing model with the following weighted averageassumptions:

 

7

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| ** **                                                                     | ** ** | **Three Months Ended  March 31,** | ** ** | **Six Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|-----------------------------------|------------|---------------------------------|------------|
| ** **                                                                     | ** ** | **2006**                          | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Expected market price of the Company’s  common stock on the date of grant |       | $                                 | 6.75       |                            | $          | 7.15 |   | $ | 6.75 |   | $ | 6.45 to $7.15 |   |
| Weighted average expected life of the  options                                 |       | 4 years                           |       | 4 years                         |       | 4 years |   | 4 years |   |
| Risk-free interest rate                                                        |       | 4.35                              | %          | 4.17                            | %          | 4.35 | % | 3.50% to 4.17 | % |
| Volatility                                                                     |       | 63.00                             | %          | —                          |       | 63.00 | % | — |   |
| Dividend yield                                                                 |       | 0.00                              | %          | 0.00                            | %          | 0.00 | % | 0.00 | % |
|                                                                                |            |                                   |            |                                 |            |  |  |  |  |  |  |  |  |

 

**4. Earnings Per Share**

 

The denominators for the computation of basic anddiluted earnings per share are calculated as follows:

 
| ** **                                                               | ** ** | **Three months ended  March 31,** | ** ** | **Six months ended  March 31,** | ** ** |
|--------------------------------------------------------------------------|------------|-----------------------------------|------------|---------------------------------|------------|
| ** **                                                               | ** ** | **2006**                          | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Basic earnings per common share:                                         |       |                              |       |                            |       |   |   |   |   |
| Numerator – net income                                              |       | $                                 | 1,229,223  |                            | $          | 921,848 |   | $ | 2,332,012 |   | $ | 2,008,545 |   |
|                                                                     |       |                              |       |                            |       |   |   |   |   |
| Denominator – weighted average number of  common shares outstanding |       | 6,887,286                         |       | 4,549,828                       |       | 6,792,907 |   | 4,446,048 |   |
|                                                                     |       |                              |       |                            |       |   |   |   |   |
| Basic earnings per common share                                          |       | $                                 | 0.18       |                            | $          | 0.20 |   | $ | 0.34 |   | $ | 0.45 |   |
|                                                                     |       |                              |       |                            |       |   |   |   |   |
| Diluted earnings per common share:                                       |       |                              |       |                            |       |   |   |   |   |
| Numerator – net income                                              |       | $                                 | 1,229,223  |                            | $          | 921,848 |   | $ | 2,332,012 |   | $ | 2,008,545 |   |
|                                                                     |       |                              |       |                            |       |   |   |   |   |
| Denominator:                                                             |       |                              |       |                            |       |   |   |   |   |
| Weighted average number of common shares  outstanding                    |       | 6,887,286                         |       | 4,549,828                       |       | 6,792,907 |   | 4,446,048 |   |
| Diluted stock options, warrants and  preferred shares                    |       | 1,346,630                         |       | 4,207,967                       |       | 1,201,473 |   | 4,270,503 |   |
|                                                                     |       | 8,233,916                         |       | 8,757,795                       |       | 7,994,380 |   | 8,716,551 |   |
|                                                                     |       |                              |       |                            |       |   |   |   |   |
| Diluted earnings per common share                                        |       | $                                 | 0.15       |                            | $          | 0.11 |   | $ | 0.29 |   | $ | 0.23 |   |

 

**5. Related Party Transactions**

 

We have an employment agreement with ourChief Executive Officer, Jacob Y. Terner that runs through August 1, 2008and provides for compensation of $250,000 per year. The agreement furtherprovides that if we terminate Dr. Terner’s employment without cause, wewill be required to pay him $12,500 for each month of past service as our ChiefExecutive Officer, commencing as of July 31, 1996. Effective September 8,2004, the Company’s maximum contingent obligation under this terminationprovision was frozen at $1,237,500.

 

Prospect Medical Group, Inc. (PMG), which is wholly owned by Dr.Terner, and whose accounts are consolidated in these financial statements underEITF 97-2, maintains an intercompany account receivable due from prospectMedical Holdings, Inc. The intercompany receivable was created in connectionwith previous acquisitions. In the event that PMG is required by the HMO’s orregulatory agencies to maintain a positive tangible net equity and positiveworking capital, Dr. Terner had previously agreed to personally guarantee theintercompany account receivable due from Prospect Medical Holdings, Inc. up toa level sufficient to enable PMG to attain positive tangible net equity andworking capital.

 

On June 1, 2003, in consideration for Dr. Terner’s personalguarantee and pledge, the Compensation Committee of the Board of Directorsgranted to Dr. Terner a six-year, non-qualified stock option to purchase 800,000shares of common stock at $3.00 per share. During its term, Dr. Terner agreedto maintain his personal guarantee and collateral in effect until PMG hadpositive tangible net equity. This personal guarantee arrangement wasterminated by the Board of directors effective January 19, 2005.

 

**6. Long Term Debt**

 

Long-term debt at March 31, 2006 consists ofthe following:

 
| Term loan                 |   | $          | 10,900,000 |   |
|---------------------------|--------|------------|------------|--------|
| Revolving credit facility |   | 2,000,000  |       |
|                      |   |       |       |
| Less current maturities   |   | (4,800,000 | )          |
|                      |   | $          | 8,100,000  |   |

 

8

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On September 27, 2004, the Company enteredinto a credit facility with Residential Funding Corporation (RFC), comprised ofa $5,000,000 revolving credit facility and a $10,000,000 term loan.

 

The RFC revolving credit facility commitment is for three years, withinterest at prime plus 0.5% per annum and an unused line fee of 0.25% perannum. The RFC term loan is amortized over a five-year period with principalpayments of $166,667 per month, plus interest payable monthly on theoutstanding balance at prime plus 2.0% per annum. The remaining balance of theterm loan is due and payable in full after 36 months. The Company is subject tocertain financial covenants under the loan agreement, including a maximumsenior debt/EBITDA ratio, minimum fixed charge coverage ratio, minimumconsolidated net worth, minimum liquidity and a limit on capital expenditures.The Company is also restricted, without consent, from using the net proceeds ofany sale of equity securities except to pay down indebtedness under the loanagreement.

 

TheCompany exceeded the 1.50 maximum senior debt/EBITDA ratio as of September 30,2004 and December 31, 2004. The actual senior debt/EBITDA ratio as of September30, 2004 and December 31, 2004 was 1.57 and 1.51, respectively. Effective April7, 2005, RFC has waived these covenant violations. RFC, in addition, agreed toexclude certain items from the covenant computations for a twelve month period,the exclusion of which enabled the Company to meet the minimum fixed chargecoverage ratio at December 31, 2004. The Company has subsequently been incompliance with all required RFC covenants.

 

In November 2005, in connection with the acquisition of GenesisHealthcare of Southern California, RFC provided us with additional term loandebt financing of $4,000,000, on terms similar to our existing term loan. Thisadditional term loan requires monthly principal payments of $66,667 untilSeptember 27, 2007, at which time the remaining unpaid balance is due.

 

**7. Acquisition**

 

On November 1, 2005Prospect Medical Group, Inc., acquired the assets and assumed theliabilities of Genesis HealthCare of Southern California for $8,000,000 incash. The purchase price was funded using $4,000,000 of the company’s existingcash and a $4,000,000 term loan from RFC. Revenues and expenses for thisacquisition have been included in our consolidated results starting November 1,2005. The Company is using an outside valuation firm to determine the fairvalue of the Identifiable Assets at November 1, 2005. Pending completion ofthis valuation study, the following table summarizes the preliminary estimatedfair values of the assets acquired and liabilities assumed, as of the date ofacquisition:

 
| ** **                                                     | ** ** | **Genesis** | ** ** |
|----------------------------------------------------------------|------------|-------------|------------|
| Current assets                                                 |       | $           | 1,495,653  |   |
| Property, improvements and equipment                           |       | —      |       |
| Goodwill                                                       |       | 7,218,994   |       |
| Identifiable intangibles                                       |       | 800,000     |       |
| Other assets acquired                                          |       | 31,565      |       |
| Total assets                                                   |       | 9,496,212   |       |
| Current liabilities                                            |       | 1,461,024   |       |
| Long-term liabilities                                          |       | —      |       |
| Total liabilities assumed                                      |       | 1,461,024   |       |
| Total purchase price (including $35,188 in  transaction costs) |       | $           | 8,035,188  |   |

 

Under the acquisitionagreement, differences between the estimated claims and tax liabilitiesrecorded on the closing date and the ultimate payments will be paid to or receivedfrom the seller. The agreement also guarantees a minimum amount of risk poolincentives for the 2005 calendar year. If actual amounts are less, we will receive $500,000 from the seller inaddition to any other amounts due. This amount will be recorded as a purchaseprice adjustment if and when received. The seller also provides customary indemnification of up to $1.5 millionfor eligible non-medical and non-tax claims submitted within a two year period.The indemnification limit is reduced ratably over the 24 months.  In conjunction with the acquisition, we haveentered into an employment agreement with the sole selling shareholder ofGenesis and 2 of its employees.

 

9

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The following pro formainformation for the three and six months ended March 31, 2005 and 2006 giveseffect to the Genesis acquisition as if it had occurred on October 1,2004. Such unaudited pro forma information is based on historical financialinformation with respect to the acquisition and does not include operational orother changes that might have been effected by the Company.

 
| ** **                 | ** ** | **Three months ended   March 31,** | ** ** | **Six months ended   March 31,** | ** ** |
|----------------------------|------------|------------------------------------|------------|----------------------------------|------------|
| ** **                 | ** ** | **2006**                           | ** ** | **2005**                         | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net revenue                |       | $                                  | 34,572,146 |                             | $          | 34,587,843 |   | $ | 68,926,358 |   | $ | 70,125,901 |   |
| Net income                 |       | $                                  | 1,229,223  |                             | $          | 1,058,398 |   | $ | 2,368,981 |   | $ | 2,037,578 |   |
| Basic earnings per share   |       | $                                  | 0.18       |                             | $          | 0.23 |   | $ | 0.35 |   | $ | 0.46 |   |
| Diluted earnings per share |       | $                                  | 0.15       |                             | $          | 0.12 |   | $ | 0.30 |   | $ | 0.23 |   |

 

**8.Investment in Brotman Medical Center, Inc (Hospital)**

** **

EffectiveAugust 31, 2005, the Company acquired an approximately 38% stake inBrotman Medical Center, Inc. for $1,000,000. The Company made theinvestment with the intention that it, with the Hospital, would be able tooffer joint contracting to HMOs operating in the area surrounding the Hospital.The Hospital, previously owned by Tenet HealthCare, had been incurringsignificant operating deficits. The new investors in the Hospital, includingProspect, hoped to help turn around the Hospital operations and restoreprofitability.

 

DuringSeptember 2005, the first month of operation under new ownership, theHospital experienced a net loss of approximately $1,100,000, of whichProspect’s portion totaled approximately $400,000. The Hospital has continuedto incur significant losses after September 30, 2005, and, with itslimited capital, may not ultimately be able to survive.

 

We are not obligated,nor do we have any current intention, to invest any additional monies in theHospital.

 

As of September 30, 2005,based on the Hospital’s current significant operating deficits, uncertainability to increase revenues and cut costs and limited capital, we concludedthat our remaining investment in Brotman Medical Center was impaired and wroteoff our entire investment in the Hospital.

 

10

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

 

**Forward-Looking Statements**

 

The following discussion of our financial conditionand results of operations should be read in conjunction with the accompanyingunaudited condensed consolidated financial statements and the notes to thosestatements appearing elsewhere in this report and the audited financialstatements for the year ended September 30, 2005 appearing in our annual reporton Form 10-K filed with the Securities and Exchange Commission.

 

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

 

Forward-looking statements involve known and unknownrisks and uncertainties that may cause our actual results in future periods todiffer materially from those projected or contemplated in the forward-lookingstatements as a result of, but not limited to, the following factors:

 

•                  Decreases in the number of HMO enrollees usingour provider networks reduce our profitability and inhibit future growth.

 

•                  Our working capital deficit could adverselyaffect our ability to satisfy our obligations as they come due.

 

•                  If the value of our goodwill and intangibleassets with indefinite useful lives becomes impaired, the impaired portion willhave to be written off, which could materially reduce the value of our assetsand reduce our net income for the year in which the write-off occurs.

 

•                  We may not be able to make any additionalsignificant acquisitions without first obtaining additional financing andobtaining the consent of our commercial lender.

 

•                  If we are not able to comply with thefinancial covenants and other conditions required by our loan agreement with ourcommercial lender, our lender could require full repayment of the loan, whichwould negatively impact our liquidity and preclude us from making furtheracquisitions.

 

•                  Substantially all of our revenues aregenerated from contracts with a limited number of HMOs, and if our affiliatedphysician organizations were to lose HMO contracts or to renew HMO contracts onless favorable terms, our revenues and profitability could be significantlyreduced.

 

•                  Our profitability may be reduced oreliminated if we are not able to manage health care costs of our affiliatedphysician organizations effectively.

 

•                  Our operating results could be adverselyaffected if our actual health care claims exceed our reserves.

 

•                  We may be exposed to liability or fail toestimate IBNR claims accurately if we cannot process our increased volume ofclaims accurately and timely.

 

•                  Medicareand private third-party payer cost containment efforts and reductions inreimbursement rates could reduce our revenue and our cash flow.

 

11

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•                  Risk-sharing arrangements that our affiliatedphysician organizations have with HMOs and hospitals could result in theircosts exceeding the corresponding revenues, which could reduce or eliminate anyshared risk profitability.

 

•                  If we do not successfully integrate theoperations of acquired physician organizations into our service network, ourcosts could increase, our business could be disrupted, and we may not be ableto realize the anticipated benefits from those acquisitions.

 

•                  When we acquire operations that havehistorically operated at a loss, we may not be able to reverse those losses andoperate those businesses at a profit, which could reduce our earnings.

 

•                  If we are unable to identify suitable acquisitioncandidates or to negotiate or complete acquisitions on favorable terms, ourprospects for growth could be limited.

 

•                  Any acquisitions we complete in the futurecould potentially dilute the equity interests of our current stockholders orcould increase our indebtedness and cost of debt service, thereby reducing ournet income and profitability.

 

•                  We operate in a competitive market; increasedcompetition could adversely affect our revenues.

 

•                  Failure to comply with federal and stateregulations could result in substantial penalties and changes in businessoperations.

 

•                  Future reforms in health care legislation andregulation could reduce our revenues and profitability.

 

•                  Whenever weseek to acquire an IPA, an HMO that has a contract with that IPA couldpotentially refuse to consent to the transfer of its contract, and this coulddeter us from completing the acquisition or could deprive us of the enrolleesand revenues associated with that HMO contract if we chose to complete theacquisition without the HMO’s consent.

 

•                  Our profitability could be adversely affectedby any changes that would reduce payments to HMOs under government-sponsoredhealth care programs.

 

•                  Our revenues and profits could be diminishedif we lose the services of key physicians in our affiliated physicianorganizations.

 

•                  Because our business is currently limited tothe Southern California area, any reduction in our revenues and profitabilityfrom a local economic downturn would not be offset by operations in othergeographic areas.

 

•                  We are required to upgrade and modify ourmanagement information systems to accommodate growth in our business andchanges in technology and to satisfy new government regulations. As we seek toimplement these changes, we may experience complications, delays and increasingcosts, which could disrupt our business and reduce our profitability.

 

•                  If we were to lose the services ofDr. Terner or other key members of management, we might not be able toreplace them in a timely manner with qualified personnel, which could disruptour business and reduce our profitability and revenue growth.

 

•                  We and our affiliated physician organizationsmay become subject to claims of medical malpractice or HMO bad-faith liabilityclaims for which our insurance coverage may not be adequate. Such claims couldmaterially increase our costs and reduce our profitability.

 

•                  Fluctuations in our quarterly operatingresults may make it difficult to predict our future results of operations,which could decrease the market value of our common stock.

 

•                  The NASD has conducted an informal inquiryregarding trading in our common stock.

 

12

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•                  If we are not able to develop or sustain anactive trading market for our common stock, it may be difficult forstockholders to dispose of their common stock.

 

•                  Even if an active market develops for ourcommon stock, the market price of our stock is likely to be volatile.

 

•                  If our common stock becomes subject to theSEC’s penny stock rules, our stockholders may find it difficult to sell theirstock.

 

Investors should also refer to our Form 10-K annual reportfiled with the Securities and Exchange on December 27, 2005 for a discussion ofrisk factors. Given these risks and uncertainties, we can give no assurancesthat any forward-looking statements will in fact occur and therefore cautioninvestors not to place undue reliance on them.

 

**Overview**

 

Prospect Medical Holdings, Inc. (we, orthe “Company”) is a health care management services organization. We providemanagement services to affiliated physician organizations that operate asindependent physician associations (“IPAs”) or medical clinics. Our affiliatedphysician organizations enter into agreements with health maintenanceorganizations (“HMOs”) to provide enrollees of the HMOs with a full range ofmedical services in exchange for fixed, prepaid monthly fees known as “capitation”payments.

 

The IPAs contract with physicians (primarycare and specialist) and other health care providers to provide all of theirmedical services. The medical clinics employ their primary care physicians,which provide the vast majority of their medical services, while contractingwith specialist physicians and other health care providers to provide otherrequired medical services.

 

Through our management subsidiaries –Prospect Medical Systems and Sierra Medical Management – we have entered intolong-term agreements to provide management services to each of our affiliatedphysician organizations in exchange for a management fee. The managementservices 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.

 

Our management subsidiaries currently providemanagement services to thirteen affiliated physician organizations, whichinclude Prospect Medical Group, eleven other affiliated physician organizationsthat Prospect Medical Group owns or controls, and one affiliated physicianorganization (AMVI/Prospect Health Network) that is an unconsolidated jointventure in which Prospect Medical Group owns a 50% interest. We have utilizedProspect Medical Group, which was our first affiliated physician organization,to acquire 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 thirteen affiliated physician organizationsprovide medical services to a combined total of approximately 178,800 HMOenrollees at  March 31, 2006, including 7,400AMVI Prospect Health Network enrollees that we manage for the economic benefitof our partner in this joint venture, and for which we earn management feeincome.

 

Currently, our affiliated physicianorganizations have contracts with approximately twelve HMOs, from which ourrevenue is primarily derived. HMOs offer a comprehensive health care benefitspackage in exchange for a capitation fee per enrollee that does not varythrough the contract period regardless of the quantity of medical servicesrequired or used. HMOs enroll members by entering into contracts with employergroups or directly with individuals to provide a broad range of health careservices for a prepaid charge, with minimal deductibles or co-payments requiredof the members. All of the contracts between our affiliated physicianorganizations and the HMOs provide for the provision of medical services by theaffiliated physician organization to the HMO enrollees in consideration for theprepayment of the fixed monthly capitation fee per enrollee paid by the HMOs.

 

Our consolidated business has grown throughthe acquisition of IPAs by Prospect Medical Group. Our plan is for ProspectMedical Group to continue to acquire additional IPAs. We do not intend tofurther acquire any individual or small medical practices, clinics or medicalgroup practices.

 

13

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

 

Operating revenue consists primarily of fees for medical services providedby our affiliated physician organizations under capitated contracts withvarious HMOs or under fee-for-service arrangements. Capitation revenue underHMO contracts is prepaid monthly to the affiliates based on the number ofenrollees electing any one of the affiliates as their health care provider.Management fees primarily comprise amounts earned from managing the operationsof AMVI, Inc., which is our joint venture partner in the AMVI/Prospect HealthNetwork joint venture. Management services have historically related only toMediCal members. However, starting in fiscal 2006, our services were expandedto also include management services related to Medicare members enrolling inCalOPTIMA’s OneCare HMO; as well as management services provided to BrotmanMedical Center.

 

Revenues are comprised of the followingamounts:

 
| ** **      | ** ** | **Three months ended  March 31,** | ** ** | **%**** of Increase** | ** ** | **Six months ended  March 31,** | ** ** | **%**** of Increase** | ** ** |
|-----------------|------------|--------------------------------------------------|------------|---------------------------------|------------|------------------------------------------------|------------|---------------------------------|------------|
| ** **      | ** ** | **2006**                                         | ** ** | **2005**                        | ** ** | **(Decrease)**                                 | ** ** | **2006**                        | ** ** | **2005** | ** ** | **(Decrease)** | ** ** |
| Capitation      |       | $                                                | 33,653,872 |                            | $          | 31,411,215                                     |       | 7                               | %          | $ | 66,271,978 |   | $ | 63,929,977 |   | 4 | % |
| Fee for service |       | 558,015                                          |       | 563,323                         |       | -1                                             | %          | 1,123,765                       |       | 1,063,604 |   | 6 | % |
| Management fees |       | 356,700                                          |       | 214,171                         |       | 67                                             | %          | 631,767                         |       | 426,934 |   | 48 | % |
| Other           |       | 3,559                                            |       | 141,913                         |       | -97                                            | %          | 9,395                           |       | 190,943 |   | -95 | % |
|            |       |                                             |       |                            |       |                                           |       |                            |       |   |   |   |   |
| Total           |       | $                                                | 34,572,146 |                            | $          | 32,330,622                                     |       | 7                               | %          | $ | 68,036,905 |   | $ | 65,611,458 |   | 4 | % |

 

Net membership growth has been the primary reasonfor our increasing revenues. We have increased our membership throughacquisitions. These increases through acquisition are offset by HMO enrollmentdeclines at our affiliated physician organizations, which declines areconsistent with, though greater than, general HMO enrollment trends inCalifornia in recent years. The following table sets forth the approximatenumber of members, by category, as of the dates indicated.

 
| **Member Category** | ** ** | **As of  March 31,  2006** | ** ** | **As of****March 31****,  2005** | ** ** |
|--------------------------|------------|---------------------------------|------------|--------------------------------------------|------------|
| Commercial               |       | 147,300                         |       | 154,000                                    |       |
| Senior – owned      |       | 15,100                          |       | 13,600                                     |       |
| Senior - managed         |       | 300                             |       | —                                     |       |
| MediCal – owned     |       | 9,000                           |       | 7,100                                      |       |
| MediCal – managed   |       | 7,100                           |       | 7,300                                      |       |
|                     |       |                            |       |                                       |       |
| Total                    |       | 178,800                         |       | 182,000                                    |       |

 

The following table details total paid membermonths, by member category, for the three-month and six-month periods endedMarch 31, 2006 and 2005:

 
| ** **         | ** ** | **Three months ended  March 31,** | ** ** | **%**** of Increase** | ** ** | **Six months ended  March 31,** | ** ** | **%**** of Increase** | ** ** |
|--------------------|------------|--------------------------------------------------|------------|---------------------------------|------------|------------------------------------------------|------------|---------------------------------|------------|
| ** **         | ** ** | **2006**                                         | ** ** | **2005**                        | ** ** | **(Decrease)**                                 | ** ** | **2006**                        | ** ** | **2005** | ** ** | **(Decrease)** | ** ** |
| Commercial         |       | 442,000                                          |       | 465,000                         |       | -5                                             | %          | 894,000                         |       | 953,000 |   | -6 | % |
| Senior -  owned    |       | 48,700                                           |       | 42,000                          |       | 15                                             | %          | 87,800                          |       | 86,000 |   | 2 | % |
| Senior -  managed  |       | 1,500                                            |       | —                          |       | 100                                            | %          | 1,500                           |       | — |   | 100 | % |
| MediCal -  owned   |       | 25,600                                           |       | 21,000                          |       | 22                                             | %          | 47,200                          |       | 43,000 |   | 10 | % |
| MediCal -  managed |       | 21,500                                           |       | 22,000                          |       | -2                                             | %          | 43,400                          |       | 44,000 |   | -1 | % |
|               |       |                                             |       |                            |       |                                           |       |                            |       |   |   |   |   |
| Total              |       | 539,300                                          |       | 550,000                         |       | -2                                             | %          | 1,073,900                       |       | 1,126,000 |   | -5 | % |

 

14

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

 

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

 

Capitation payments are fixed in advance of periodscovered and are not subject to significant accounting estimates. These paymentsare expensed in the period the providers are obligated to provide services.Fee-for-service payments are expensed in the period services are provided toour members. Medical care costs include actual historical claims experience andestimates of medical expenses incurred but not reported, or IBNR. Monthly, weestimate our IBNR based on a number of factors, including prior claimsexperience. As part of this review, we also consider estimates of amounts tocover uncertainties related to fluctuations in provider billing patterns,claims payment patterns, membership and medical cost trends. These estimatesare adjusted monthly as more information becomes available. In addition to ourown IBNR estimation process, we obtain biannual certifications of our IBNRliability from independent actuaries. We believe that our process forestimating IBNR is adequate, but there can be no assurance that medical carecosts will not exceed such estimates.

 

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

 

15

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**Results of Operations**

 

The following table sets forth selectedrevenue categories, cost of revenue categories and other income statement itemsfor the three and six month periods ended March 31, 2006 and 2005:

 
| ** **                                       | ** ** | **Three months ended  March 31,** | ** ** | **%**** of Increase** | ** ** | **Six months ended  March 31,** | ** ** | **%**** of Increase** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------|------------|---------------------------------|------------|------------------------------------------------|------------|---------------------------------|------------|
| ** **                                       | ** ** | **2006**                                         | ** ** | **2005**                        | ** ** | **(Decrease)**                                 | ** ** | **2006**                        | ** ** | **2005** | ** ** | **(Decrease)** | ** ** |
| Revenues:                                        |       |                                             |       |                            |       |                                           |       |                            |       |   |   |   |   |
| Capitation                                       |       | $                                                | 33,653,872 |                            | $          | 31,411,215                                     |       | 7.1                             | %          | $ | 66,271,978 |   | $ | 63,929,977 |   | 3.7 | % |
| Fee for service                                  |       | 558,015                                          |       | 563,323                         |       | -0.9                                           | %          | 1,123,765                       |       | 1,063,604 |   | 5.7 | % |
| Management fees                                  |       | 356,700                                          |       | 214,171                         |       | 66.5                                           | %          | 631,767                         |       | 426,934 |   | 48.0 | % |
| Other revenues                                   |       | 3,559                                            |       | 141,913                         |       | -97.5                                          | %          | 9,395                           |       | 190,943 |   | -95.1 | % |
|                                             |       |                                             |       |                            |       |                                           |       |                            |       |   |   |   |   |
| Total revenues                                   |       | 34,572,146                                       |       |                            | 32,330,622 |                                           | 6.9        | %                               | 68,036,905 |   | 65,611,458 |   | 3.7 | % |
|                                             |       |                                             |       |                            |       |                                           |       |                            |       |   |   |   |   |
| Cost of revenues:                                |       |                                             |       |                            |       |                                           |       |                            |       |   |   |   |   |
| PCP capitation                                   |       | 5,864,165                                        |       | 5,954,027                       |       | -1.5                                           | %          | 11,768,475                      |       | 12,389,417 |   | -5.0 | % |
| Specialists capitation                           |       | 5,274,763                                        |       | 5,922,149                       |       | -10.9                                          | %          | 10,679,197                      |       | 11,772,722 |   | -9.3 | % |
| Claims expense                                   |       | 11,939,058                                       |       | 10,889,852                      |       | 9.6                                            | %          | 24,145,705                      |       | 22,984,261 |   | 5.1 | % |
| Physician salaries                               |       | 617,238                                          |       | 637,601                         |       | -3.2                                           | %          | 1,308,263                       |       | 1,072,842 |   | 21.9 | % |
| Other cost of revenues                           |       | 268,439                                          |       | 252,585                         |       | 6.3                                            | %          | 548,239                         |       | 237,584 |   | 130.8 | % |
|                                             |       |                                             |       |                            |       |                                           |       |                            |       |   |   |   |   |
| Total cost of revenues                           |       | 23,963,663                                       |       | 23,656,214                      |       | 1.3                                            | %          | 48,449,879                      |       | 48,456,826 |   | 0.0 | % |
|                                             |       |                                             |       |                            |       |                                           |       |                            |       |   |   |   |   |
| Gross margin                                     |       | 10,608,483                                       |       | 8,674,408                       |       | 22.3                                           | %          | 19,587,026                      |       | 17,154,632 |   | 14.2 | % |
|                                             |       |                                             |       |                            |       |                                           |       |                            |       |   |   |   |   |
| General and administrative expenses              |       | 8,461,134                                        |       | 6,550,266                       |       | 29.2                                           | %          | 15,592,208                      |       | 13,123,077 |   | 18.8 | % |
| Depreciation and amortization expense            |       | 335,573                                          |       | 263,680                         |       | 27.3                                           | %          | 657,589                         |       | 496,910 |   | 32.3 | % |
| Total operating expenses                         |       | 8,796,707                                        |       | 6,813,946                       |       | 29.1                                           | %          | 16,249,797                      |       | 13,619,987 |   | 19.3 | % |
|                                             |       |                                             |       |                            |       |                                           |       |                            |       |   |   |   |   |
| Income (loss) from unconsolidated joint  venture |       | 330,732                                          |       | (143,396                        | )          | -330.6                                         | %          | 676,893                         |       | 97,682 |   | 593.0 | % |
|                                             |       |                                             |       |                            |       |                                           |       |                            |       |   |   |   |   |
| Operating income                                 |       | 2,142,508                                        |       | 1,717,066                       |       | 24.8                                           | %          | 4,014,122                       |       | 3,632,327 |   | 10.5 | % |
|                                             |       |                                             |       |                            |       |                                           |       |                            |       |   |   |   |   |
| Other expense, net                               |       | 83,507                                           |       | 172,007                         |       | -51.5                                          | %          | 106,551                         |       | 272,028 |   | -60.8 | % |
|                                             |       |                                             |       |                            |       |                                           |       |                            |       |   |   |   |   |
| Income before income taxes                       |       | 2,059,001                                        |       | 1,545,059                       |       | 33.3                                           | %          | 3,907,571                       |       | 3,360,299 |   | 16.3 | % |
|                                             |       |                                             |       |                            |       |                                           |       |                            |       |   |   |   |   |
| Provision for income taxes                       |       | 825,392                                          |       | 618,650                         |       | 33.4                                           | %          | 1,569,575                       |       | 1,346,809 |   | 16.5 | % |
|                                             |       |                                             |       |                            |       |                                           |       |                            |       |   |   |   |   |
| Minority interest                                |       | 4,386                                            |       | 4,561                           |       | -3.8                                           | %          | 5,984                           |       | 4,945 |   | 21.0 | % |
|                                             |       |                                             |       |                            |       |                                           |       |                            |       |   |   |   |   |
| Net income                                       |       | $                                                | 1,229,223  |                            | $          | 921,848                                        |       | 33.3                            | %          | $ | 2,332,012 |   | $ | 2,008,545 |   | 16.1 | % |
|                                                  |            |                                                  |            |                                 |            |                                                |            |                                 |            |  |  |  |  |  |  |  |  |  |  |

 

16

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The following table sets forth selected operatingitems, expressed as a percentage of total revenue:

 
| ** **                                       | ** ** | **Three Months  Ended March 31,** | ** ** | **Six months  Ended March 31,** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                       | ** ** | **2006**                                         | ** ** | **2005**                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenues:                                        |       |                                             |       |                                           |       |   |   |   |   |
| Capitation revenue                               |       | 97.3                                             | %          | 97.2                                           | %          | 97.4 | % | 97.4 | % |
| Fee for service revenue                          |       | 1.6                                              | %          | 1.7                                            | %          | 1.7 | % | 1.6 | % |
| Management fees                                  |       | 1.0                                              | %          | 0.7                                            | %          | 0.9 | % | 0.7 | % |
| Other revenues                                   |       | 0.1                                              | %          | 0.4                                            | %          | 0.0 | % | 0.3 | % |
| Total revenues                                   |       | 100.0                                            | %          | 100.0                                          | %          | 100.0 | % | 100.0 | % |
|                                             |       |                                             |       |                                           |       |   |   |   |   |
| Cost of revenues:                                |       |                                             |       |                                           |       |   |   |   |   |
| PCP capitation                                   |       | 16.9                                             | %          | 18.4                                           | %          | 17.3 | % | 18.9 | % |
| Specialists capitation                           |       | 15.3                                             | %          | 18.3                                           | %          | 15.7 | % | 18.0 | % |
| Claims expense                                   |       | 34.5                                             | %          | 33.7                                           | %          | 35.5 | % | 35.0 | % |
| Physician salaries                               |       | 1.8                                              | %          | 2.0                                            | %          | 1.9 | % | 1.6 | % |
| Other cost of revenues                           |       | 0.8                                              | %          | 0.8                                            | %          | 0.8 | % | 0.4 | % |
| Total cost of revenues                           |       | 69.3                                             | %          | 73.2                                           | %          | 71.2 | % | 73.9 | % |
|                                             |       |                                             |       |                                           |       |   |   |   |   |
| Gross margin                                     |       | 30.7                                             | %          | 26.8                                           | %          | 28.8 | % | 26.1 | % |
|                                             |       |                                             |       |                                           |       |   |   |   |   |
| General and administrative expenses              |       | 24.5                                             | %          | 20.3                                           | %          | 22.9 | % | 20.0 | % |
| Depreciation and amortization expense            |       | 1.0                                              | %          | 0.8                                            | %          | 1.0 | % | 0.8 | % |
| Total operating expenses                         |       | 25.5                                             | %          | 21.1                                           | %          | 23.9 | % | 20.8 | % |
|                                             |       |                                             |       |                                           |       |   |   |   |   |
| Income (loss) from unconsolidated joint  venture |       | 1.0                                              | %          | (0.4                                           | )%         | 1.0 | % | 0.2 | % |
|                                             |       |                                             |       |                                           |       |   |   |   |   |
| Operating income                                 |       | 6.2                                              | %          | 5.3                                            | %          | 5.9 | % | 5.5 | % |
|                                             |       |                                             |       |                                           |       |   |   |   |   |
| Other expense, net                               |       | 0.2                                              | %          | 0.5                                            | %          | 0.2 | % | 0.4 | % |
|                                             |       |                                             |       |                                           |       |   |   |   |   |
| Income before income taxes                       |       | 6.0                                              | %          | 4.8                                            | %          | 5.7 | % | 5.1 | % |
|                                             |       |                                             |       |                                           |       |   |   |   |   |
| Provision for income taxes                       |       | 2.4                                              | %          | 1.9                                            | %          | 2.3 | % | 2.0 | % |
|                                             |       |                                             |       |                                           |       |   |   |   |   |
| Minority interest                                |       | 0.0                                              | %          | 0.0                                            | %          | 0.0 | % | 0.0 | % |
|                                             |       |                                             |       |                                           |       |   |   |   |   |
| Net income                                       |       | 3.6                                              | %          | 2.9                                            | %          | 3.4 | % | 3.1 | % |

 

**Three Months Ended March 31, 2006 Compared to ThreeMonths Ended March 31, 2005**

 

*Capitation Revenue*

 

Capitationrevenue for the three months ended March 31, 2006 was $33,653,872 representingan increase of 7.1% over capitation revenue for the three months ended March31, 2005, of $31,411,215.

 

Theincrease is comprised of three main factors. We estimate that higher capitationrates on our core business, exclusive of acquisitions, contributedapproximately $3,600,000 in increased capitation revenue during the 2006 periodas compared to the 2005 period. We estimate that enrollment declines reducedcapitation revenue by approximately $4,200,000 during the 2006 period, ascompared to the 2005 period. The acquisition of Genesis increased capitationrevenue by approximately $2,900,000 for the 2006 period.

 

17

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*Fee for Service Revenue*

 

Feefor service revenue for the three months ended March 31, 2006 was $558,015,representing a decrease of $5,308 (0.9%) from fee for service revenue for thethree months ended March 31, 2005 of $563,323.

 

Thedecrease in fee for service revenue during the 2006 quarter was primarily theresult of normal business fluctuations.

 

*Management Fee Revenue*

 

Managementfee revenue for the three months ended March 31, 2006 was $356,700,representing an increase of 66.5% over management fee revenue for the threemonths ended March 31, 2005 of $214,171.

 

Theincrease in management fee revenue during the 2006 quarter was primarily theresult of new management contracts related to OneCare and Brotman MedicalCenter. OneCare is a new managed care offering for the approximately 50,000individuals who qualify for both Medicare and Medi-Cal benefits in OrangeCounty, California.  Prospect’s jointventure, AMVI/Prospect Medical Group,, from which we earn management fees,began accepting OneCare enrollees during fiscal 2006.

 

*Other Revenue*

 

Otherrevenue for the three months ended March 31, 2006 was $3,559, representing adecrease of $138,354 (97.5%) from other revenue for the three months endedMarch 31, 2005 of $141,913.

 

Thedecrease in other revenue during the 2006 quarter was primarily the result oftiming of the Pay-for-Performance incentives received from our contractedHealth Plans.

 

*PCP Capitation Expense*

 

PrimaryCare Physician (“PCP”) capitation expense for the three months ended March 31,2006 was $5,864,165, representing a decrease of $89,862 (1.5%) from PCPcapitation expense for the three months ended March 31, 2005 of $5,954,027.

 

We estimate that net membership growth from the November 1, 2005 acquisitioncontributed approximately $660,000 in increased PCP capitation expense duringthe 2006 period, as compared to the 2005 period. We estimate that highercapitation rates on our core business, exclusive of acquisitions, increased PCPcapitation expense by approximately $60,000 during the 2006 period as comparedto the 2005 period. We estimate that enrollment declines related to our corebusiness, exclusive of the acquisitions, reduced PCP capitation expense byapproximately $810,000 during the 2006 period, as compared to the 2005 period.

 

*Specialist Capitation Expense*

 

Specialistcapitation expense for the three months ended March 31, 2006 was $5,274,763,representing a decrease of $647,386 (10.9%) from specialist capitation expensefor the three months ended March 31, 2005 of $5,922,149.

 

We estimate that net membership growthfrom the November 1, 2005 acquisitions contributed approximately $270,000 inincreased specialist capitation expense during the 2006 period, as compared tothe 2005 period. We estimate that higher capitation rates on our core business,exclusive of acquisitions, increased specialist capitation expense byapproximately $130,000 during the 2006 period as compared to the 2005 period.We estimate that enrollment declines related to our core business, exclusive ofthe acquisitions, reduced specialist capitation expense by approximately$780,000 during the 2006 period, as compared to the 2005 period.

 

*Claims Expense*

 

Claimsexpense for the three months ended March 31, 2006 was $11,939,058, representingan increase of $1,049,206, or 9.6%, over claims expense for the three monthsended March 31, 2005 of $10,889,852.

 

We estimate that net membership growth fromacquisitions contributed approximately $1,320,000 in increased claims expenseduring the 2006 period, as compared to the 2005 period. We estimate that higherclaims per member rates on our core business, exclusive of acquisitions,increased claims expense by approximately $1,380,000 during the 2006 period as

 

18

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compared to the 2005 period. Weestimate that enrollment declines related to our core business, exclusive ofacquisitions, reduced claims expense by approximately $1,650,000 during the2006 period, as compared to the 2005 period.

 

*Physician Salaries Expense*

 

Physiciansalaries expense for the three months ended March 31, 2006 was $617,238,representing a decrease of $20,363 (3.2%) over physician salaries expense forthe three months ended March 31, 2005, of $637,601.

 

Thedecrease in physician salaries expense during the 2006 quarter was primarilythe result of a workers compensation premium refund compared to the 2005quarter.

 

*Other Cost of Revenues*

 

Othercost of revenue for the three months ended March 31, 2006 was $268,439,representing an increase of $15,854 (6.3%) over other cost of revenue for thethree months ended March 31, 2005, of $252,585.

 

Theincrease in other cost of revenue during the 2006 quarter was primarily theresult of an increase in the level of certain pharmacy and injectibles costs.

 

*Gross Margin*

 

Medicalcare costs as a percentage of medical revenues (the medical care ratio) largelydetermines our gross margin. Our gross margin increased by 3.9%, to 30.7% inthe 2006 quarter, from 26.8% in the 2005 quarter.

 

Theincrease in our gross margin percentage between the 2005 and 2006 periods wasthe result of the decrease in PCP capitation, specialist capitation and otherphysician compensation as a percent of revenue by 1.5%, 3.1% and 0.2%,respectively compared to the same quarter in 2005. This was offset by anincrease in the claims expense of 0.9% as a percent of revenue. During the 2006period, the Company had a higher number and proportion of more profitableMedicare members than in the 2005 period. The Company was also receiving morerevenue per Medicare member in the 2006 period as a result of Medicare’s phasein of its Risk-Adjusted payment methodology.

 

*General and Administrative Expenses*

 

Generaland administrative expenses were $8,461,134 for the 2006 quarter, representing24.5% of total revenues, as compared with $6,550,266, or 20.3% of totalrevenues, for the 2005 quarter.

 

Theincrease in general and administrative expenses during the 2006 quarter wasprimarily the result of adding Genesis, information technology developmentprojects related to new revenue initiatives including participation in theOneCare Program, and Sarbanes-Oxley implementation costs.

 

*Depreciation and Amortization*

 

Depreciationand amortization expense for the three months ended March 31, 2006 increased to$335,573 from $263,680 for the same period of the prior year. The increase wasprimarily due to additional amortization of identifiable intangible assets,including those related to the Genesis acquisition, as well as depreciationexpense associated with increased capital expenditures.

 

*Income (Loss) From Unconsolidated Joint Venture*

 

Theincrease in income from unconsolidated joint venture during the 2006 periodresults from the fiscal year 2006 participation in the OneCare program, wherebysome of the Medicare beneficiaries joining CalOPTIMA’s OneCare program wereassigned to the AMVI/Prospect Medical Group.

 

19

----

 

*Other Expense, Net*

 

Otherexpense, net for the three months ended March 31, 2006 decreased to $83,507from $172,007 for the same period of the prior year. The decrease during the2006 period was primarily due to increased investment income, partially offsetby additional interest expense on the $4 million GMAC Residential FundingCorporation credit facility entered into on November 1, 2005 in connection withthe Genesis acquisition.

 

*Provision for Income Taxes*

 

Incometax expense increased approximately 33.4% or $206,742 to $825,392 for the 2006quarter, from $618,650 in the 2005 quarter. The increase in income tax expensewas principally due to a $513,942 or 33.3% increase in pretax income. Theeffective income tax rate remained consistent between the 2005 and 2006periods.

 

**Six months Ended March 31, 2006 Compared to Six monthsEnded March 31, 2005**

 

*Capitation Revenue*

 

Capitationrevenue for the six months ended March 31, 2006 was $66,271,978, representingan increase of $2,342,001 (3.7%) over capitation revenue for the six monthsended March 31, 2005, of $63,929,977.

 

Theincrease is comprised of three main factors. We estimate that net membershipgrowth from the acquisitions and higher capitation rates on our core business,exclusive of acquisitions, contributed approximately $4,700,000 and $6,400,000in increased capitation revenue, respectively, during the 2006 period ascompared to the 2005 period. We estimate that enrollment declines related toour core business, exclusive of the acquisitions, reduced capitation revenue byapproximately $8,700,000 during the 2006 period, as compared to the 2005period.

 

*Fee for Service Revenue*

 

Feefor service revenue for the six months ended March 31, 2006 was $1,123,765representing an increase of $60,161 (5.7%) over fee for service revenue for thesix months ended March 31, 2005, of $1,063,604.

 

Theincrease in fee for service revenue during the 2006 period was primarily due tofluctuations in collection and bad debt ratios between the periods.

 

*Management Fee Revenue*

 

Managementfee revenue for the six months ended March 31, 2006 was $631,767, representingan increase of $204,833 (48.0%) over management fee revenue for the six monthsended March 31, 2005, of $426,934.

 

Theincrease in management fee revenue during the 2006 period was primarily theresult of new management contracts related to OneCare and Brotman Medical Care.

 

*Other Revenue*

 

Otherrevenue for the six months ended March 31, 2006 was $9,395, representing adecrease of $181,548 (95.1%) over other revenue for the six months ended March31, 2005, of $190,943.

 

Thedecrease in other revenue during the 2006 period was primarily the result oftiming of Pay-for-Performance incentives from our contracted Health Plans.

 

*PCP Capitation Expense*

 

PrimaryCare Physician (PCP) Capitation expense for the six months ended March 31, 2006was $11,768,475, representing a decrease of $620,942 (5.0%) over PCP capitationexpense for the six months ended March 31, 2005, of $12,389,417.

 

20

----

 

Weestimate that net membership growth from the November 1, 2005 acquisitioncontributed approximately $1,100,000 in increased PCP capitation expense duringthe 2006 period, as compared to the 2005 period. We estimate that lowercapitation rates on our core business, exclusive of acquisitions, reduced PCPcapitation expense by approximately $50,000 during the 2006 period as comparedto the 2005 period. We estimate that enrollment declines related to our corebusiness, exclusive of the acquisitions, reduced PCP capitation expense by approximately$1,670,000 during the 2006 period, as compared to the 2005 period.

 

*Specialist Capitation Expense*

 

SpecialistCapitation expense for the six months ended March 31, 2006 was $10,679,197,representing a decrease of $1,093,525 (9.3%) over specialist capitation expensefor the six months ended March 31, 2005, of $11,772,722.

 

Weestimate that net membership growth from the November 1, 2005 acquisitionscontributed approximately $470,000 in increased specialist capitation expenseduring the 2006 period, as compared to the 2005 period. We estimate that highercapitation rates on our core business, exclusive of acquisitions, increasedspecialist capitation expense by approximately $40,000 during the 2006 periodas compared to the 2005 period. We estimate that enrollment declines related toour core business, exclusive of the acquisitions, reduced specialist capitationexpense by approximately $1,590,000 during the 2006 period, as compared to the2005 period.

 

*Claims Expense*

 

Claimsexpense for the six months ended March 31, 2006 was $24,145,705, representingan increase of $1,161,444 (5.1%) over claims expense for the six months endedMarch 31, 2005, of $22,984,261.

 

Weestimate that net membership growth from acquisitions contributed approximately$2,100,000 in increased claims expense during the 2006 period, as compared tothe 2005 period. We estimate that higher claims per member rates on our corebusiness, exclusive of acquisitions, increased claims expense by approximately$2,400,000 during the 2006 period as compared to the 2005 period. We estimatethat enrollment declines related to our core business, exclusive of theacquisitions, reduced claims expense by approximately $3,300,000 during the2006 period, as compared to the 2005 period.

 

*Physician Salaries Expense*

 

Physiciansalaries expense for the six months ended March 31, 2006 was $1,308,263,representing an increase of $235,421 (21.9%) over physician salaries expensefor the six months ended March 31, 2005, of $1,072,842.

 

The increase in physician salaries expense during the 2006 period wasprimarily the result of higher bonus accruals than in the 2005 period.

 

*Other Cost of Revenue*

 

Othercost of revenue for the six months ended March 31, 2006 was $548,239,representing an increase of $310,655 (130.8%) over other cost of revenue forthe six months ended March 31, 2005, of $237,584.

 

Theincrease in other cost of revenue during the 2006 period was primarily theresult of an increase in the level of certain pharmacy and injectibles beingpaid as contracted. Also, in the 2005 quarter there was a stop-loss recoverythat offset costs in that quarter.

 

*Gross Margin*

 

Medicalcare costs as a percentage of medical revenues (the medical care ratio) largelydetermines our gross margin. Our gross margin increased 2.7%, to 28.8% for thesix months ended March 31, 2006, from 26.1% for the six months ended March 31,2005.

 

21

----

 

Theincrease in our gross margin percentage between the 2005 and 2006 periods wasthe result of the decrease in PCP and specialist capitation as a percent ofrevenue by 1.6% and 2.3%, respectively compared to the same period in 2005. Thiswas offset by an increase in claims expense and other costs of 0.5% and 0.7% asa percent of revenue. During the 2006 period, the Company had a higher numberand proportion of more profitable Medicare members than in the 2005 period. TheCompany was also receiving more revenue per Medicare member in the 2006 periodas a result of Medicare’s phase in of its Risk-Adjusted payment methodology.

 

*General and Administrative Expenses*

 

Generaland administrative expenses were $15,592,208 for the 2006 period, representing22.9% of total revenues, as compared with $13,123,077, or 20.0% of totalrevenues, for the 2005 period.

 

Theincrease in general and administrative expenses during the 2006 quarter wasprimarily the result of adding Genesis, information technology developmentprojects related to new revenue initiatives including participation in theOneCare Program, and Sarbanes-Oxley implementation costs.

 

*Depreciation and Amortization*

 

Depreciationand amortization expense for the six months ended March 31, 2006 increased to$657,589 from $496,910 for the same period of the prior year. The increase of$160,679 was primarily due to additional amortization of identifiableintangible assets, including those related to the Genesis acquisition, as wellas additional depreciation expense for increased capital expenditures.

 

*Income (Loss) from Unconsolidated Joint Venture*

 

Theincrease in income from unconsolidated joint venture during the 2006 periodresults from the fiscal year 2006 participation in the OneCare program, wherebysome of the Medicare beneficiaries joining CalOPTIMA’s OneCare program wereassigned to the AMVI/Prospect Medical Group.

 

*Other Expense, Net*

 

Otherexpense, net for the six months ended March 31, 2006 decreased to $106,551 from$272,028 for the same period of the prior year. The decrease in net interestexpense during the 2006 period was primarily due to increased investmentincome, partially offset by additional interest expense on the $4 million GMACResidential Funding Corporation credit facility entered into November 1, 2005.

 

*Provision for Income Taxes*

 

Incometax expense increased approximately 16.5%, or $222,766, to $1,569,575 for the2006 period, from $1,346,809 in the 2005 period. The increase in income taxexpense was principally due to a 16.3% increase in pretax income. The effectiveincome tax rate remained consistent between the 2005 and 2006 periods.

 

**Liquidity and Capital Resources**

 

Wegenerate cash from capitation revenue, healthcare services provided on afee-for-service basis at our clinics, management fee revenue and investmentincome. Our primary uses of cash include the payment of expenses related tomedical care services and G&A expenses. We generally receive capitationrevenue in advance of payment of capitation expenses and claims for relatedhealth care services.

 

Ourinvestment policies are designed to preserve principal, maintain liquidity foroperations and statutory requirements,  and maximize investment return. As of March 31, 2006, we invested asubstantial portion of our cash in a portfolio that included Federal Home Loanbonds with an average maturity of approximately 60 days, and overnight and highyield money market funds. All of these amounts are classified as current assetsand included in cash and cash equivalents in the accompanying balance sheets.We are also required by some of our HMO contracts to set aside certain amountsin restricted

 

22

----

 

certificates of deposit. Theserestricted certificates of deposit, with an average maturity of approximately75 days as of March 31, 2006, are included in Investments in the accompanying financialstatements.

 

Netcash used in operations was $306,785 for the six months ended March 31, 2006and $2,105,237 for the six months ended March 31, 2005. The decrease in netcash used in operations for the six months ended March 31, 2006 when comparedto the six months ended March 31, 2005 was due to the following factors:

 

•                  increased net income ($323,467 higher in  2006);

 

•                  increased depreciation and amortizationexpense ($160,679 higher in 2006);

 

•                  changes in net deferred taxes, a source of $387,401in the six months ended March 31, 2006 compared to a source of $257,862 in thesix months ended March 31, 2005;

 

•                  changes in risk pool receivable balances, ause of $392,733 in the six months ended March 31, 2006 compared to a use of$137,608 in the six months ended March 31, 2005;

 

•                  changes in accounts receivable balances, asource of $959,383 in the six months ended March 31, 2006 compared to a use of$93,859 in the six months ended March 31, 2005;

 

•                  changes in prepaid expenses and other, a useof $86,136 in the six months ended March 31, 2006 compared to a use of $679,906in the six months ended March 31, 2005;

 

•                  changes in income tax receivable, a use of $2,868,865for the six months ended March 31, 2006 compared to a use of $1,089,046 for thesix months ended March 31, 2005;

 

•                  changes in medical claims liabilities, whichwere a use of $835,191 in the six months ended March 31, 2006 compared to asource of $69,017 in the six months ended March 31, 2005;

 

•                  changes in accounts payable, which were a useof $618,724 in the six months ended March 31, 2006 compared to a use of$2,873,452 in the six months ended March 31, 2005.

 

Netcash used in investing activities was $6,529,719 for the six months ended March31, 2006 and $572,812 for the six months ended March 31, 2005.  The increase in net cash used in investingactivities was due to the following factors:

 

•                  changes in cash paid for acquisition, net ofcash received, a use of $6,596,080 for the six months ended March 31, 2006compared to none the for the six months ended March 31, 2005;

 

•                  payments on our notes receivable from sale ofthe Gateway clinics, a source of $17,429 for the six months ended March 31,2006 compared to a source of $220,051 for the six months ended March 31, 2005;

 

•                  changes in restricted certificates ofdeposit, a source of $294,364 in the six months ended March 31, 2006 comparedto a use of $638,115 in the six months ended March 31, 2005;

 

•                  Net cash provided by financing activities was$5,921,076 for the six months ended March 31, 2006 and cash used in financingactivities was $6,043,551 for the six months ended March 31, 2005.  The increase in net cash provided byfinancing activities was due to the following factors:

 

•                  proceeds from issuance of notes payable and adraw on the credit line, a source of $6,000,000 in the six months ended March31, 2006 compared to a use of $5,000,000 in the six months ended  March 31, 2005;

 

23

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•                  repayments of notes payable and capitalleases, a use of $1,266,667 in the six months ended March 31, 2006 compared toa use of $841,888 in the six months ended March 31, 2005.

 

AtMarch 31, 2006, we had negative working capital of $2,983,568 as compared tonegative working capital of $681,961 at September 30, 2005. The change resultedprimarily from our using $4,000,000 of cash to fund the Genesis acquisition. AtMarch 31, 2006 and September 30, 2005, cash and cash equivalents were$16,033,876 and $16,949,304 respectively.

 

Oursubsidiaries are required to maintain minimum capital prescribed by variousHMOs with whom we contract. As of  March31, 2006, all of our subsidiaries were in compliance with the minimum capitalrequirements. Barring any change in regulatory requirements, we believe that wewill continue to be in compliance with these requirements at least through theend of fiscal 2006. We also believe that our cash resources and internallygenerated funds will be sufficient to support our operations, regulatoryrequirements and capital expenditures for at least the next 12 months.

 

**Contractual Obligations**

 

Inour annual report on Form 10-K filed on December 27, 2005, we reported on ourcontractual obligations as of that date. There have been no material changes toour contractual obligations since that report.

 

**Critical Accounting Policies**

 

Whenwe prepare our consolidated financial statements, we use estimates andassumptions that may affect reported amounts and disclosures. The determinationof our liability for medical claims and other health care costs payable isparticularly important to the determination of our financial position andresults of operations and requires the application of significant judgment byour management and, as a result, is subject to an inherent degree ofuncertainty.

 

Ourmedical care costs include actual historical claims experience and estimatesfor medical care costs incurred but not reported to us (“IBNR”). We, togetherwith our independent actuaries, estimate medical claims liabilities usingactuarial methods based upon historical data adjusted for payment patterns,cost trends, product mix, utilization of health care services and otherrelevant factors. The estimation methods and the resulting reserves arefrequently reviewed and updated, and adjustments, if necessary, are reflectedin the period known. While we believe our estimates are adequate, it ispossible that future events could require us to make significant adjustments orrevisions to these estimates. In assessing the adequacy of accruals for medicalclaims liabilities, we consider our historical experience, the terms ofexisting contracts, our knowledge of trends in the industry, informationprovided by our customers and information available from other sources asappropriate.

 

Themost significant estimates involved in determining our claims liability concernthe determination of claims payment completion factors and trended per memberper month cost estimates.

 

Weconsider historical activity for the current month, plus the prior 24 months,in our IBNR calculation. For the months of service five months prior to thereporting date and earlier, we estimate our outstanding claims liability basedupon actual claims paid, adjusted for estimated completion factors. Completionfactors seek to measure the cumulative percentage of claims expense that willhave been paid for a given month of service as of a date subsequent to thatmonth of service. Completion factors are based upon historical paymentpatterns. For the four months of service immediately prior to the reportingdate, actual claims paid are not a reliable measure of our ultimate liability,given the delay inherent between the patient/physician encounter and the actualsubmission of a claim for payment. For these months of service we estimate ourclaims liability based upon trended per member per month (“PMPM”) costestimates. These estimates reflect recent trends in payments and expense,utilization patterns, authorized services and other relevant factors. Thefollowing tables reflect (i) the change in our estimate of claims liability asof March 31, 2006 that would have resulted had we changed our completionfactors for all applicable months of service included in our IBNR calculation(i.e., the preceding 5ththrough 25th months) by thepercentages indicated; and (ii) the change in our estimate of claims liabilityas of March 31, 2006 that would have resulted had we changed trended PMPMfactors for all applicable months of service included in our IBNR calculation(i.e., the preceding 1st through4th months) by the percentagesindicated.

 

24

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| **Increase (Decrease) in  Estimated  Completion Factors** | ** ** | **Increase (Decrease) in****Accrued**** Medical Claims  Payable** | ** ** |
|--------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------|------------|
| (3)%                                                                     |       | $                                                                                     | 3,400,000  |   |
| (2)%                                                                     |       | $                                                                                     | 2,300,000  |   |
| (1)%                                                                     |       | $                                                                                     | 1,100,000  |   |
| 1%                                                                       |       | $                                                                                     | (1,100,000 | ) |
| 2%                                                                       |       | $                                                                                     | (2,300,000 | ) |
| 3%                                                                       |       | $                                                                                     | (3,400,000 | ) |

 
| **Increase (Decrease) in  Trended PMPM Factors** | ** ** | **Increase (Decrease) in****Accrued**** Medical Claims  Payable** | ** ** |
|----------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------|------------|
| (3)%                                                                 |       | $                                                                                     | 600,000    |   |
| (2)%                                                                 |       | $                                                                                     | 400,000    |   |
| (1)%                                                                 |       | $                                                                                     | 200,000    |   |
| 1%                                                                   |       | $                                                                                     | (200,000   | ) |
| 2%                                                                   |       | $                                                                                     | (400,000   | ) |
| 3%                                                                   |       | $                                                                                     | (600,000   | ) |

 

Additionally,for each 1% (hypothetical) difference between our March 31, 2006 estimatedclaims liability (of $11,695,000) and the actual claims incurred run-out, netincome for the six months ended March 31, 2006 would increase or decrease byapproximately $70,000.

 

The following table shows the components of thechange in medical claims and benefits payable for the six months ended March31, 2006 and 2005:

 
| ** **                                                         | ** ** | **2006**    | ** **       | **2005**    | ** ** |
|--------------------------------------------------------------------|------------|-------------|------------------|-------------|------------|
| IBNR as of beginning of period                                     |       | $           |  11,532,328 |        | 13,323,622 |   |
| Health care  claims expense incurred during the period related to: |       |        |             |        |       |
| Current year                                                       |       | 24,974,938  |             | 23,963,561  |       |
| Prior years                                                        |       | (829,233    | )                | (979,300    | )          |
| Total  incurred                                                    |       | 24,145,705  |             | 22,984,261  |       |
| Health care  claims paid during the period related to:             |       |        |             |        |       |
| Current year                                                       |       | (14,571,178 | )                | (12,601,380 | )          |
| Prior years                                                        |       | (10,409,718 | )                | (10,451,898 | )          |
| Total paid                                                         |       | (24,980,896 | )                | (23,053,278 | )          |
| IBNR  acquired during the period                                   |       | 997,863     |             | —      |       |
| IBNR as of  end of period                                          |       | $           |  11,695,000 |        | $          | 13,254,605 |   |
|                                                                    |            |             |                  |             |            |  |  |

 

**Inflation**

 

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

 

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

 

25

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**Item 3. Quantitative andQualitative Disclosures About Market Risk.**

 

**Concentrations of Credit Risk**

 

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

 

As of March 31, 2006, we had cash and cashequivalents of $16,033,876. Cash equivalents consist of highly liquidsecurities with original maturities of up to three months. We invest asubstantial portion of our cash equivalents in Federal Home Loan bonds andovernight, high yield money market funds. We also had $835,153 ofinvestments, primarily consisting of restricted, interest-bearing certificatesof deposit required by various HMOs with whom we do business. These investmentsare subject to interest rate risk and will decrease in value if market ratesincrease. All non-restricted investments are maintained at fair market value onthe balance sheet. We have the ability to hold these investments untilmaturity, and as a result, we would not expect the value of these investmentsto decline significantly as a result of a sudden change in market interestrates. Declines in interest rates over time will reduce our investment income.

 

Our term loan withResidential Funding Corporation, with a balance of $10,900,000 at March 31,2006, requires monthly principal payments of $233,334 and monthly interestpayments at prime plus 2% per annum. The fair value of this debt instrument isaffected by changes in market interest rates. As of March 31, 2006, thecarrying value of our term loan approximated its estimated fair value.Considerable judgment is required to develop estimates of fair value. Accordingly,the estimate is not necessarily indicative of the amount we could realize in acurrent market exchange. The use of different market assumptions and/orestimation methodologies may have a material effect on the estimated fair valueamounts. For terms relating to our long-term debt, see Note 6 of the Notes toCondensed Consolidated Financial Statements.

 

**Item 4. Controls and Procedures.**

 

***Evaluation ofDisclosure Controls and Procedures:***Our management, with the participation of ourChief Executive Officer and our Chief Financial Officer, has concluded, basedupon its evaluation as of the end of the period covered by this report, thatthe Company’s “disclosure controls and procedures” (as defined in Rules13(a)-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “ExchangeAct”)) are effective to ensure that information required to be disclosed in thereports that the Company files or submits under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms.

 

Because of its inherent limitations, internal control over financialreporting may not prevent or detect misstatements. Therefore, even thosesystems determined to be effective can provide only reasonable assurance withrespect to financial statement preparation and presentation.

 

***Changes inInternal Controls:***Therewere no changes in the Company’s internal control over financial reportingduring the six months ended March 31, 2006 that have materially affected, orare reasonably likely to materially affect, the Company’s internal controlsover financial reporting.

 

***Sarbanes-Oxley404 Compliance:***Wehave begun a detailed assessment of our internal controls as called for by theSarbanes-Oxley Act of 2002. We are still in the evaluation of design phase. Wehave supplemented our internal project team with the services of an outsidespecialist. Although we have made this project a priority for the Company,there can be no assurances that all control deficiencies that may be identifiedand validated will be remediated before the required due date of September 30,2007.

 

26

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**PART II –OTHER INFORMATION**

 

**Item 1. Legal Proceedings.**

 

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

 

**Item 1A. Risk Factors.**

 

None.

 

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

 

None.

 

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

 

None.

 

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

 

(a)          Our annual meeting ofstockholders was held on March 22, 2006.

(b)         Each of the persons whowas previously serving as a director was re-elected by the stockholders, asdescribed in paragraph (c) below.

(c)          Voting for the twomatters that were submitted to a vote was as follows:

 

1.               For election ofdirectors:

 
| **Name**              | ** ** | **Votes For** | ** ** | **Votes Withheld** | ** ** |
|-----------------------|------------|---------------|------------|--------------------|------------|
| Jacob Y.  Terner      |       | 4,209,965     |       | 2,774              |       |
| Catherine S.  Dickson |       | 4,209,965     |       | 2,774              |       |
| David  Levinsohn      |       | 4,209,825     |       | 2,914              |       |
| Kenneth  Schwartz     |       | 4,209,965     |       | 2,774              |       |
| Joel Kanter           |       | 4,191,965     |       | 20,774             |       |
| Gene  Burleson        |       | 4,209,965     |       | 2,774              |       |

 

2.               For approval of theselection of Ernst & Young LLP as our independent auditors for 2006:

 
| **Votes For** | ** ** | **Votes Against** | ** ** | **Votes Abstaining** | ** ** | **Broker Non-Votes** | ** ** |
|---------------|------------|-------------------|------------|----------------------|------------|----------------------|------------|
| 4,212,715     |       | 0                 |       | 24                   |       | 0                    |       |

 

**Item 5. Other Information.**

 

None.

 

**Item 6. Exhibits.**

 

The following documents are being filed asexhibits to this report:

 

27

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| **Exhibit No.** | ** ** | **Title**                                                                                                                                            |
|----------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **           | ** ** | ** **                                                                                                                                           |
| 3.1                  |       | Amended and Restated Certificate of Incorporation  of Prospect Medical Holdings, Inc.(1)                                                             |
|                 |       |                                                                                                                                                 |
| 3.2                  |       | Certificate of Amendment of Amended and Restated Certificate  of Incorporation of Prospect Medical Holdings,   Inc.(1)                               |
|                 |       |                                                                                                                                                 |
| 3.3                  |       | Certificate of Amendment of Amended and Restated  Certificate of Incorporation of Prospect Medical Holdings,   Inc.(1)                               |
|                 |       |                                                                                                                                                 |
| 3.4                  |       | Certificate of Designation of Series A Convertible  Preferred Stock of Prospect Medical Holdings, Inc.(1)                                            |
|                 |       |                                                                                                                                                 |
| 3.5                  |       | Amended and Restated Bylaws of Prospect Medical  Holdings, Inc.(1)                                                                                   |
|                 |       |                                                                                                                                                 |
| 3.6                  |       | First Amendment to Amended and Restated Bylaws of  Prospect Medical Holdings, Inc.(1)                                                                |
|                 |       |                                                                                                                                                 |
| 4.1                  |       | Specimen Common Stock Certificate(1)                                                                                                                 |
|                 |       |                                                                                                                                                 |
| 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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(1)           Previously filed asan exhibit to our Form 10 registration statement on May 27, 2004, andincorporated herein by reference.

 

28

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|          | PROSPECT  MEDICAL HOLDINGS, INC.  |
|---------------|-----------------------------------|
|          | (Registrant)                      |
|          |                              |
| May  15, 2006 | /s/  JACOB Y. TERNER              |
| ** **    | **Jacob Y. Terner, M.D.**    |
| ** **    | **Chairman of the Board and**     |
| ** **    | **Chief Executive Officer**       |
| ** **    | **(Principal Executive Officer)** |
| ** **    | ** **                        |
| May  15, 2006 | /s/  MIKE HEATHER                 |
| ** **    | **Mike Heather**                  |
| ** **    | **Chief Financial Officer**       |
| ** **    | **(Principal Financial Officer)** |

 

29

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Exhibit Index

 
| **Exhibit No.** | ** ** | **Title**                                                                                                                                            |
|----------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **           | ** ** | ** **                                                                                                                                           |
| 3.1                  |       | Amended  and Restated Certificate of Incorporation of Prospect Medical Holdings,  Inc.(1)                                                            |
|                 |       |                                                                                                                                                 |
| 3.2                  |       | Certificate  of Amendment of Amended and Restated Certificate of Incorporation of Prospect  Medical Holdings,   Inc.(1)                              |
|                 |       |                                                                                                                                                 |
| 3.3                  |       | Certificate  of Amendment of Amended and Restated Certificate of Incorporation of Prospect  Medical Holdings,   Inc.(1)                              |
|                 |       |                                                                                                                                                 |
| 3.4                  |       | Certificate  of Designation of Series A Convertible Preferred Stock of Prospect Medical  Holdings, Inc.(1)                                           |
|                 |       |                                                                                                                                                 |
| 3.5                  |       | Amended  and Restated Bylaws of Prospect Medical Holdings, Inc.(1)                                                                                   |
|                 |       |                                                                                                                                                 |
| 3.6                  |       | First  Amendment to Amended and Restated Bylaws of Prospect Medical Holdings,  Inc.(1)                                                               |
|                 |       |                                                                                                                                                 |
| 4.1                  |       | Specimen  Common Stock Certificate(1)                                                                                                                |
|                 |       |                                                                                                                                                 |
| 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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(1)           Previously filed asan exhibit to our Form 10 registration statement on May 27, 2004, andincorporated herein by reference.

 

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