**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K/A**

**AmendmentNo. 1**

**ANNUAL REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

**Forthe fiscal year ended September 30, 2006**

**CommissionFile Number 1-32203**

**PROSPECT MEDICAL HOLDINGS, INC.**

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

 

**(310) 338-8677**(Registrant’s telephonenumber, including area code)

**Securities registered pursuant toSection 12(b) of the Act:**

| Title of each class:       | ** ** | **Name of each exchange on which registered:** |
|----------------------------|------------|------------------------------------------------|
| Common stock,              |       | American Stock  Exchange                       |
| Par value $0.01  per share |       |                                           |

 

**Securities registered pursuant toSection 12(g) of the Act:**None

Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the SecuritiesAct. o Yes  x No

Indicate by check mark if the registrant is notrequired to file reports pursuant to Section 13 orSection 15(d) of the Exchange Act. o Yes  x No

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

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of Registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of thisForm 10-K or any amendment to this Form 10-K. o Yes  x No

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act. (checkone):
| Large accelerated filer  o | Accelerated  filer  o | Non-accelerated filer  x |
|--------------------------------------|---------------------------------|------------------------------------|

 

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

The aggregate market value of common stock held bynon-affiliates of the Registrant as of March 31, 2006 (the last businessday of our most recently completed second fiscal quarter) was approximately $24,038,960based upon the closing price for shares of our common stock as reported by theAmerican Stock Exchange on such date.

As of December 19, 2006, 7,348,053 shares of theRegistrant’s common stock were outstanding.

 

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**Table of ContentsForm 10-K**
| Explanatory Note | ** **                                                      |
|------------------|-----------------------------------------------------------------|
|             |                                                            |   |
| PART III    |                                                            |
|             |                                                            |
| Item 10.         | Directors  and Executive Officers of the Registrant             |   |
| Item 11.         | Executive  Compensation                                         |   |
| Item 12.         | Security  Ownership of Certain Beneficial Owners and Management |   |
| Item 13.         | Certain  Relationships and Related Transactions                 |   |
| Item 14.         | Principal  Accounting Fees and Services                         |   |
|             |                                                            |   |
| PART IV     |                                                            |
|             |                                                            |
| Item 15.         | Exhibits  and Financial Statement Schedules                     |   |
| Signatures       |                                                            |   |

 

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**EXPLANATORYNOTE**

This Amendment No. 1 on Form 10-K/A to our AnnualReport on Form 10-K for the year ended September 30, 2006 that was originallyfiled with the Securities and Exchange Commission on December 28, 2006 is beingfiled to provide the information required by Items 10, 11, 12, 13 and 14 ofPart III. This amendment does not change our previously reported financialstatements and other financial disclosure.

**PART III**

**Item10.**                   Directors, Executive Officers andCorporate Governance.

The following table summarizes the name, age, titleand business experience for the past five years of each of our executiveofficers and directors. Other than as described below, no family relationshipsexist between or among any of our officers and directors.
| Name                  | ** ** | **Age** | ** ** | **Position**                                               |
|-----------------------|------------|---------|------------|------------------------------------------------------------|
| Jacob Y. Terner, M.D. |       | 72      |       | Chairman, Chief Executive Officer and Director             |
| Catherine S. Dickson  |       | 37      |       | President, Chief Operating Officer and Director            |
| Mike Heather          |       | 48      |       | Chief Financial Officer                                    |
| R. Stewart Kahn       |       | 55      |       | Executive Vice President and Secretary                     |
| Linda Hodges          |       | 62      |       | Executive Vice President of Compliance                     |
| Michael A. Terner     |       | 45      |       | Vice President, HMO Contracting and Health Plan  Relations |
| Donna Vigil           |       | 58      |       | Vice President, Finance                                    |
| David Levinsohn       |       | 72      |       | Director                                                   |
| Kenneth Schwartz, CPA |       | 71      |       | Director                                                   |
| Joel S. Kanter        |       | 50      |       | Director                                                   |
| Gene Burleson         |       | 66      |       | Director                                                   |

 

**JacobY. Terner, M.D.****  **JacobY. Terner, M.D. has served as our Chairman, Chief Executive Officer and amember of our Board of Directors since July 31, 1996. Dr. Terner isalso the Chief Executive Officer and a Director of each of our managementsubsidiaries and is the Chief Executive Officer, President, Treasurer and aDirector of each of our affiliated physician organizations except forAMVI/Prospect Health Network, which is a joint venture partner whereDr. Terner is Chief Executive Officer, President, Treasurer and a Directorof one of the two general partners; Sierra Primary Care Medical Group, whereDr. Terner serves as Chief Executive Officer, Treasurer and a Director;and Nuestra Familia Medical Group, where Dr. Terner serves as Secretaryand a Director. Dr. Terner held the position of Clinical Professor ofObstetrics and Gynecology at the University of Southern California, School ofMedicine from 1972 to 2001. Dr. Terner is currently Emeritus ClinicalProfessor of Obstetrics and Gynecology. Dr. Terner also served as Chairmanand Chief Executive Officer of Century MediCorp, Inc., a publicly-traded,integrated health-management organization from June 24, 1988 until itsOctober 1992 merger with Foundation Health Corporation. Following thismerger, Dr. Terner was named to Foundation’s Board of Directors and servedas its Executive Vice President and as a Director until his resignation inDecember 1992. Dr. Terner is also a Director of Brotman MedicalCenter, Inc.

**CatherineS. Dickson.****  **CatherineS. Dickson serves as our President and Chief Operating Officer, positions shehas held since July 2003. In February 2004, Ms. Dickson waselected as a member of our Board of Directors. Ms. Dickson is also thePresident and Chief Executive Officer of Prospect Medical Systems. Prior toMs. Dickson’s appointment as our President and Chief Operating Officer,Ms. Dickson served as Vice President of Contracting and Credentialing forProspect Medical Systems since February 2000. Ms. Dickson has beenwith Prospect Medical Systems since January 1998. Ms. Dickson hassignificant experience across a broad range of managed care divisions,including contract negotiation and implementation, claims adjudication,eligibility, utilization management and credentialing. Before joining ProspectMedical Systems, Ms. Dickson served as an Associate Contract Administratorfor Orange Coast Managed Care Services, Inc., the health care managementcompany for the Sisters of St. Joseph Health Organization Independent PhysicianAssociation.

**MikeHeather.****  **MikeHeather was appointed Chief Financial Officer of the company and each of ourmanagement subsidiaries in April 2004. Mr. Heather also serves asChief Financial Officer of each of our affiliated physician organizationsexcept for AMVI/Prospect Health Network, which is a joint venture partner whereMr. Heather is Chief Financial Officer of one of the two general partners.Most recently, Mr. Heather served as Co-Chief Executive Officer ofWebVision, Inc. from March 2001 to June 2002, and ChiefFinancial Officer from June 2000 through June 2002. Prior to joiningWebVision, Mr. Heather was a Partner at Deloitte & Touche which

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he joined in 1980, andwas the founder and Partner-in-Charge of the HealthCare Services Practice ofDeloitte & Touche in Orange County from June 1992 toJune 2000.

**R.Stewart Kahn.****  **R.Stewart Kahn has served as our Executive Vice President since March 1998and as our Secretary since July 1998. Mr. Kahn is also the ExecutiveVice President and Secretary of each of our management subsidiaries, and is theSecretary of each of our affiliated physician organizations except for NuestraFamilia Medical Group, where Mr. Kahn serves as Vice President, andAMVI/Prospect Health Network, which is a joint venture partner whereMr. Kahn is the Secretary of one of the two general partners.Mr. Kahn has responsibility for mergers and acquisitions and day-to-daybusiness operations of the company and its management subsidiaries. From 1987to 1999, Mr. Kahn was the President and Chief Executive Officer of LegendCapital Corporation, a consulting firm specializing in financial, marketing,lending and accounting services to the health care industry. Mr. Kahn hasmore than 30 years of experience in the commercial finance and equipmentleasing industry and is intimately familiar with asset based lending, leveragedbuyouts, merger and acquisition financing, and contractual and businessmatters.

**LindaHodges.****  **LindaHodges has served as our Executive Vice President of Compliance sinceAugust 1, 2003. Previously, Ms. Hodges served as President and ChiefOperations Officer of Prospect Medical Systems from November 1998 toJuly 2003, and she has performed a number of other senior managementfunctions for Prospect Medical Systems since 1996. Ms. Hodges has over20 years of health care related experience in management and operations.Ms. Hodges has also served in positions such as Interim Chief ExecutiveOfficer of VivaHealth Plan, Executive Director of Foundation Health Corporation(Southern California Region), and President of Loma Linda Health Plan, a whollyowned subsidiary of Century MediCorp, Inc.

**DonnaVigil.****  **DonnaVigil has served as our Vice President of Finance since April 2004, priorto which she served as our Chief Financial Officer commencing July 1998.Ms. Vigil served as Chief Financial Officer of NetSoft, a privately held,$20 million software development company with five European subsidiaries,from October 1989 to September 1997. Ms. Vigil was Acting ChiefFinancial Officer/Consultant of Strategic HR Services, for the staffingdivision of a large real estate developer in Southern California, from October 1997to May 1998.

**MichaelA. Terner.****  **MichaelA. Terner has served as our Vice President of HMO Contracting and Health PlanRelations since October 1, 2003. From 1998 to 2003, Mr. Terner was aportfolio manager for Ocean Park Capital Management, LLC, a private investmentcompany. From 1994 through 1998, Mr. Terner was an independent financialconsultant for various entities including Prospect Medical Holdings and theColumbia Charitable Foundation. From 1991 to 1993, he was the BusinessDevelopment Executive with Century Medicorp, and from 1990 to 1991,Mr. Terner was involved in the health care consulting practice of KPMGPeat Marwick. From 1983 to 1988, Mr. Terner was a risk arbitrage traderwith LF Rothschild, Unterberg and Laterman Co. Mr. Terner received his MBAfrom the Anderson Graduate School of Management at UCLA in 1990, and his BADegree from Harvard College in 1983. Mr. Terner is the son of Jacob Y.Terner, our Chief Executive Officer.

**David Levinsohn.  **DavidLevinsohn has served as a member of our Board of Directors since July 1996 andas a member of the Audit Committee of our Board of Directors since 1996. Mr.Levinsohn has been the President and Chief Executive Officer of Sherman OaksHealth Systems, Inc. d/b/a Sherman Oaks Hospital and Medical Center since March1995. Prior to being named to those positions, Mr. Levinsohn served as theChief Operating Officer of Sherman Oaks Health Systems since May 1994. FromNovember 1993 to May 1994, Mr. Levinsohn was the Vice President of EncinoTarzana Medical Center. From 1989 until November 1993, Mr. Levinsohn wasExecutive Director of Sherman Oaks Hospital.

**Kenneth Schwartz, CPA.  **KennethSchwartz has served as a member of our Board of Directors since June 1998. Mr.Schwartz served as a Director of Deloitte & Touche LLP from December 1990to June 1998. Mr. Schwartz previously served as a member of the NationalManagement Committee and Managing Partner of the Los Angeles office of Spicer& Oppenheimer.

**Joel S. Kanter.  **Mr. Kanterwas elected as a member of our Board of Directors in February 2004. Mr. Kanterhas been the President of Windy City, Inc., a privately held investmentcompany, since 1986. From 1993 to 1999, Mr. Kanter was the President or ChiefExecutive Officer of Walnut Financial Services, Inc., a publicly traded company(NMS:WNUT). Mr. Kanter’s past experience includes serving as a LegislativeAssistant to former Congressman Abner J. Mikva (D-Illinois), Special Assistantto the National Association of Attorneys General, Staff Director of the HouseRules Committee’s Subcommittee on Legislative Process, and Managing Director ofThe Investors’ Washington Service. Mr. Kanter serves on the Board of Directorsof Echo Healthcare Acquisition Corp. (OTC Bulletin Board: EHHA), I-FlowCorporation (NASDAQ: IFLO), Nesco Industries, Inc. (OTC Bulletin Board:

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NESK), and Magna-Lab,Inc. (OTC Bulletin Board: MAGLA.OB). Mr. Kanter is also a Trustee at theGeorgetown Day School (Washington, D.C.), The Langley School (McLean,Virginia), and the Union Institute & University (Cincinnati, OH).

**Gene E. Burleson.**Mr. Burleson was selected by Spencer Trask, the placement agent for our 2004preferred stock offering, as its designee to our Board of Directors, effectiveJuly 2004. Mr. Burleson served as Chairman of the Board of Directors of MarinerPost-Acute Network Inc., an operator of longterm care facilities from January2000 to June 2002. Mr. Burleson also served as Chairman of the Board ofDirectors of Alterra Healthcare Inc., a developer and operator of assistedliving facilities and is on the Board of Deckers Outdoor Corporation, Inc. Inaddition he is involved with several private health care companies as aninvestor and director. Mr. Burleson served as Chairman of the Board of GranCareInc. from October 1989 to November 1997. Additionally, Mr. Burleson served asPresident and Chief Executive Officer of GranCare Inc. from December 1990 toFebruary 1997. Upon completion of the merger of GranCare’s pharmacy operationswith Vitalink Pharmacy Services Inc. in February 1997, he became ChiefExecutive Officer and a Director of Vitalink Pharmacy Services Inc. Mr.Burleson resigned as Chief Executive Officer and a director of VitalinkPharmacy Services in August 1997. From June 1986 to March 1989 Mr. Burlesonserved as President, Chief Operating Officer and a director of American MedicalInternational Inc. (“AMI”), an owner and operator of acute care hospitals.Based in London from May 1981 to June 1986, Mr. Burleson served as ManagingDirector of AMI’s international operations.

**Terms of Office**

Directors are elected annually by our stockholders andhold office until their successors are elected and qualified, or until theirearlier resignation or removal. Our Board of Directors currently consists ofsix members. In connection with a recent private offering, the placement agentwas granted the right, until the second anniversary of the effective date ofour Form S-1 Securities Act registration statement (July 27, 2005) to designateone person (the “Designee”) reasonably acceptable to us to serve, at theplacement agent’s sole discretion, on our Board of Directors. Mr. Gene Burlesonwas selected as the Designee and now sits on our Board of Directors. He alsoserves as a member of the Compensation Committee to authorize stock optiongrants by our company; provided, however, that any proposed stock option grantsby our company to senior management will also be subject to the specificapproval of the Designee, which approval will not be unreasonably withheld ordelayed.

Officers are elected by and serve at the discretion ofour Board of Directors. They hold office until their successors are chosen andqualified, or until they resign or have been removed from office. The Board ofDirectors may appoint, or empower the Chief Executive Officer to appoint orterminate, such other officers and agents as the business of the corporationmay require, each of whom shall hold office for such period, and have suchauthority, and perform such duties as are provided in the Bylaws, or as theBoard of Directors may from time to time determine.

**Audit Committee**

Audit Committee. The Board of Directors hasestablished an audit committee in accordance with Section 3(a)(58)(A) of theSecurities Exchange Act of 1934. The Audit Committee makes recommendations tomanagement concerning the engagement of independent public accountants, reviewswith the independent public accountants the plans and results of the auditengagement, approves professional services provided by the independent publicaccountants, reviews independence of the independent public accountants,considers the range of audit and non-audit fees and reviews the adequacy of ourinternal accounting controls. Mr. Schwartz is the Chairman of the AuditCommittee, and Mr. Levinsohn, Mr. Kanter and Mr. Burleson serve as members ofthe Audit Committee.

**Code of Ethics**

The Board of Directors has adopted a Financial Code ofEthics that applies to our senior financial officers, including the principalexecutive officer, principal financial officer, principal accounting officer orcontroller, or persons performing similar functions. The financial code ofethics addresses conflicts of interest, corporate opportunities,confidentiality, protection and proper use of company assets, financialdisclosure and reporting, maintenance of books and records and compliance withlaws, rules and regulations. The Financial Code of Ethics is posted on ourwebsite at www.prospectmedicalholdings.com.

The Board of Directors has also adopted a Code ofBusiness Conduct and Ethical Business Practice which applies to all officers, employeesand directors of the Company. A copy of the Code of Business Conduct and

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Ethical Business Practicehas been filed as an exhibit to our Annual Report on Form 10-K for the fiscalyear ended September 30, 2006 and may be viewed on the SEC’s website athttp://www.sec.gov.

The Financial Code of Ethics and the Code of BusinessConduct and Ethical Business Practice contain written standards that areintended to deter wrongdoing and to promote honest and ethical conduct,including the ethical handling of actual or apparent conflicts of interestbetween personal and professional relationships; full, fair, accurate, timely,and understandable disclosure in reports and documents that Prospect fileswith, or submits to, the SEC and in other public communications made byProspect; compliance with applicable governmental laws, rules and regulations;the prompt internal reporting of violations of these standards to the AuditCommittee or Corporate Compliance Officer; and accountability for adherence tothese standards.

**Procedures for NominatingDirectors**

There have been no changes to our previously disclosedprocedures by which stockholders may recommend nominees to our board ofdirectors.

**Section 16(a) BeneficialOwnership Reporting Compliance**

Under the Securities Exchange Act of 1934, as amended,our directors, certain executive and other officers, and any person holdingmore than 10% of Prospect’s common stock are required to report their ownershipand any changes in that ownership to the Securities and Exchange Commission, orSEC, and any exchange or quotation system on which our common stock is listedor quoted. Specific due dates for these reports have been established and theCompany is required to report any failure by directors, officers and 10%holders to file such reports on a timely basis. Based solely on a review ofcopies of reports furnished to the Company as filed with the SEC, we believethat our directors and officers have complied with the filing requirementsapplicable to them for the year ended September 30, 2006, with the exceptionthat one report for David Levinsohn concerning an exercise of stock options wasfiled late, and one report for Michael Terner concerning two option exercisesand three sales of underlying shares was filed late.

**Item11.**                   Executive Compensation.

The tables and discussion below set forth informationabout the compensation of our Chief Executive Officer and our other namedexecutive officers for each of the last three fiscal years.
|                                                | ** ** | ** **             | ** ** | ** **                   | ** ** | ** ** | ** ** | ** **            | ** ** | **Long-term  compensation  awards** | ** ** |
|------------------------------------------------|------------|------------------------|------------|------------------------------|------------|------------|------------|-----------------------|------------|-------------------------------------|------------|
| ** **                                     | ** ** | **Fiscal year**   | ** ** | **Annual compensation** | ** ** | **Shares** | ** ** |
| ** **                                     | ** ** | **ended**              | ** ** | ** **                   | ** ** | ** ** | ** ** | **Other annual** | ** ** | **underlying**                      | ** ** |
| **Name and principal position** | ** ** | **September 30,** | ** ** | **Salary**                   | ** ** | **Bonus**  | ** ** | **compensation**      | ** ** | **options**                         | ** ** |
| Jacob Y. Terner, M.D.                          |       | 2006                   |       | $                            | 250,000    |       | $          | 0                     |       | $                                   | 0          |   | 0 |   |
| Chief Executive Officer                        |       | 2005                   |       | $                            | 250,000    |       | $          | 20,000                |       | $                                   | 0          |   | 13,333 |   |
|                                                |       | 2004                   |       | $                            | 185,417    |       | $          | 0                     |       | $                                   | 0          |   | 40,000 | (1) |
| Catherine Dickson                              |       | 2006                   |       | $                            | 200,000    |       | $          | 0                     |       | $                                   | 0          |   | 0 |   |
| President and  Chief Operating Officer         |       | 2005                   |       | $                            | 200,000    |       | $          | 20,000                |       | $                                   | 0          |   | 11,458 |   |
|                                           |       | 2004                   |       | $                            | 142,958    |       | $          | 0                     |       | $                                   | 0          |   | 34,375 |   |
| Mike Heather(2)                                |       | 2006                   |       | $                            | 180,000    |       | $          | 36,000                |       | $                                   | 0          |   | 0 |   |
| Chief Financial Officer                        |       | 2005                   |       | $                            | 180,000    |       | $          | 20,000                |       | $                                   | 0          |   | 0 |   |
|                                                |       | 2004                   |       | $                            | 75,000     |       | $          | 0                     |       | $                                   | 0          |   | 300,000 |   |
| Donna Vigil(2)                                 |       | 2006                   |       | $                            | 150,000    |       | $          | 22,500                |       | $                                   | 0          |   | 0 |   |
| Vice President  of Finance                     |       | 2005                   |       | $                            | 150,000    |       | $          | 12,000                |       | $                                   | 0          |   | 8,333 |   |
|                                           |       | 2004                   |       | $                            | 133,792    |       | $          | 0                     |       | $                                   | 0          |   | 25,000 |   |
| R. Stewart Kahn(3)                             |       | 2006                   |       | $                            | 139,000    |       | $          | 20,850                |       | $                                   | 6,000      |   | 0 |   |
| Executive Vice President                       |       | 2005                   |       | $                            | 139,000    |       | $          | 10,000                |       | $                                   | 6,000      |   | 8,333 |   |
|                                                |       | 2004                   |       | $                            | 136,771    |       | $          | 0                     |       | $                                   | 6,000      |   | 25,000 |   |

 

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(1)                                  Doesnot include options to purchase 800,000 shares of common stock that weregranted to Dr. Terner, not as employee compensation, but as considerationfor his personal guarantee of corporate obligations as described in “CertainRelationships and Related Transactions.”

(2)                                  Ms. Vigilserved as Chief Financial Officer until April 2004, when she was namedVice President of Finance and Mike Heather was appointed Chief FinancialOfficer.

(3)                                  Thecompensation reported as other annual compensation was received in the form ofan automobile allowance.

**Aggregated Option Exercises in LastYear and Fiscal Year-End Option Values**

We did not grantany stock options during the year ended September 30, 2006. The following tableshows, as to the individuals named in the Summary Compensation Table above,information about stock options exercised during the year ended September 30,2006 and the number and value of unexercised options at that date.
| ** **                                      | ** ** | **Number of  Shares  Acquired on  Excercise** | ** ** | **Value  Realized** | ** ** | **Number of Securities  Underlying Unexercised  Options at  September 30, 2006** | ** ** | **Value of Unexercised  In-the-Money Options  at September 30, 2006 (1)** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------------|------------|---------------------|------------|----------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------|------------|
| ** **                                      | ** ** | ** **                                              | ** ** | ** **          | ** ** | **(Exercisable/Unexercisable)**                                                                                | ** ** | **(Exercisable/Unexercisable)**                                                                              | ** ** |
| Jacob Y. Terner,  M.D.  Chief Executive Officer |       | 175,000                                                 |       | $                   | 455,000    |                                                                                                           | 903,333/0  | (2)                                                                                                          | $          | 2,364,233/$0 |   |
| Catherine  Dickson  President and COO           |       | 10,000                                                  |       | $                   | 26,859     |                                                                                                           | 184,333/0  |                                                                                                         | $          | 238,808/$0 |   |
| Mike Heather  Chief Financial Officer           |       | -0-                                                     |       | $                   | -0-        |                                                                                                           | 300,000/0  |                                                                                                         | $          | 255,000/$0 |   |
| Donna Vigil  Vice President of Finance          |       | 30,000                                                  |       | $                   | 80,092     |                                                                                                           | 117,333/0  |                                                                                                         | $          | 198,733/$0 |   |
| R. Stewart Kahn  Executive Vice President       |       | 74,550                                                  |       | $                   | 208,905    |                                                                                                           | 85,283/0   |                                                                                                         | $          | 107,391/$0 |   |

 

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(1)                                  Theclosing price of our common stock on September 30, 2006 was $5.85. Value iscalculated by multiplying (a) the difference between the closing sales priceand the option exercise price by (b) the number of shares of common stockunderlying the option. The amounts in this column may not represent amountsthat will actually be realized by the named executive officers.

(2)                                  Includesoptions to purchase 800,000 shares of common stock that were granted toDr. Terner, not as employee compensation, but as consideration for hispersonal guarantee of corporate obligations.

**Employment Agreements**

We have anemployment agreement with our Chief Executive Officer, Jacob Y. Terner, whichhas been extended for a three-year term that ends on August 1, 2008 andprovides for compensation of $250,000 per year. The agreement further providesthat if we terminate Dr. Terner’s employment without cause, we will berequired to pay him $12,500 for each month of past service as our ChiefExecutive Officer, commencing as of July 31, 1996. EffectiveSeptember 8, 2004, the Company’s maximum contingent obligation under thistermination provision was frozen at $1,237,500.

Our otherexecutive officers are employed at will and currently do not have writtenemployment agreements. However, our Board of Directors approved a payment toMs. Dickson equal to six months of salary (equal to $100,000 atSeptember 30, 2006) as a severance package in the event of her terminationby us.

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**Director Compensation**

*Cash Compensation*

Independentdirectors receive $750 for each meeting of our Board of Directors that theyattend. The members of our Audit Committee and the Compensation Committeereceive $375 for each committee meeting they attend. The Chairman of the AuditCommittee also receives $12,000 annual compensation for service on thatcommittee. Employees that serve as directors receive no compensation for theirservice as directors or committee members. All of our directors are eligible toreceive options under our 1998 Stock Option Plan. No stock options were awardedto our directors during the year ended September 30, 2006.

*Stock Options*

As previouslydisclosed in last year’s annual report, on September 30, 2005 each of ourindependent directors received an annual grant of nonqualified options topurchase 30,000 shares of our common stock, with an exercise price of $4.97,which was equal to 100% of the fair market value of our common stock on thegrant date. These options were granted as incentive compensation for the 2006fiscal year.

**Stock Option Plan**

We currently haveone stock option plan, the 1998 Stock Option Plan (the “Plan”), although in thepast, and most recently on April 19, 2004 as additional employmentcompensation to our Chief Financial Officer, Mike Heather, and on May 7,2004 as compensation to our board members for service on the company’s Board ofDirectors, we have also granted non-qualified stock options outside the Plan.The purpose of the Plan is to provide incentives to attract, retain andmotivate eligible persons whose present and potential contributions areimportant to our success by offering them an opportunity to participate in ourfuture performance through awards of stock options. Under the Plan, stockoptions may be granted to our directors, officers, employees, consultants,independent contractors and advisers, or those of our subsidiaries oraffiliated physician organizations. We also use stock options as signingbonuses to attract key employees. By encouraging stock ownership, we seek toattract, retain and motivate such persons and to encourage them to devote theirbest efforts to our business and financial success.

As last amended,effective as of May 7, 2004, the Plan provides for a continuous pool of2,040,000 shares of our common stock for allocation to previously issued andoutstanding or exercised stock option awards under the Plan and future stockoption grants under the Plan. Options which have terminated without beingexercised, whether by forfeiture or otherwise, no longer have shares allocatedto them and therefore do not count against the 2,040,000 pool amount.

The Plan isadministered by the Compensation Committee of our Board of Directors.Management proposes option grants to the Compensation Committee, and theCompensation Committee may approve, reject or amend the proposed option grants.The Compensation Committee then presents the final proposed option grants tothe entire Board of Directors for final approval.

Options grantedunder the Plan may be qualified incentive stock options or non-qualified stockoptions, and each grant is evidenced by a written stock option agreement. Theexercise price to be paid for shares upon exercise of each option granted underthe Plan is determined by our Board of Directors at the time the option isgranted, but may not be less than the fair market value of the stock, asdetermined on the date of grant. The maximum term of each option is ten years.The aggregate fair market value of shares of common stock with respect to whichqualified incentive stock options are exercisable for the first time by anysingle optionee in any calendar year is limited to $100,000.

An option underthe Plan terminates 90-days after the holder ceases to be employed by us,except that in the case of death or disability, the option may be exercisedwithin twelve months by the holder or the holder’s legal representative,executor, administrator, legatee or heirs, as the case may be.

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**Item12.**                   Security Ownership of CertainBeneficial Owners and Management and Related Stockholder Matters.

**Amountand Nature of Shares Beneficially Owned**

The table belowshows how much of our common stock is beneficially owned by directors, namedexecutive officers (as set forth in the Summary Compensation Table above),directors and executive officers as a group and beneficial owners of more than5% of our outstanding common stock known to us, as of December 31, 2006).
| **Name (1)**                                                | ** ** | **Number of  Shares  Owned** | ** ** | **Right to  Acquire(2)** | ** ** | **Total  Shares  Beneficially  Owned(3)** | ** ** | **Percent  of** Class(4) | ** ** |
|------------------------------------------------------------------|------------|-----------------------------------|------------|-------------------------------|------------|-------------------------------------------|------------|-------------------------------|------------|
| Kevin Kimberlin                                                  |       | 286,302                           | (5)        | 440,482                       | (6)        | 726,784                                   |       | 9.2                           |       |
| Paul Amir                                                        |       | 481,313                           | (7)        | 72,816                        |       | 554,129                                   |       | 7.3                           |       |
| Karunyan Arulanantham                                            |       | 358,270                           | (8)        | 65,535                        |       | 423,805                                   |       | 5.6                           |       |
| Nelson Obus                                                      |       | 397,400                           | (9)        | —                        |       | 397,400                                   |       | 5.3                           |       |
| Jacob Y. Terner, M.D.                                            |       | 617,702                           | (10)       | 906,149                       |       | 1,523,851                                 |       | 18.2                          |       |
| Catherine S. Dickson                                             |       | 12,855                            |       | 158,833                       |       | 171,688                                   |       | 2.2                           |       |
| Mike Heather                                                     |       | —                            |       | 300,000                       |       | 300,000                                   |       | 3.9                           |       |
| R. Stewart Kahn                                                  |       | 25,000                            |       | 85,283                        |       | 110,283                                   |       | 1.5                           |       |
| Donna Vigil                                                      |       | 12,603                            |       | 92,333                        |       | 104,936                                   |       | 1.4                           |       |
| David A. Levinsohn                                               |       | 115,211                           | (11)       | 135,000                       |       | 250,211                                   |       | 3.3                           |       |
| Kenneth Schwartz, CPA                                            |       | 44,694                            |       | 130,000                       |       | 174,694                                   |       | 2.3                           |       |
| Joel S. Kanter                                                   |       | 50,000                            | (12)       | 90,000                        |       | 140,000                                   |       | 1.9                           |       |
| Gene E. Burleson                                                 |       | 25,000                            |       | 90,000                        |       | 115,000                                   |       | 1.5                           |       |
| All directors and executive officers as a group (11 persons)(13) |       | 942,761                           |       | 2,107,597                     |       | 3,050,358                                 |       | 31.8                          |       |

 

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(1)                                  Exceptas indicated otherwise, each holder has sole voting and investment power overthe shares listed in the table, except to the extent they share that power withtheir spouse. Except as otherwise stated, the address of each person in thetable is 400 Corporate Pointe, Suite 525, Culver City, CA 90230.

(2)                                  Theseare shares which the holders have the right to acquire within 60 days throughthe exercise of outstanding options or warrants. As such, the holders aredeemed to beneficially own these shares even though they are not outstanding.

(3)                                  Totalof shares in column one and column two.

(4)                                  Calculatedbased on a total of 7,475,340 shares outstanding on December 31,2006.

(5)                                  Includes62,667 shares of common stock held by the Kimberlin Family 1998 Trust, 81,818shares of common stock held by Spencer Trask Private Equity Fund I LP, 40,909shares of common stock held by Spencer Trask Private Equity Fund II LP, 51,818shares of common stock held by Spencer Trask Private Equity Accredited Fund IIILLC, and 49,090 shares of common stock held by Spencer Trask Illumination FundLLC. Mr. Kimberlin’s address is 535 Madison Avenue, 18th Floor, New York, New York10022.

(6)                                  Includes350,563 shares of common stock issuable upon exercise of warrants held by theKimberlin Family 1998 Trust and 89,919 shares of common stock issuable uponexercise of warrants held by Spencer Trask & Co.

(7)                                  Theseshares are held by Paul Amir as Trustee of the Herta and Paul Amir Family Trust.Mr. Amir’s address is 8730 Wilshire Boulevard, Beverly Hills, California90211.

(8)                                  Includes285,453 shares of common stock held by the Arul Family Trust. Mr. Arulanantham’saddress is 1675 Staffordshire Drive, Lancaster, California 93534.

(9)                                  Ofthis total, 76,500 shares are beneficially owned by Wynnefield Partners SmallCap Value, L.P. and 124,500 shares are beneficially owned by WynnefieldPartners Small Cap Value, L.P. I, and the 201,000 total shares held by thesetwo limited partnerships are indirectly beneficially owned by WynnefieldCapital Management, LLC as general partner of the limited partnerships.Mr. Obus acts as the managing partner of Wynnefield Capital Management,LLC. Another 107,500 shares are beneficially owned by Wynnefield Small Cap ValueOffshore Fund, Ltd. and indirectly beneficially owned by the fund’s corporatemanager, Wynnefield Capital, Inc., whose president is Mr. Obus.Another 88,900 shares are beneficially owned by Channel

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Partnership II, L.P. and are indirectly beneficially owned byMr. Obus as the general partner of that limited partnership. The foregoinginformation is based on a Schedule 13G statement of beneficial ownership filedby these reporting persons as an affiliated group on February 14, 2006.The address of the reporting persons is 450 Seventh Avenue, Suite 509, NewYork, New York 10123.

(10)                            Beneficialownership of 81,407 shares of common stock is shared by Jacob Y. Terner andSandra W. Terner as co-trustees of the Terner Family Trust.

(11)                            Includes30,211 shares of common stock held by David Levinsohn as Trustee of theLevinsohn Revocable Family Trust.

(12)                            Beneficialownership of 45,000 shares of common stock is shared with the Kanter FamilyFoundation.

(13)                            Inaddition to the directors and executive officers named in this table, two otherexecutive officers are included as members of this group. Such other executiveofficers hold a total of 39,696 shares of common stock and have the rightto acquire a total of 119,999 shares of common stock through the exerciseof outstanding options within the next 60 days.

**Equity Compensation Plan Information**

The followingtable provides information as of the most recently completed fiscal year endedSeptember 30, 2006 with respect to compensation plans and individualcompensation arrangements under which equity securities of Prospect areauthorized for issuance:
| ** **                                                  | ** ** | **(a)**                            | ** ** | **(b)**                    | ** ** | **(c)**                               | ** ** |
|-------------------------------------------------------------|------------|------------------------------------|------------|----------------------------|------------|---------------------------------------|------------|
| ** **                                                  | ** ** | ** **                         | ** ** | ** **                 | ** ** | **Number of securities**    | ** ** |
| ** **                                                  | ** ** | **Number of**                 | ** ** | **Weighted-**              | ** ** | **remaining available for** | ** ** |
| ** **                                                  | ** ** | **securities to be**     | ** ** | **average**                | ** ** | **future issuance under**   | ** ** |
| ** **                                                  | ** ** | **issued upon exercise** | ** ** | **exercise price**    | ** ** | **equity compensation**          | ** ** |
| ** **                                                  | ** ** | **of outstanding**            | ** ** | **of outstanding**    | ** ** | **plans (excluding**             | ** ** |
| ** **                                                  | ** ** | **options, warrants**         | ** ** | **options, warrants** | ** ** | **securities reflected in** | ** ** |
| **Plan category**                                      | ** ** | **and rights**                | ** ** | **and rights**        | ** ** | **column (a))**                  | ** ** |
| Equity compensation  plans approved by security holders     |       | 1,602,247                          |       | $                          | 4.29       |                                  | 203,639    |   |
| Equity compensation  plans not approved by security holders |       | 2,725,644                          |       | $                          | 3.75       |                                  | 0          |   |
| Total                                                       |       | 4,327,891                          |       | $                          | 3.95       |                                  | 203,639    |   |

 

Included in equity compensation plans approved bysecurities holders is our 1998 Stock Option Plan. Included in equitycompensation plans not approved by security holders are employee stock optionsand warrants issued outside of our 1998 Stock Option Plan.

**Item13.**                   Certain Relationships and RelatedTransactions, and Director Independence.

The Company has an employment agreement with our ChiefExecutive Officer, Jacob Y. Terner, which has been extended for a three-yearterm that ends on August 1, 2008 and provides for compensation of $250,000 peryear. The agreement further provides that if we terminate Dr. Terner’semployment without cause, we will be required to pay him $12,500 for each monthof past service as our Chief Executive Officer, commencing as of July 31, 1996.The contingent termination obligation was frozen at $1,237,500, effective September8, 2004. Since the Company has not indicated any intention to terminate Dr.Terner, no such potential liability is accrued as of September 30, 2006.

**Director Independence**

A majority of our Board is comprised of independentdirectors, and only independent directors serve on our Audit Committee,Compensation Committee and Corporate Governance and Nominating Committee.

No director will be deemed to be independent unlessthe Board affirmatively determines that the director has no materialrelationship with Prospect, directly or as an officer, stockholder or partnerof an organization that has a material relationship with Prospect. The Boardconsults with the Company’s legal counsel to ensure that the Board’sdeterminations are consistent with all relevant securities and other laws andregulations regarding the definition of

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“independent,” includingthose set forth in SEC rules and regulations and pertinent listing standards ofthe American Stock Exchange, as in effect from time to time.

In its annual review of director independence, theBoard considers all commercial, banking, consulting, legal, accounting,charitable or other business relationships that any director may have withProspect. As a result of its annual review, the Board has determined that alldirectors, with the exception of Dr. Terner and Ms. Dickson, are independentfor AMEX purposes. Dr. Terner is not independent because he is the ChiefExecutive Officer of Prospect. Ms. Dickson is not independent because she isthe President and Chief Operating Officer of Prospect.

**Item14.**                   Principal Accounting Fees andServices.

For the fiscal years ended September 30, 2006 and2005, professional services were performed for us by Ernst & Young LLP. Ouraudit committee annually approves the engagement of outside auditors for auditservices in advance. The audit committee has also established complementaryprocedures to require pre-approval of all audit-related, tax and permittednon-audit services provided by our outside auditors, and to consider whetherthe outside auditors’ provision of non-audit services is compatible withmaintaining the independence of the outside auditors. The audit committee maydelegate pre-approval authority to one or more of its members. Any such feespre-approved in this manner shall be reported to the audit committee at itsnext scheduled meeting. All services described below were pre-approved by theaudit committee.

The following table represents aggregate fees billedto us by Ernst & Young LLP for fiscal year ended September 30, 2006 and2005, notwithstanding when the fees were billed or when the services wererendered.
|                     | ** ** | **Fiscal 2006** | ** ** | **Fiscal 2005** | ** ** |
|---------------------|------------|----------------------|------------|----------------------|------------|
|                |       |                 |       |                 |       |
| Audit fees (1)      |       | $                    | 399,000    |                 | $          | 327,000 |   |
|                |       |                 |       |                 |       |
| Audit-related  fees |       | 46,841               | (2)        | 235,462              | (3)        |
|                |       |                 |       |                 |       |
| Tax fees            |       | -0-                  |       | -0-                  |       |
|                |       |                 |       |                 |       |
| All other fees  (4) |       | 1,500                |       | -0-                  |       |
|                |       |                 |       |                 |       |
| Total fees          |       | $                    | 447,341    |                 | $          | 562,462 |   |

 

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(1) Includes fees and expenses related to the fiscalyear audit of the consolidated financial statements, quarterly reviews andstandalone audits of subsidiaries.

(2) Includes fees and expenses for services renderedduring the fiscal year in connection with financial statement audits ofacquisition candidates, preparation of the Company’s Form S-3 registrationstatement filing, Sarbanes-Oxley Act consultation and review of proxy filings.

(3) Includes fees and expenses for services renderedduring the fiscal year in connection with financial statement audits ofacquisition candidates, preparation of the Company’s Form 10 and Form S-1registration statement filings, and Rule 3-05 consultation. Also includes feesfor quarterly review for the quarter ended December 31, 2004, which wasincluded in the Form 10 registration statement.

(4) Annual subscription to EY On-Line, an accountingresearch tool.

**PART IV**

**Item15.**                   Exhibits andFinancial Statement Schedules

The exhibits listed in the accompanying Exhibit Indexhave been filed with this report.

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**SIGNATURES**

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto dulyauthorized.
|                             |   | PROSPECT MEDICAL HOLDINGS, INC.    |
|-----------------------------|--------|-----------------------------------------|
|                        |   | (Registrant)                            |
|                        |   |                                    |
|                        |   |                                    |
| Date: January 28, 2007 | By:    | /s/ jacob y. terner, m.d.               |
|                        |   | Jacob Y. Terner,  M.D.                  |
|                        |   | *Chairman  and Chief Executive Officer* |

 

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**EXHIBIT INDEX**
| 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 |

 

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