**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

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

**Forthe fiscal year ended September 30, 2005**

**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 to Section 12(b) ofthe Act:**

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

 

**Securities registered pursuant to Section 12(g) ofthe Act:**None

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

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Exchange Act. o Yes   x No

Indicate by check markwhether 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 ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of Registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K. o Yes   x No

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act). o Yes   x No

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

The aggregate market valueof common stock held by non-affiliates of the Registrant as of March 31,2005 (the last business day of our most recently completed second fiscalquarter) was approximately $17,795,127 based upon the closing price for sharesof our common stock as reported by the American Stock Exchange on such date.

As of December 20,2005, 6,840,362 shares of the Registrant’s common stock were outstanding.

**DOCUMENTSINCORPORATED BY REFERENCE**

Portionsof the proxy statement for the Registrant’s 2006 annual stockholders meeting,which will be filed with the Commission on or before January 28, 2006, areincorporated by reference in Part III of this report.

 

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**Tableof ContentsForm 10-K**
| **PART I**   |
|-------------------|
| Item 1.           |   | Business |   | 3 |
| Item 1A.          |   | Risk Factors |   | 38 |
| Item 1B.          |   | Unresolved  Staff Comments |   | 50 |
| Item 2.           |   | Properties |   | 51 |
| Item 3.           |   | Legal  Proceedings |   | 52 |
| Item 4.           |   | Submission  of Matters to a Vote of Security Holders |   | 53 |
| **PART II**  |
| Item 5.           |   | Market  for Registrant’s Common Equity, Related Stockholder Matters and Issuer  Purchases of Equity Securities |   | 54 |
| Item 6.           |   | Selected  Financial Data |   | 55 |
| Item 7.           |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operation  |   | 57 |
| Item 7A.          |   | Quantitative  and Qualitative Disclosures About Market Risk |   | 73 |
| Item 8.           |   | Financial Statements and Supplementary Data |   | 74 |
| Item 9.           |   | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosure |   | 75 |
| Item 9A.     |   | Controls  and Procedures |   | 75 |
| Item 9B.     |   | Other  Information |   | 75 |
| **PART III** |
| Item 10.          |   | Directors  and Executive Officers of the Registrant |   | 76 |
| Item 11.          |   | Executive  Compensation |   | 76 |
| Item 12.          |   | Security  Ownership of Certain Beneficial Owners and Management |   | 76 |
| Item 13.          |   | Certain  Relationships and Related Transactions |   | 76 |
| Item 14.          |   | Principal  Accounting Fees and Services |   | 76 |
| **PART IV**  |
| Item 15.          |   | Exhibits  and Financial Statement Schedules |   | 77 |
| Signatures        |   | 99 |
|                   |  |  |  |  |  |

 

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**PART I**

**Item 1.**                        Business.

Prospect Medical Holdings, Inc.is a health care management services organization. We provide managementservices to affiliated physician organizations that operate as independentphysician associations (“IPAs”) or medical clinics. Our affiliated physicianorganizations enter into agreements with health maintenance organizations (“HMOs”)to provide enrollees of the HMOs with a full range of medical services inexchange for fixed, prepaid monthly fees known as “capitation” payments.

The IPAs contract withphysicians (primary care and specialist) and other health care providers toprovide all of their medical services. The medical clinics employ their primarycare physicians, which provide the vast majority of their medical services, whilecontracting with specialist physicians and other health care providers toprovide other required medical services.

Through our two managementsubsidiaries—Prospect Medical Systems and Sierra Medical Management—we haveentered into long-term agreements to provide management services to each of ouraffiliated physician organizations in exchange for a management fee. Themanagement services we provide include negotiation of contracts with physiciansand HMOs, physician recruiting and credentialing, human resources services,claims administration, financial services, provider relations, member services,case management including utilization management and quality assurance, datacollection, and management information systems. For further discussion of theseservices, see Item 1, “Business—Management Services Agreements.”

Our two managementsubsidiaries currently provide management services to twelve affiliatedphysician organizations, including Prospect Medical Group, ten other affiliatedphysician organizations that Prospect Medical Group owns or controls, and oneaffiliated physician organization that is a joint venture in which ProspectMedical Group owns a 50% interest. We have utilized Prospect Medical Group,which was our first affiliated physician organization, to acquire the ownershipinterest in all of our other affiliated physician organizations. Thus, whileProspect Medical Group is itself an affiliated physician organization that doesthe same business in its own service area as all of our other affiliatedphysician organizations do in theirs, Prospect Medical Group also serves as aholding company for our other affiliated physician organizations.

Physician organizations,by California law, may only be owned by physicians. We have designated Jacob Y.Terner, M.D., our Chairman and Chief Executive Officer, to be the owner of allof the capital stock of Prospect Medical Group. As such he indirectly controlsProspect Medical Group’s ownership interest in each of our other affiliatedphysician organizations. Dr. Terner is also the Chief Executive Officer ofProspect Medical Group and all of our other affiliated physician organizationsthat Prospect Medical Group owns. Dr. Terner is the Chief ExecutiveOfficer of one of the two general partners of our joint venture affiliatedphysician organization.

We control each affiliatedphysician organization through an assignable option agreement that we haveentered into through our management subsidiary, Prospect Medical Systems, with Dr. Ternerand Prospect Medical Group. The assignable option agreement gives us the rightto designate a successor physician to buy the capital stock of Prospect MedicalGroup from Dr. Terner for nominal consideration. The assignable optionagreement allows us to control who owns the stock of Prospect Medical Group andindirectly control each affiliated physician organization that Prospect MedicalGroup controls. We refer to this arrangement as a “single shareholder model.”

For financial reportingpurposes, we are deemed to control Prospect Medical Group under U.S. GenerallyAccepted Accounting Principles (see Item 7, “Financial Information—Management’sDiscussion and Analysis of Financial Condition and Results of Operations—CriticalAccountingPolicies—Consolidation of Financial Statements”) and are therefore required toconsolidate the financial statements of Prospect Medical Group with those ofour management subsidiaries.

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The thirteen affiliatedphysician organizations that we currently manage through our subsidiariesinclude Prospect Medical Group, which is an IPA wholly owned by Dr. Terner,eight IPAs wholly owned by Prospect Medical Group, two medical clinics whollyowned by Prospect Medical Group, one IPA in which Prospect Medical Group has a55% controlling interest, and one IPA which is a joint venture in whichProspect Medical Group owns a 50% interest through another affiliated physicianorganization. In July 1999, we entered into the joint venture partnershipagreement with an unrelated third party, AMVI/IMC Health Network, Inc. (“AMVI”),in order to aggregate sufficient Medicaid enrollees to qualify forparticipation in the CalOPTIMA Medicaid (Medi-Cal in California) program inOrange County, California. We own a 50% interest in the joint venturepartnership, although our portion of the business is operated autonomously. Inaccordance with the joint venture partnership agreement, profits and losses arenot split in accordance with the partnership ownership interest, but rather,are directly tied to the results of our portion of the business. Separate fromany earnings we generate from our portion of the business within the jointventure, we also earn fees for management services we provide to our partner inthe joint venture. We account for our interest in the joint venture using theequity method of accounting. We include in our financial statements only thenet results attributable to those Medicaid enrollees specifically identified asassigned to us, together with the management fee that we charge for managingthose Medicaid enrollees specifically assigned to the other joint venturepartner. Operations for the joint venture are similar to our other affiliatedphysician organizations, with the distinction that all enrollees are Medicaidbeneficiaries.

Information about our thirteen affiliated physicianorganizations is listed in the table below:

**AffiliatedPhysician Organizations of Prospect Medical Holdings**

| **Name of Affiliated  Physician Organization** | ** ** | ** **      | ** ** | **Type**                                                                                     | ** ** | **Owned By**          | ** ** | **Managed By(1)** | ** ** |
|---------------------------------------------------------------|------------|-----------------|------------|----------------------------------------------------------------------------------------------|------------|----------------------------|------------|------------------------|------------|
| Prospect Medical Group                                        |       | IPA             |       | Jacob Y. Terner, M.D. (100%)                                                                 |       | Prospect  Medical Systems  |       |
| Prospect Health Source Medical Group                          |       | IPA             |       | Prospect Medical Group (100%)                                                                |       | Prospect  Medical Systems  |       |
| Prospect Professional Care Medical Group                      |       | IPA             |       | Prospect Medical Group (100%)                                                                |       | Prospect  Medical Systems  |       |
| Prospect NWOC Medical Group                                   |       | IPA             |       | Prospect Medical Group (100%)                                                                |       | Prospect  Medical Systems  |       |
| Santa Ana/Tustin Physicians Group                             |       | IPA             |       | Prospect Medical Group (100%)                                                                |       | Prospect  Medical Systems  |       |
| Nuestra Familia Medical Group                                 |       | IPA             |       | Prospect Medical Group (55%)                                                                 |       | Prospect  Medical Systems  |       |
| AMVI Prospect Health Network                                  |       | IPA             |       | Prospect  Medical Group, through Santa Ana/Tustin Physician’s Group (50% joint venture) |       | Prospect  Medical Systems  |       |
| Sierra Primary Care Medical Group                             |       | Medical  Clinic |       | Prospect Medical Group (100%)                                                                |       | Sierra  Medical Management |       |
| Pegasus Medical Group                                         |       | Medical  Clinic |       | Prospect Medical Group (100%)                                                                |       | Sierra  Medical Management |       |
| Antelope Valley Medical Associates                            |       | IPA             |       | Prospect Medical Group (100%)                                                                |       | Sierra  Medical Management |       |
| APAC Medical Group                                            |       | IPA             |       | Prospect Medical Group (100%)                                                                |       | Prospect  Medical Systems  |       |
| StarCare Medical Group                                        |       | IPA             |       | Prospect Medical Group (100%)                                                                |       | Prospect  Medical Systems  |       |
| Genesis HealthCare  of Southern CA(2)                         |       | IPA             |       | Prospect Medical Group (100%)                                                                |       | Prospect Medical Systems   |       |

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(1)          ProspectMedical Systems and Sierra Medical Management are wholly owned directsubsidiaries of Prospect Medical Holdings.

(2)          AcquiredNovember 1, 2005. Operations will be included in our financial statementsbeginning November 1, 2005.

Our affiliated physicianorganizations provided medical services to a combined total of approximately172,000 HMO enrollees at September 30, 2005. AMVI Prospect Health Networkenrollees include approximately 5,600 enrollees that we manage for our owneconomic benefit, and 7,300 enrollees that we 

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managefor the economic benefit of our partner in this joint venture, for which weearn management fee income. Genesis HealthCare of Southern California (“Genesis”),which was acquired effective November 1, 2005, has a total of approximately16,000 HMO enrollees. Currently, our affiliated physician organizations havecontracts with approximately twelve HMOs, from which our revenue is primarilyderived. HMOs offer a comprehensive health care benefits package in exchangefor a monthly capitation fee per enrollee, which does not vary regardless ofthe quantity of medical services required or used. HMOs enroll members byentering into contracts with employer groups or directly with individuals toprovide a broad range of health care services for a prepaid charge, withminimal deductibles or co-payments required of the members. All of thecontracts between our affiliated physician organizations and the HMOs providefor the provision of medical services to the HMO enrollees by the affiliatedphysician organization to the HMO enrollees in consideration for the prepaymentof the fixed monthly capitation fee paid by the HMOs.

We, through our managementsubsidiaries, control the expense for the medical component of the costs of ouraffiliated physician organizations by “sub-capitating” all primary carephysicians and many of the specialist physicians that provide the medicalservices to the HMO enrollees. Sub-capitation is an arrangement that existswhen an organization being paid under capitated contracts with an HMO, in turncontracts with other providers on a capitated basis, for a portion of theoriginal capitated premium. For those specialties for which we cannot, or donot, choose to obtain a sub-capitated contract, we negotiate discounted fee-for-servicecontracts. By contract, our affiliated physician organizations generally do notassume responsibility for the costs of providing medical services (“medicalcosts”) that occur outside of their service area, which has been defined as a 30-mileradius around the office of the HMO enrollee’s primary care physician. Allnon-emergent care requires prior authorization, in order to limit unnecessaryprocedures and to direct the HMO enrollee requiring care to the physicians ofour affiliated physician organizations, and the most cost effective facility.Our affiliated physician organizations utilize board certified pulmonologistsand internists, trained in intensive care to maintain control over the patient’sstay in the hospital, reducing unnecessary consultations and facilitating thepatient’s treatment and discharge. We also review medical costs monthly on aregion by region basis and compare those costs to the trend of patientutilization of medical services in each region. In those instances where thepatient utilization is trending very low, we determine whether it would be lessexpensive for our affiliated physician organizations to pay their providers ona discounted fee-for-service basis rather than a fixed capitation payment foreach enrollee per month. See Item 1, “Business—Risk Management.”

Our consolidated businesshas grown through the acquisition of IPAs by Prospect Medical Group. Our planis for Prospect Medical Group to continue to acquire additional IPAs. Wecurrently do not intend to further acquire any individual or small medicalpractices, clinics or medical group practices.

We believe that differentIPAs present different medical cultures and are best served by local medicalmanagement. Therefore, we typically attempt to retain the senior medicalmanagement of the entities that we acquire or with which we affiliate.

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

Our profit growth as aconsolidated business is primarily driven by increasing our revenue throughacquisitions by Prospect Medical Group, and in parallel, reducing theadministrative expenses of our affiliated physician organizations andmanagement subsidiaries. We select our acquisition candidates based in largepart on a history of profitable operations or where we can foresee a synergy,such as, opportunities for economies of scale through a consolidation ofmanagement functions, a competitive environment with respect to hospital andphysician services, and a geographic proximity to current operations or amaterial share of the potential acquisition candidate’s own local market. Uponcompletion of every IPA acquisition, one of our management subsidiaries entersinto a long-term management services agreement with the newly-acquiredphysician organization.

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In effecting anacquisition, our affiliated physician organizations generally acquire medicalassets, including such things as HMO contracts, provider contracts and patientrecords. If related non-medical assets are to be acquired as part of theacquisition, such as, management contracts, furniture, fixtures or equipment,non-medical personnel or real property leases, these are acquired by one of ourmanagement subsidiaries. In some cases, the stock of an acquisition candidateis acquired rather than its assets.

With respect to anyacquisition of assets or stock of an acquisition candidate that is beingacquired by one of our affiliated physician organizations, we, or one or moreof our affiliated entities, may advance cash, or, in some cases, stock to thataffiliated physician organization, for use in consummating the acquisition.

Advances from ourmanagement subsidiaries to the affiliated physician organization are covered bythe terms of the respective management services agreement, which obligate theaffiliated physician organization to repay the advance. Specifically, ourmanagement services agreements give the manager the authority to advance fundsto the affiliated physician organization in order for the affiliated physicianorganization to meet its financial obligations. The management servicesagreements allow the manager and the affiliated physician organization to setthe terms of such advances. The advances are deemed loans that are reflected asa payable or receivable, as applicable, in the financial statements of eachentity and are repayable upon demand. Cash advances among our affiliatedphysician organizations are inter-company in nature and are eliminated inconsolidation in our financial statements.

Furthermore, ProspectMedical Group, our affiliate physician organization which is the owner of allor a significant portion of the capital stock of each of our other affiliatedphysician organizations, has executed a security agreement with its manager,Prospect Medical Systems, covering all of Prospect Medical Group’s obligationsto Prospect Medical Systems under its management services agreement. Thecollateral pledged under such security agreement is all accounts and otherassets of Prospect Medical Group. The manager could technically foreclose onsuch collateral if its loan was not repaid. However, because of our affiliaterelationship with the physician organizations that we manage, we are able tocontrol the timing of the repayment of any loans by our affiliated physicianorganizations. The security interest of Prospect Medical Systems has, however,been subordinated to our loans under our senior secured credit facility untilsuch time as the loans under that facility have been paid in full.

Advances from ouraffiliated physician organization to us or one of our management subsidiariesare covered by the terms of a cash management agreement, which obligates therecipient of the advance to repay it. These advances, like advances from ourmanagement subsidiaries to our affiliated physician organizations, arereflected in the financial statements of each entity as a payable orreceivable, as applicable.

Our executive managementteam consists of seasoned operational, physician, financial, contracting, andadministration executives, who have extensive experience in the healthcareindustry. Jacob Y. Terner, M.D., our Chairman, Chief ExecutiveOfficer and a Director since November 1996, has held positions as aphysician, medical professor, and corporate executive. Dr. Terner was amember of the voluntary faculty at the University of Southern California,School of Medicine for approximately thirty years and holds the title ofEmeritus Clinical Professor of Obstetrics and Gynecology. Prior to his tenurewith our company, Dr. Terner served as Chairman of the Board and ChiefExecutive Officer of Century MediCorp, Inc., a publicly-traded HMOand vertically integrated health-management organization until its October 1992merger with Foundation Health Corporation. Each of our senior executives hasmore than ten years of general business and/or health care experience.

Our principal executiveoffices are located at 400 Corporate Pointe, Suite 525, Culver City, CA,90230. Our telephone number is (310) 338-8677. Our web site addressis *www.prospectmedicalholdings.com*. A copyof this filing is posted on our web site.

A chart of theorganizational structures of both the company and Prospect Medical Group is setforth on the next page.

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**ORGANIZATIONALSTRUCTURE OF OUR BUSINESS**

****

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**Summary of the Structure of our Business**

1.                 Jacob Y. Terneris the nominee shareholder of PMG; CEO of PMH, SMM, and PHR; Secretary andDirector of Nuestra Familia Medical Group, which is 55% owned by ProspectMedical Group; and CEO of Santa Ana-Tustin Physicians Group, which is a 50%joint venture partner in AMVI/Prospect Health Network.

2.                 PMG is anaffiliated physician organization and owns 100% of the stock of all of ourother affiliated physician organizations, 55% of Nuestra Familia Medical Group,and a 50% interest in AMVI/Prospect Health Network.

3.                 PMS, PMG and Dr. Ternerare parties to an Assignable Option Agreement whereby PMS can change theowner/shareholder of PMG at any time. PMS and PMH are deemed to control all theaffiliated physician organizations, except AMVI/Prospect Health Network, forfinancial accounting purposes, dictating a consolidation of the financialstatements of all these entities with PMH and its management subsidiaries. Weaccount for our interest in AMVI/Prospect Health Network using the equitymethod of accounting and we record only the net results derived from ourspecifically identified portion of the joint venture’s operations. In addition,we record the management fee revenue we earn for providing management servicesto our partner’s specifically identified portion of the joint ventureoperations.

4.                 Allof the affiliated physician organizations operate as independent physicianassociations (IPAs) except Sierra Primary Care Medical Group and PegasusMedical Group, which operate as medical clinics.

**Managed Care Industry Overview**

We operate our business in the rapidly evolvingmanaged health care industry. Historically, the substantial majority of medicalservices were provided on a fee-for-service (indemnity) basis, with insurancecompanies or individuals assuming responsibility for paying all or a portion ofsuch fees. The costs of medical services have historically risen at a higherrate than the consumer price index. As a result, insurers, employers, state andfederal governments and other health insurance payers have sought to reduce orcontrol the sustained increases in health care costs. The response to thesecost increases has been a shift away from the traditional fee-for-servicemethod of paying for health care to managed health care models, such as HMOs,that rely on the concept that pre-payment based on prior negotiation is an effectiveway of controlling health care costs.

HMOs offer a comprehensive health care benefitspackage in exchange for a fixed prepaid monthly fee or premium per enrolleethat does not vary regardless of the quantity of medical services required orused. HMOs enroll members by entering into contracts with employer groups ordirectly with individuals to provide a broad range of health care services fora prepaid charge, with minimal deductibles or co-payments required of themembers. HMOs contract directly with medical clinics, independent physicianassociations, hospitals and other health care providers to provide medical careto HMO enrollees. In California, it is customary for the HMOs to delegate theresponsibility for managing the provision of medical services to independentphysician associations or medical clinics with which the HMOs have contracts.In states such as California, a provider can only accept risk from an HMO forthose services that the provider is authorized to perform within the scope ofits licensure. For example, a physician organization cannot accept risk for theprovision of hospital services, and a hospital cannot accept risk forprofessional medical services. The affiliated physician organization contractswith the HMOs provide for payment to the affiliated physician organizations ofa fixed monthly fee per enrollee, which is called a capitation payment. Oncenegotiated, the total payment is based on the number of enrollees covered,regardless of the actual need for and utilization of covered services. Underthese contracts, we, through our affiliated physician organizations andmanagement subsidiaries, assume the financial risk that all 

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necessary health careservices and the management costs associated with the provision of thoseservices can be provided at a cost less than the amount paid to our affiliatedphysician organizations by the HMOs.

The management services we provide, through ourmanagement subsidiaries, include the negotiation of contracts with physiciansand HMOs, physician recruiting and credentialing, human resources services,claims administration, financial services, provider relations, member services,medical management including utilization management and quality assurance, datacollection and management information systems. Physicians have not beenequipped by training or experience to handle all of these functions.Accordingly, physicians have either hired staff and purchased the necessaryequipment to support these functions within their practice, or hired an outsidemanagement company.

Physicians, includingthose in small to mid-sized physician groups, find themselves at a competitivedisadvantage in the current managed care environment. They generally do nothave a significant market presence and lack the capital to purchasesophisticated management information systems required to manage riskarrangements. Administrative burdens have been exacerbated by the presence ofmultiple HMOs, requiring physicians to comply with multiple formats for claimsprocessing, credentialing and medical management. Additionally, a proliferationof state and federal regulations has increased the paper-work burden andhampered the application of the traditional controls used by managed careorganizations. Physicians increasingly are responding to these pressures withinthe managed care industry by affiliating with organizations such as our companyto mitigate their economic risk and perform the non-medical managementand administrative tasks that arise from the delegated managed care model.

**Our Strategy**

Our business strategy is to target geographicalregions with many IPAs and to achieve growth and scale within those regions,primarily through the acquisition of selected IPAs by Prospect Medical Group.

As of December 1, 2005, there were approximately160 small, medium and large IPAs in California. Many of these IPAs cannotobtain or have been unwilling to pursue the acquisition of capital with whichto enhance their facilities or the human resources and information technologyin order to grow. Smaller IPAs are disadvantaged in that they have fewermembers and revenue over which to spread high fixed costs and the increasingcost of governmental regulation. Additionally, and because of their size, manysmaller IPAs do not have as much leverage in physician and HMO contracting.Owners of IPAs that fall into this category likewise may be more amenable toconsidering fair offers for their businesses.

As Prospect gets larger in the markets in which weoperate, our increasing size should allow us to absorb the high fixed costs andcost of governmental regulation, while also providing additional leverage inour physician and HMO contracting.

To date, we havefocused on acquisition candidates in Southern California. We have identifiedpotential IPA acquisition candidates in Southern California having an aggregateof approximately 200,000 HMO enrollees, although no assurance can be given ofour ability to acquire any of those IPAs. We select acquisition candidatesbased in large part on the following broad criteria:

·        Ahistory of profitable operations or a predictable synergy such as opportunitiesfor economies of scale through a consolidation of management functions;

·        Acompetitive environment with respect to a high concentration of hospitals andphysicians; and

·       Ageographic proximity to current operations or a material share of the potentialacquisition candidate’s own local market.

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Oursubsidiary Prospect Medical Systems conducts substantially all of itsoperations in Orange and Los Angeles Counties of Southern California, while oursubsidiary Sierra Medical Management conducts certain medical managementoperations in the Antelope Valley region in northern Los Angeles County, andshares some functions with Prospect Medical Systems in Orange County. Ouraffiliated physician organizations are listed below:

| **Affiliated Physician Organizations**                     | ** ** | ** ** | ** ** | **Percentage   Owned  By Prospect  Medical  Group, Inc.(1)** | ** ** | **Area of Operations** |
|------------------------------------------------------------|------------|------------|------------|-------------------------------------------------------------------|------------|------------------------|
| Prospect Medical  Group, Inc.(1)(4)                   |       | —     |       | Orange, Los Angeles and Riverside  Counties                       |
| Sierra Primary Care  Medical Group, Inc.(2)           |       | 100%       |       | Antelope Valley  (Los Angeles County)                             |
| Santa Ana-Tustin  Physicians Group, Inc.(4)(5)        |       | 100%       |       | Orange County                                                     |
| Pegasus Medical  Group, Inc.(2)                       |       | 100%       |       | Antelope Valley  (Los Angeles County)                             |
| Antelope Valley Medical  Associates, Inc.(4)          |       | 100%       |       | Antelope Valley  (Los Angeles County)                             |
| Nuestra Familia Medical  Group, Inc.(4)               |       | 55%        |       | East Los Angeles                                                  |
| AMVI/Prospect Health  Network(3)(4)                        |       | 50%        |       | Orange County                                                     |
| Prospect Health Source  Medical Group, Inc.(4)        |       | 100%       |       | West Los Angeles                                                  |
| Prospect Professional  Care Medical Group, Inc.(4)(6) |       | 100%       |       | North Orange County and East  Los Angeles                         |
| Prospect NWOC Medical  Group, Inc.(4)(7)              |       | 100%       |       | North Orange County                                               |
| StarCare Medical  Group, Inc.(4)(7)                   |       | 100%       |       | North Orange County                                               |
| APAC Medical  Group, Inc.(4)(7)                       |       | 100%       |       | Central Orange County                                             |
| Genesis HealthCare of Southern California (4)(8)           |       | 100%       |       | Central Orange County                                             |

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(1)          A medical corporationowned by a single shareholder, currently, Jacob Y. Terner, M.D.

(2)          Medical clinic.

(3)          Joint venturepartnership with AMVI/IMC Health Network to service only enrollees of CalOPTIMAwhich are all Medi-Cal enrollees. (Medi-Cal is the California Medicaidprogram.)

(4)          IPA.

(5)          Consolidated intoProspect Medical Group, Inc. (November 1998).

(6)          Acquired September 30,2003.

(7)          Acquired February 1,2004.

(8)          Acquired November 1,2005.

To support our growth strategy, we have invested over$2,000,000 in the expansion of our operational infrastructure implementing asophisticated management information system called IDX Systems Managed CareApplication (“IDX”). In February 2005, we paid $475,000 to renew allrequired IDX software licenses for a ten year period. In addition, we paymonthly IDX maintenance fees of approximately $16,000. IDX processes andmonitors virtually all facets of our management operations, including claimsmanagement and eligibility. The IDX system provides timely operating informationand trend data, to enable rapid and proactive management action, wherenecessary.

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Additionally, wehave developed significant knowledge capital with separate departments tomanage the key areas of our affiliated physician organizations operations. Thesedepartments include:

·        Clinicaloperations, including case management, medically related member services andquality control;

·        Claims,including financially related member services;

·        Contractingand credentialing, including provider relations;

·        Eligibility;

·        Financeand accounting;

·        HMOrelations;

·        Informationtechnology;

·        Physiciannetworks, including business development and marketing.

On behalf of ouraffiliated physician organizations, we managed data for approximately 172,000HMO enrollees as of September 30, 2005. We estimate that our IDX systemhas the capacity to process the data of at least an additional 350,000 HMOenrollees. Therefore, we believe that the cost per enrollee of adding a largenumber of new enrollees would be significantly less than our current cost perenrollee.

**Our Market**

Southern California is a mature managed care market.According to the California Department of Finance (Demographic Research Unit),the California population was approximately 36.8 million as of January 1,2005. According to the latest survey by Cattaneo and Stroud, Inc. (afor-profit California managed care industry research group funded, in part, bythe California Healthcare Foundation), approximately 17.3 million individuals,or approximately 47% of California residents were enrolled in HMOs as of March 2005,representing a decrease of approximately 80,000 HMO enrollees compared to March 2004.HMO enrollment in California has declined slightly over the past three years,which has been attributed to the economy, unemployment, and a consumer move topreferred provider organizations (“PPOs”), which are another type of managedcare plan modeled after the original fee-for-service indemnity plans, butrequiring physicians to accept discounted fees. PPO customers experience higherpremiums, co-payments and increased deductibles in exchange for the ability tochoose their own physicians, whereas HMO enrollees receive virtually allnecessary healthcare coverage with minimal co-payments.

Another reason we believe that California offers moreeconomic opportunity for us is because physicians and hospitals haveestablished practice and referral patterns that are consistent with providingservices within a managed care framework. With a substantial portion of the Californiapopulation utilizing either an HMO or a PPO (discounted fee-for-service),managed care is commonplace.

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So farProspect Medical Group has limited its acquisition of physician organizationsto the following organizations in Orange County, California and Los AngelesCounty, California:

| ** **                                        | ** ** | **As of September 30, 2005** | ** ** |
|---------------------------------------------------|------------|--------------------------------------------------|------------|
| **Affiliated Physician Organizations**  | ** ** | ** **                                       | ** ** | **Primary  Care  Physicians** | ** ** | **Specialists** | ** ** | **Enrollees** | ** ** | **Area of Operations** | ** ** |
| Prospect Medical Group,  Inc.                     |       |                                             | 293        |   |   |   | 4162 |   |   |   | 34,500 |   |   | Orange,  Los Angeles &  Riverside Counties |   |
| Prospect Health  Source Medical Group, Inc.  |       |                                             | 76         |   |   |   | 622 |   |   |   | 21,100 |   |   | West  Los Angeles |   |
| Sierra Primary  Care Medical Group, Inc.(1)  |       |                                             | 6          |   |   |   | 899 |   |   |   | 12,300 |   |   | Antelope  Valley  (Los Angeles County) |   |
| Pegasus Medical Group, Inc.                  |       |                                             | 2          |   |   |   | 17 |   |   |   | 3,500 |   |   | Antelope  Valley  (Los Angeles County) |   |
| Nuestra Familia  Medical Group, Inc.         |       |                                             | 86         |   |   |   | 214 |   |   |   | 5,600 |   |   | East  Los Angeles |   |
| Antelope Valley  Medical Associates, Inc.    |       |                                             | 14         |   |   |   | 162 |   |   |   | 8,300 |   |   | Antelope  Valley  (Los Angeles County) |   |
| AMVI / Prospect  Health Network(5)                |       |                                             | 47         |   |   |   | 47 |   |   |   | 12,800 |   |   | Orange  County |   |
| Prospect  Professional Care Medical Group(2) |       |                                             | 106        |   |   |   | 1264 |   |   |   | 31,000 |   |   | East  Los Angeles &  Orange County |   |
| Prospect NWOC  Medical(3) Group, Inc.   |       |                                             | 65         |   |   |   | 628 |   |   |   | 12,400 |   |   | North  Orange County |   |
| StarCare Medical  Group, Inc.(3)(4)          |       |                                             | 59         |   |   |   | 209 |   |   |   | 26,900 |   |   | North  Orange County |   |
| APAC Medical  Group, Inc.(3)(4)              |       |                                             | 38         |   |   |   | 119 |   |   |   | 3,500 |   |   | Central  Orange County |   |
| Totals                                            | ** ** | ** **                                       | **792**    |   | ** ** | ** ** | **8,343** |   | ** ** | ** ** | **171,900** |   |   |   |   |
|                                                   |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Excludes 11 full timephysicians and 2 part time physicians employed by Sierra Primary Care MedicalGroup and Pegasus Medical Group.

(2)          Acquisition completed asof September 30, 2003.

(3)          Acquisition completed asof February 1, 2004.

(4)          StarCare and APAC sharespecialist physicians.

(5)          Includes approximately 5,600enrollees that we manage for our own economic benefit, and 7,300 enrolleesthat we manage for the economic benefit of our partner in this joint venture,for which we earn management fee income.

(6)          Primarycare physicians, specialists and enrollees of Genesis HealthCare of SouthernCalifornia, as of its November 1, 2005 acquisition date, totaledapproximately 198, 292, and 16,000, respectively.

**EnrollmentStatisticsAs of September 30**

| ** ** | ** ** | **1997**   | ** ** | **1998**   | ** ** | **1999**    | ** ** | **2000**   | ** ** | **2001**    | ** ** | **2002**    | ** ** | **2003**    | ** ** | **2004**    | ** ** | **2005**    | ** ** |
|------------|------------|------------|------------|------------|------------|-------------|------------|------------|------------|-------------|------------|-------------|------------|-------------|------------|-------------|------------|-------------|------------|
| Commercial |       | 62,000     |       | 83,000     |       | 87,000      |       | 83,000     |       | 105,000     |       | 102,000     |       | 136,200     |       | 168,500     |       | 144,900     |       |
| Medicare   |       | 7,300      |       | 8,200      |       | 8,800       |       | 7,800      |       | 9,800       |       | 7,000       |       | 11,200      |       | 15,500      |       | 12,500      |       |
| Medi-Cal   |       | 6,000      |       | 6,700      |       | 7,600       |       | 6,700      |       | 6,300       |       | 8,500       |       | 13,700      |       | 14,400      |       | 14,500      |       |
| **Totals** | ** ** | **75,300** | ** ** | **97,900** | ** ** | **103,400** | ** ** | **97,500** | ** ** | **121,100** | ** ** | **117,500** | ** ** | **161,100** | ** ** | **198,400** | ** ** | **171,900** | ** ** |

 

The Medi-Cal enrollment statistics above include bothenrollees that we manage for our own economic benefit, and enrollees that,starting in 1999, we manage for the economic benefit of our partner in the AMVI/ProspectHealth Network joint venture. The number of enrollees included in the abovetable for which we provide management services to our joint venture partner,but in which we have no beneficial 

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ownership interest, was 4,200,4,000, 5,600, 7,100, 7,100 and 7,300 as of September 30, 2000, 2001, 2002,2003, 2004 and 2005, respectively.

Commercial and MedicareEnrollment Statistics for Genesis HealthCare of Southern California, as of its November 1,2005 acquisition date, totaled approximately 14,900, and 1,100, respectively.Genesis has no Medi-Cal enrollees.

**Revenue Concentration Statistics of our AffiliatedProfessional OrganizationsFor the Fiscal Years Ended September 30, 2003, 2004 and 2005**

Forthe fiscal years ended September 30, 2003, 2004 and 2005 our affiliatedphysician organizations recognized capitation revenue of $63,512,597, $125,860,567and $129,143,656, respectively. During those periods, the four largest clientsof our affiliated physician organizations, PacifiCare of California, Health Netof California, Blue Cross of California and Blue Shield of California accountedfor approximately 84% 80% and 80% of total capitation revenue, respectively:

| ** **  | ** ** | **Capitation  Revenue**      | ** **     | ** **               | ** ** | **Capitation  Revenue**      | ** ** | ** **               | ** ** | **Capitation  Revenue**      | ** ** | ** **               | ** ** |
|-------------|------------|------------------------------|----------------|--------------------------|------------|------------------------------|------------|--------------------------|------------|------------------------------|------------|--------------------------|------------|
| ** **  | ** ** | **Year Ended**          | ** **     | **% of Total** | ** ** | **Year Ended**          | ** ** | **% of Total** | ** ** | **Year Ended**          | ** ** | **% of Total** | ** ** |
| ** **  | ** ** | **September 30,  2003** | ** **     | **Capitation  Revenue**  | ** ** | **September 30,  2004** | ** ** | **Capitation  Revenue**  | ** ** | **September 30,  2005** | ** ** | **Capitation  Revenue**  | ** ** |
| PacifiCare  |       | $                            | 19,238,866     |                     |       | 30                           | %          |                     | $          | 40,903,464                   |       |                     | 32         | % |   | $ | 40,155,679 |   |   | 31 | % |   |
| Health Net  |       | 15,318,402                   |           |                     | 24         | %                            |       | 25,933,742               |       |                         | 21         | %                        |       | 25,224,324 |   |   | 20 | % |   |
| Blue Cross  |       | 11,850,966                   |           |                     | 19         | %                            |       | 19,899,135               |       |                         | 16         | %                        |       | 21,365,598 |   |   | 17 | % |   |
| Blue Shield |       | 7,399,387                    |           |                     | 11         | %                            |       | 13,467,152               |       |                         | 11         | %                        |       | 14,802,756 |   |   | 12 | % |   |
| **Totals**  | ** ** | **$**                        | **53,807,621** | ** **               | ** ** | **84**                       | **%**      | ** **               | **$**      | **100,203,493**              | ** ** | ** **               | **80**     | **%** | ** ** | **$** | **101,548,357** | ** ** | ** ** | **80** | **%** | ** ** |

 

See Item 1, “Business—Competition” and Item 1A, “RiskFactors”—for additional details regarding concentration.

As of December 1,2005, our affiliated physician organizations were listed as having a combinedmarket share (based on number of HMO enrollees served) of approximately 9.3percent in Orange County (135,054 enrollees compared to 1,443,750 totalenrollees in Orange County), and approximately 1.1 percent in Los AngelesCounty (52,808 enrollees compared to 4,784,090 total enrollees in Los AngelesCounty).

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**ManagementFees and Revenue Generation**

We,through our management subsidiaries, provide management and administrativesupport services to each of our affiliated physician organizations in returnfor management fees generally ranging from 8.5% to 15% of each organization’sgross revenues. The specific management fee paid by each affiliated physicianorganization is set forth below:

| **Affiliated Physician Organization** | ** ** | ** ** | ** ** | **Management  Fee** | ** ** |
|-------------------------------------------------|------------|------------|------------|---------------------|------------|
| Prospect Medical  Group                         |       |       | 15         | %                   |       |
| Nuestra Familia  Medical Group                  |       |       | 12         | %                   |       |
| AMVI/Prospect  Health Network(1)                |       |       | 8.5        | %                   |       |
| Prospect Health  Source Medical Group           |       |       | 12.5       | %                   |       |
| Prospect  Professional Care Medical Group       |       |       | 15         | %                   |       |
| Prospect NWOC  Medical Group                    |       |       | 15         | %                   |       |
| Starcare Medical  Group                         |       |       | 15         | %                   |       |
| APAC Medical  Group                             |       |       | 15         | %                   |       |
| Sierra Primary  Care Medical Group              |       |       | 15         | %                   |       |
| Pegasus Medical  Group, Inc.               |       |       | 15         | %                   |       |
| Antelope Valley  Medical Associates             |       |       | 15         | %                   |       |
| Genesis HealthCare of  Southern California      |       |       | 15         | %                   |       |

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(1)          AMVI/Prospect HealthNetwork has an agreement with Prospect Medical Systems which is based upon aper member/per month management fee that equates to approximately 8.5% ofAMVI/Prospect Health Network’s gross revenues.

In addition to the management fees described above, wealso receive an incentive bonus based on the net profit or loss of each wholly-ownedaffiliated physician organization. With the exception of Prospect Health SourceMedical Group, we are allocated a 50% residual interest in the profits above 8%of the profits or a 50% residual interest in the net losses, after deductionfor costs to the management subsidiary and physician compensation. For ProspectHealth Source Medical Group, we are allocated a 40% residual interest in itsprofits or losses.

Because of the ownership of a controlling financialinterest by Prospect Medical Group or Dr. Terner in all of our affiliatedphysician organizations, other than AMVI/Prospect Health Network, should wedetermine that an adjustment to our management fees is appropriate (other thanAMVI/Prospect Health Network), we are able to accomplish this adjustment due toour controlling financial interest in the affiliated physician organization. Inthe case of AMVI/Prospect Health Network, because Prospect Medical Group’sownership interest is a 50% interest, in the event we determine that anadjustment of the management fee for AMVI/Prospect Health Network isappropriate, an adjustment would require negotiation with the joint venturepartner.

Notwithstanding our ability to control the managementfee adjustment process, we are limited by laws affecting management fees ofhealth care management service companies. Such laws require that our managementfees reflect fair market value for the services being rendered, givingconsideration however to the costs of providing the services. Such laws alsolimit our ability to increase our management fees more frequently than once ayear.

The management fees received by our managementsubsidiaries and the revenue of our affiliated physician organizations (otherthan AMVI/Prospect Health Network) are consolidated in our financial statementsdue to our controlling financial interest. In the case of AMVI/Prospect HealthNetwork, only that portion of the results which are allocated to us areconsolidated in the accompanying financial 

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statements, together withthe management fee that we charge our joint venture partner, AMVI, for managingAMVI’s share of the joint venture operations.

The management fee percentage listed above for theAMVI/Prospect Health Network joint venture approximates the followingspecifically determined management fees. There are two primary CalOPTIMAprograms; basic Medi-Cal and a related program called Healthy Families, focusedon health coverage for children. For the management services we provide to enrolleesassigned to AMVI’s division of the joint venture, one of our managementcompanies, Prospect Medical Systems, is compensated $4.36 per member per monthfor the Medicaid enrollees, and 11% of hospital capitation revenues received bythem for Healthy Families enrollees. We record these amounts as revenue. Forthe management services we provide to enrollees assigned to our division of thejoint venture, Prospect Medical Systems is compensated $4.70 per member permonth for the Medicaid enrollees and 11% of hospital capitation revenuesreceived for Healthy Families enrollees. We eliminate these intercompanyamounts in consolidation. The fee we charge AMVI is lower than our own, as aresult of matching a competing management services proposal that AMVI receivedfrom another management company. AMVI does not receive any management fees fromthe joint venture.

Revenues of our affiliated IPAs and affiliated medicalclinics are generated under their contracts with the HMOs. Substantially all ofthe capitation revenue paid by the HMOs is received by our IPAs between the10th and the 25th day of each month. The amount of the revenue is determined bythe contract with the various HMOs, which pay the affiliated physicianorganizations a predetermined amount of money per enrollee, per month (known asa capitation payment).

Our three management subsidiaries have the right,under their management services agreements, to control the depository accountsof the affiliated physician organizations they manage. Our management subsidiariesmake disbursements on behalf of each affiliated physician organization to payfor all physician medical expenses for the HMO enrollees.

The payments includeprimary care and specialist sub-capitation, and fee-for-service payments forthose physicians who are not sub-capitated. Sub-capitation is an arrangementwhereby a physician accepts a single payment per patient per month which is aportion of the capitation payment received by the affiliated physicianorganizations from the HMO in exchange for which the physician provides allservices in their area of expertise or specialty.

**Risk Management**

We must control themedical expense or medical risk of our affiliated physician organizations. Weuse sub-capitation as one technique to control this risk. Approximately 50% ofthe medical costs of our affiliated physician organizations are sub-capitated.Another 20% of the medical costs are not sub-capitated because the patientutilization is so low that sub-capitation would be counter-productive.The remaining 30% of the medical costs of our affiliated physicianorganizations are controlled in the following ways:

·        FLEXIBILITY:As a general policy, we do not undertake the management of IPAs which we do notcontrol through the single shareholder model. As a result, we can bettercontrol costs due to the absence of competing interests or diverse agendasbetween the affiliated IPAs and our management subsidiaries.

·        SUB-CAPITATINGAND CONTRACTING: For those specialties for which our affiliated physicianorganizations cannot or do not choose to obtain a sub-capitated contract, wenegotiate discounted fee-for-service contracts. The reimbursement mode of thesecontracts is approximately 80% of the amount Medicare allows. The range is 65%to 120% of Medicare allowable.

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·        SERVICEAREA RESTRICTION: In negotiating contracts for our affiliated physicianorganizations with the HMOs, we have been able to define the service area ofour affiliated physician organizations as a 30-mile radius around theoffice of the HMO enrollee’s primary care physician. By contract, ouraffiliated physician organizations generally do not assume responsibility formedical costs that occur outside of their service area. The out-of-area andnon-physician components of hospitalization costs are generally theresponsibility of the HMO.

·        REFERRALREVIEW: All non-emergent care requires the prior authorization of ouraffiliated physician organizations. Consequently, our affiliated physicianorganizations have the ability to limit unnecessary procedures and to directthe enrollees requiring care to their contracted physicians and the most costeffective facility.

·        AUTOMATION:Our information technology systems allow us generally to analyze medical costdistribution by the fifteenth day following the month in which claims are paid,facilitating a rapid response to any perceived distortion in medical costs.

·        EFFICIENTUSE OF HOSPITALS: Our affiliated physician organizations contract withhospitalists to see all of our physician groups’ patients who are hospitalized.Hospitalists are board certified pulmonologists and internists who are trainedin intensive care. They effectively maintain control over the patient’s stay inthe hospital, cutting down unnecessary consultations and facilitating thepatient’s treatment and discharge.

In addition, our affiliated physician organizations’agreements with HMOs and hospitals contain risk-sharing arrangements underwhich the affiliated physician organizations can earn additional compensationby coordinating the provision of high quality, cost-effective health care toenrollees, but they may also be required to assume a portion of any losssustained from these arrangements. Risk-sharing arrangements are based upon thecost of hospital services or other services for which our physicianorganizations are not capitated. The terms of the particular risk-sharingarrangement allocate responsibility to the respective parties when the cost ofservices exceeds a budget, which results in a “deficit,” and permit the partiesto share in any amounts remaining in the budget, known as a “surplus,” whichoccurs when actual cost is less than the budgeted amount. The amount ofnon-capitated and hospital costs in any period could be affected by factorsbeyond our control, such as changes in treatment protocols, new technologiesand inflation. To the extent that such non-capitated and hospital costs arehigher than anticipated, revenue paid to our affiliated physician organizationsmay not be sufficient to cover the risk-sharing deficits they are responsiblefor paying, which could reduce our revenues and profitability. It is ourexperience that “deficit” amounts for hospital costs are applied to offset any “surplus”amount we would otherwise be entitled to receive. We have historically not beenrequired to reimburse the HMOs for any hospital cost deficit amount. Most ofour contracts with HMOs specifically provide that we will not have to reimbursethe HMO for hospital cost deficit amounts.

In addition to hospital risk-sharing arrangements,many HMOs also provide a risk-sharing arrangement for pharmaceutical costs.Unlike hospital pools where nearly all the HMO contracts mandate participationby our affiliated physician organizations in the risk sharing for hospitalcosts, a lesser number of the HMO contracts mandate participation in a pharmacyrisk-sharing arrangement, and although (unlike hospital pools) our affiliatedphysician organizations are generally responsible for their 50% allocation ofpharmacy cost deficits, the deficit amounts of pharmacy costs have to date notbeen material.

HMOs often insist onwithholding negotiated amounts from the affiliated physician organizations’professional capitation payments, which the HMOs are permitted to retain, inorder to cover the affiliated physician organizations’ share of anyrisk-sharing deficits; and hospitals often demand cash settlements of risksharing deficits as a “quid pro quo” for joining in these arrangements.Whenever possible, we seek to contractually reduce or eliminate our affiliatedphysician organizations’ liability for risk-sharing deficits.

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**OurAffiliated Physician Organizations**

Our affiliated physician organizations consist ofaffiliated IPAs and affiliated medical clinics. Our affiliated IPAs contractwith physicians (primary care and specialist) and other health care providers,to provide all of their medical services. Our affiliated medical clinics employtheir primary care physicians to provide the vast majority of their medicalservices, while contracting with specialist physicians and other health careproviders to provide other required medical services.

All of our affiliated physician organizations enterinto contracts with HMOs to provide medical services to enrollees of the HMOs.Most of the HMO agreements have an initial term of two years renewingautomatically for successive one-year terms. However, because the HMOagreements generally do not provide for any increased capitation rates afterthe initial term, we generally renegotiate the HMO agreements on behalf of ouraffiliated physician organizations at the end of the initial term of such HMOagreements and enter into new agreements or amendments for additional two-yearterms. This provides our affiliated physician organizations with more favorablerates than allowing their HMO agreements to renew pursuant to the automaticsuccessive renewal provisions which would require our affiliated physicianorganizations to continue to provide services at the same rates as the initialterm during such successive term(s).

The HMO agreements generally provide for a terminationby the HMOs for cause at any time, although we have never experienced afor-cause termination. The HMO agreements generally allow either the HMOs orthe affiliated physician organizations to terminate the HMO agreements withoutcause within a four to six month period immediately preceding the expiration ofthe term of the agreement.

Our management subsidiaries provide managementservices to our affiliated IPAs and affiliated medical clinics under managementservices agreements that transfer control of all non-medical components of thebusiness of the affiliated physician organizations to our managementsubsidiaries to the full extent permissible under federal and state law. Whencombined with the single shareholder model, which includes the assignableoption agreement among Prospect Medical Systems, Prospect Medical Group and Dr. Terner,we have an established affiliate relationship with our affiliated physicianorganizations.

As of September 30, 2005, our affiliatedphysician organizations employed 13 physicians (including two part timephysicians), and had independent contracts with approximately 9,135 physicians.

The physicians of the affiliated physicianorganizations are exclusively in control of and responsible for all aspects ofthe practice of medicine, subject to specialist guideline referrals developedby multi-specialty medical committees composed of our contractedphysicians and chaired by one of our medical directors.

We have entered into a management services agreementwith each of our affiliated physician organizations, each of which is for a tento thirty year term. When our existing affiliated physician organizationsacquire other affiliated physician organizations that have contracts with HMOs,we enter into a management services agreement with each newly acquiredaffiliated physician organization as well.

The management of ouraffiliated physician organizations is conducted by our two managementsubsidiaries, Prospect Medical Systems and Sierra Medical Management.

**Assignable Option Agreement**

The assignable option agreement is an essentialelement of our “single shareholder model.” The assignable option agreementprovides our management subsidiary, Prospect Medical Systems, the right at willand on an unlimited basis, to designate a successor physician to purchase thecapital stock of Prospect Medical Group for nominal consideration ($1,000) andthereby determine the ownership of Prospect 

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Medical Group. There is nolimitation on whom we may name as a successor shareholder except that anysuccessor physician must be duly licensed as a physician in the State ofCalifornia or otherwise be permitted by law to be a shareholder of aprofessional corporation.

As a result of the assignable option agreement and ourcontrol of Prospect Medical Systems, we have control over the ownership ofProspect Medical Group. Because Prospect Medical Group is the owner of all or asignificant amount of the capital stock of all of the other affiliatedphysician organizations, control over the ownership of Prospect Medical Groupensures that we can control the ownership of each of our affiliated physicianorganizations.

Execution of the assignable option agreement was arequirement of the management services agreement between Prospect MedicalSystems and Prospect Medical Group. We paid nominal consideration ($100) forthe assignable option agreement. The management services agreement and theassignable option agreement with Prospect Medical Group were executed in 1996when we commenced our affiliation with Prospect Medical Group. The assignableoption agreement terminates or expires coterminous with the management servicesagreement, which has a thirty-year term with successive automatic ten-yearrenewal terms. The assignable option agreement additionally provides that ifthe management services agreement is terminated for any reason, then ProspectMedical Systems’ assignable option is automatically and immediately exercised.Through Prospect Medical Systems, we intend to continue the term of themanagement services agreement with Prospect Medical Group for successive ten-yearterms after the completion of the initial thirty-year term. We believe theautomatic term renewal provisions of the management services agreement, coupledwith the protections afforded us by the automatic option exercise provision inthe assignable option agreement, will ensure the continued availability of theoption under the assignable option agreement.

Jacob Y. Terner, M.D. is currently the soleshareholder, sole director and Chief Executive Officer of Prospect Medical Group,as well as a director and Chief Executive Officer of Prospect Medical Holdings, Inc.,each of our management company subsidiaries except PMS, and each of our otheraffiliated physician organizations, except for AMVI/Prospect Health Network andNuestra Familia Medical Group.

Furthermore, since Dr. Terner is also an officerand director of each of the company, our management subsidiaries and ouraffiliated physician organizations, Dr. Terner has a fiduciary duty toprotect the interests of each entity and its shareholders.

At any time when Prospect Medical Systems determinesthat it is necessary to change the sole shareholder of Prospect Medical Group,with or without cause, Prospect Medical Systems may exercise its rights underthe assignable option agreement and replace the sole shareholder of ProspectMedical Group with another licensed physician selected by our Board ofDirectors. Since we and Prospect Medical Systems are fully aware of therevenues which are earned by Prospect Medical Group (as well as the otheraffiliated physician organizations) and the expenses to be paid from suchrevenue, and further since we prepare regular financial statements and reportsof Prospect Medical Group, we are confident that we would be well aware of anypotential insolvency, liquidation or dissolution of Prospect Medical Groupbefore it occurred, and if we were to conclude that this situation, or anyother type of situation, necessitated the removal of Dr. Terner as thesole shareholder of Prospect Medical Group, then Prospect Medical Systems wouldexercise its option under the assignable option agreement and appoint asuccessor to Dr. Terner.

We believe, although there can be no assurance that inthe event of a liquidation or bankruptcy of Prospect Medical Group, ProspectMedical Systems would likely be appointed to continue as the managementcompany, thereby continuing to earn management service revenue. Additionally,as a result of the substantial amount that would be due to Prospect MedicalSystems for the remaining term of its 30-year management servicesagreement, it is possible that they would become the single largest unsecured 

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creditor of ProspectMedical Group, thus placing Prospect Medical Systems in likely control of acreditors committee.

Prospect Medical Group has executed an inter-companynote and security agreement in favor of Prospect Medical Systems for advancesmade by Prospect Medical Systems to Prospect Medical Group. As a result of thesecurity agreement, those obligations would make Prospect Medical Systems asecured creditor of Prospect Medical Group.

We believe that thecumulative effect of the assignable option agreement and the fiduciary dutyimposed on the single physician shareholder of Prospect Medical Group issufficient to safeguard our control over all business decisions of theaffiliated physician organizations, including any currently unforeseeableinsolvency, liquidation or dissolution of Prospect Medical Group.

**Provider Agreements**

The physicians of theaffiliated physician organizations are exclusively in control of andresponsible for all aspects of the practice of medicine, and are subject tospecialist guideline referrals developed by multi-specialty medicalcommittees composed of our contracted physicians and chaired by one of our medicaldirectors. Each affiliated physician organization enters into the followingtypes of contracts for the provision of physician and ancillary healthservices:

*Primary CarePhysician Agreement*

A primary care physicianagreement provides for primary care physicians contracting with independentphysician associations to be responsible for both the provision of primary careservices to enrollees and for the referral of enrollees to specialistsaffiliated with the independent physician association, when appropriate.Primary care physicians receive monthly sub-capitation for the provision ofprimary care services to enrollees. An independent physician association canterminate the primary care physician agreement immediately upon the occurrenceof certain specified events, including suspension, restriction or revocation ofthe physician’s license to practice medicine in California, denial, restrictionor revocation of medical staff privileges at any hospital for medicaldisciplinary reasons, and the loss of professional liability insurance. Eitherparty to the primary care physician agreement may terminate the agreementwithout cause upon ninety days’ prior written notice.

*SpecialistAgreement*

A specialist agreementprovides for a specialty care physician contracting with the independentphysician association to receive either sub-capitated payments or discountedfee-for-service payments for the provision of specialty services to thoseenrollees referred to them by the independent physician association’s primarycare physician. An independent physician association can terminate thespecialist agreement immediately upon the occurrence of certain specifiedevents, including suspension, restriction or revocation of the physician’slicense to practice medicine in California, denial, restriction or revocationof medical staff privileges at any hospital for medical disciplinary reasons,and the loss of professional liability insurance. Either party to a specialistagreement may terminate the agreement without cause, usually upon ninety days’prior written notice.

*Ancillary ProviderAgreement*

An ancillary provideragreement provides for ancillary service providers—generally non-physicianproviders such as physical therapists, laboratories, etc.—to contract with anindependent physician association to receive either monthly sub-capitated,discounted fee-for service or case rate payments for the provision of serviceto enrollees on an as-needed basis. Generally, either party can terminate theancillary provider agreement with or without cause upon sixty or ninety days’written notice.

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**Management Services Agreements**

Our management subsidiaries, Prospect Medical Systems,and Sierra Medical Management, enter into exclusive ten to thirty yearmanagement services agreements with each of our affiliated physicianorganizations, pursuant to which we, through such subsidiaries, provide themwith management and administrative support services in return for managementfees generally ranging from 8.5% to 15% of each affiliated physician organization’sgross revenues. We also receive an incentive bonus approximating 40% of theprofit of our affiliated physician organizations. In the event of a loss, ourmanagement fee is reduced by approximately 50% of the affiliated physicianorganization’s loss.

The management services agreements with our affiliatedphysician organizations that are 100% owned by Prospect Medical Group or Dr. Ternereach have a thirty-year term and renew automatically for successive ten-yearterms unless either party elects to terminate them 90 days prior to theend of their term. The management services agreements with those affiliatedphysician organizations in which we Prospect Medical Group has less than a 100%interest have different terms. Our contract with Nuestra Familia is for onlyten years; however, because Prospect Medical Group is a 55% shareholder, anyrenewal or termination must be approved by us. Similarly, our joint venturewith AMVI is year-to-year, but because Prospect Medical Group is a 50% owner ofthat joint venture, we cannot be terminated without approval of the board ofdirectors, of which Prospect Medical Group represents 50%. The managementservices agreements are terminable by the unilateral action of the particularphysician organization prior to their normal expiration if we materially breachour obligations under the agreements or become subject to bankruptcy-relatedevents, and we are unable to cure the material breach within sixty days of theoccurrence. All management fees are eliminated in consolidation in ourfinancial statements.

Under themanagement services agreements, we, through our management subsidiaries,provide management functions only. Under these agreements, each affiliatedphysician organization delegates to us the non-physician support activitiesthat are required by the affiliated physician organizations in the practice ofmedicine. The management services agreements require us to provide suitablefacilities, fixtures and equipment and non-physician support personnel to eachaffiliated physician organization. The primary services that we provide undermanagement services agreements include the following:

·       *Utilization Management and Quality Assurance.  *Weassist each affiliated physician organization with the development andimplementation of a utilization and quality management plan. We implementsystems, programs and procedures necessary for the affiliated physicianorganizations and their physicians to perform utilization and qualitymanagement, organize procedures for prior authorization of elective procedures,urgent and emergent outpatient ambulatory surgery and hospital procedures,assist the physicians with their prospective, concurrent and retrospectivereviews of medical procedures in accordance with their policies and HMO healthplan requirements, provide data on the use of outpatient and inpatient servicesby the physicians to the affiliated physician organizations and the use ofnon-contracted physicians, and assist the medical director and the utilizationreview/quality assurance committee of each affiliated physician organization inresponding to HMO member grievances, based on the instructions of the medicaldirector.

·       *Medical Management.  *We have amedical management department that administers the processes by which referralsto specialists and ancillary health care providers are evaluated, coordinatedand implemented on an ongoing basis for both acute illnesses and enrolleesexperiencing chronic disability, complex medical cases or problems requiringlong-term care. The goal of medical management is to provide a continuum ofquality care throughout the enrollee’s treatment period.

·       *Physician Contracting.  *We negotiateagreements with primary care physicians, specialists and ancillary serviceproviders on behalf of our affiliated physician organizations. We alsonegotiate 

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agreements with hospitalsand hospital based physicians for those hospital costs that are the financialresponsibility of the affiliated physician organization.

·       *Physician Credentialing.  *Ourphysician credentialing program seeks to screen physician’s credentials priorto their entry into the independent physician association network, and maintaincredentialing standards once the physician has been accepted into theindependent physician association through a re-credentialing process everythree years. The physician credentialing program includes the investigation andverification of physicians’ qualifications, credentials, proof of malpracticeinsurance and medical staff privileges at the time they are brought into thenetwork, as well as periodically reviewing competency and continuing medicaleducation.

·       *HMO Contracting.  *We evaluate,negotiate and administer agreements with HMOs on behalf of our affiliatedphysician organizations. The contracts with the HMOs generally contain two-yearterms, and can be terminated by the HMO with cause, subject to noticeprovisions. The contracts can also generally be terminated without cause withinfour to six months immediately preceding the end of the term. Most of  our affiliated physician organizations’ HMOcontracts have been in place for many years, and are renegotiated 90-180 daysin advance of the contract expiration dates. Negotiations with HMOs covervarious terms and conditions, including increased capitation rates and thedivision of financial responsibility, which describes the HMO enrollee’scovered benefits that our affiliated physician organizations will befinancially responsible for, as opposed to the covered benefits which are theresponsibility of the HMO.

·       *Claims Administration.  *We possesscomplete medical claims processing capabilities including determining whetherenrollees are eligible, whether services are authorized, identifyingappropriate benefits, issuing payments to providers and analyzing encounterdata.

·       *Financial Services.  *We haveexclusive decision-making authority with respect to the establishment andpreparation of annual budgets for each of our affiliated physicianorganizations. In consultation with each affiliated physician organization, weestablish bank accounts for the deposit of all sums received by each affiliatedphysician organization for services provided to its enrollees. In addition, wemay endorse all checks made payable to each of our affiliated physicianorganizations and make deposits to its bank account, prepare financialstatements on a monthly basis, calculate primary care and specialistsub-capitation payments, pay claims by non-capitated providers, invoice otherpayers for the coordination of benefits and other third party liabilitypayments, such as workers’ compensation claims and automobile insurance claims,administer capitation and other distributions from HMOs including auditing andmonitoring of HMO incentive payments, negotiate and settle the affiliatedphysician organization’s share of such payments, and establish and maintainreserves for our affiliated physician organizations.

·       *Provider Relations.  *We maintain aprovider relations department that orients individual providers to managed carepolicies and procedures, assists each of our affiliated physician organizationsin developing and updating provider operations manuals, and resolves day-to-dayoperational situations that may arise.

·       *Management Information Systems.  *Ourmanagement information system, IDX, is a software system specifically designedwith a managed care application. The management information system maintains anon-line database that provides inpatient and outpatient utilization statisticsand patient encounter reporting. Patient encounter reporting consists of theinformation received from each physician on patient encounter forms for eachpatient visit, which sets forth what services the patient received from thephysician during that visit. Utilization statistics are the patterns of patientencounters for various procedures for specific segments of the patientpopulation. The availability of timely information on utilization patternsimproves physician effectiveness. This data also plays an integral role in thephysician utilization control process by enabling the medical directors and 

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utilization managementnurses to monitor medical management decisions, evaluate patient outcomes andmonitor utilization trends. In addition, the management information system iscapable of performing various administrative functions including enrolleeeligibility verification, outside service referrals and verifications, and claimsprocessing.

·       *Patient Eligibility and Services.  *Weprovide a variety of services related to patient eligibility, includingobtaining eligibility lists from HMOs, assisting with the determination ofeligibility of patients for health care coverage prior to the provision ofmedical services, maintaining a computerized eligibility database to distributeeligibility reports, and insuring that enrollee eligibility and HMO capitationpayments are synchronized.

·       *Member Services.  *Our staff istrained to aid patients in understanding managed care and the nature and extentof health plan coverage, assist patients in making informed decisionsconcerning their medical care and treatment alternatives, and provide supportin resolving patient-physician difficulties and/or qualified financialissues.

·       *Physician Recruiting.  *We seek to recruit primary carephysicians in each of our affiliated physician organizations. Additionally, weadd specialists in each of our affiliated physician organizations as vacanciesarise or based upon financial considerations.

**Marketing and Public Relations**

Our marketing, publicrelations and advertising of health care services is conducted in accordancewith the laws, rules, regulations and guidelines of all applicable governmentaland quasi-governmental agencies, including but not limited to the MedicalBoard of California. In addition to primary care physician recruitment, ourmarketing staff seeks to increase enrollment through attendance at employergroup health fairs and HMO enrollment meetings.

**Competition**

The managed careindustry is highly competitive and is subject to continuing changes withrespect to the manner in which services are provided and how providers areselected and paid. We are subject to significant competition both with respectto physicians affiliating with our physician organizations and in seekingcontracts to manage other physician organizations. Generally, both we and ouraffiliated physician organizations compete with any entity that enters intocontracts with HMOs for the provision of prepaid health care services, including:

·       Othercompanies that provide management services to health care providers but do notown the affiliated physician organization;

·       Hospitalsthat affiliate with one or more physician organizations;

·       HMOsthat contract directly with physicians; and

·       Otherphysician organizations.

Additionally, our affiliated physician organizationscompete with other medical practices in the areas in which we do business orexpect to do business in the future. Pressures to reduce the cost of medicalcare, through legal reform of the health care system or through market forcessuch as the continued expansion of managed care, could adversely impact ourrevenues and the revenues of our affiliated physician organizations. Further,increased enrollment in prepaid plans due to health care reform, increasedparticipation by physicians in group practices and other factors may attractnew entrants into the managed care industry, resulting in increasedcompetition.

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We believe that weoffer competitive services in the Southern California managed care market basedupon three primary factors:

·       *Stability.  *When physician groupsfail or are perceived to be on the brink of failure (a condition of materialbreach in virtually all HMO contracts), HMOs respond by canceling their contractwith the failed group and transferring the enrollees to other physicianorganizations. Physicians in the failing organization will have their patientsassigned to other doctors in unrelated physician organizations, often causingsignificant economic hardship. We attempt to keep our affiliated physiciansapprised of our financial and operational strength to assure our contractedphysicians that their income streams are protected and not in jeopardy. Weachieve this through our provider relations contacts and by our consistentrecord of timely payments, and by meeting health plan guidelines for tangiblenet equity and current IBNR (incurred but not reported) claims calculations. Inthe past, we have acquired and restructured several weak or failing physicianorganizations, which further demonstrated our ability to survive in thecompetitive managed care business.

·       *Competitive Compensation.  *Relativeto other organizations, we offer competitive reimbursement to our primary carephysicians, including a bonus distribution to those physicians in our networks.The amount of the bonus distribution varies with each affiliated physicianorganization depending on profitability and the level of acquisition debtassigned to each IPA. In certain of our affiliated physician organizations,specialty physicians have also received bonuses.

·       *Service.  *We attempt to provide thehighest quality of service to both providers and patients. Emphasis is placedon telephone answering etiquette. Referrals to specialists are made in a timelymanner. Many specialist visits do not require prior authorization or a referralrequest, but rather a simple patient permit form when completed by the primarycare physician, allowing direct access, without delay, to the more commonlyused specialists. As stated above, we maintain separate departments of providerand customer (patient) relations to help maintain the quality of our service.

There is competition for patients and primary carephysicians in every market in which our affiliated physician organizationsoperate. The number of significant competitors varies in each region. Thefollowing summary of information about our competitors and their estimatedenrollment in various markets is based on a recent report published by Cattaneoand Stroud, Inc., consultants to the California managed care industry.Enrollment numbers that follow differ from updated enrollment numbers of our affiliatedentities provided elsewhere in this filing, due to differing dates ofpresentation.

Based on the December 2005 Cattaneo and Stroudestimates, total HMO enrollment in Los Angeles County was approximately4,800,000 of which Prospect had approximately 53,000 enrollees, orapproximately 1.1%. HMO enrollment in Orange County was estimated atapproximately 1,400,000 of which Prospect had approximately 135,000 enrollees,or approximately 9.3%.

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In LosAngeles County, California our largest competitors include:

| **Competition**                             | ** ** | ** **    | ** ** | **Estimated  Enrollment** | ** ** | **% of Total Enrollment  of Major Competition  Including Prospect** | ** ** |
|---------------------------------------------|------------|---------------|------------|---------------------------|------------|---------------------------------------------------------------------------------------------------|------------|
| Healthcare Partners  Medical Group          |       | 425,400       |       |                      | 8.9        | %                                                                                                 |       |
| Heritage Provider  Network                  |       | 250,800       |       |                      | 5.2        | %                                                                                                 |       |
| La Vida Medical Group                       |       | 167,800       |       |                      | 3.5        | %                                                                                                 |       |
| Facey Medical Foundation                    |       | 121,000       |       |                      | 2.5        | %                                                                                                 |       |
| Los Angeles County Dept  of Health Services |       | 109,700       |       |                      | 2.3        | %                                                                                                 |       |
| Lakeside Medical Group                      |       | 88,500        |       |                      | 1.9        | %                                                                                                 |       |
| Community Medical Group  of the West Valley |       | 82,050        |       |                      | 1.7        | %                                                                                                 |       |
| Health Care LA, IPA                         |       | 80,200        |       |                      | 1.7        | %                                                                                                 |       |
| All Others including  Kaiser Foundation     |       | 3,405,740     |       |                      | 71.2       | %                                                                                                 |       |
| **Sub-Total**                               | ** ** | **4,731,190** | ** ** | ** **                | **98.9**   | **%**                                                                                             | ** ** |
| Prospect Health Source  Medical Group       |       | 21,100        |       |                      |       |                                                                                              |       |
| Sierra Primary Care  Medical Group          |       | 12,300        | ** ** | ** **                | ** ** | ** **                                                                                        | ** ** |
| Antelope Valley Medical  Group              |       | 8,300         |       |                      |       |                                                                                              |       |
| Pegasus Medical Group                       |       | 3,500         |       |                      |       |                                                                                              |       |
| Nuestra Familia Medical  Group              |       | 5,600         |       |                      |       |                                                                                              |       |
| Prospect Professional  Care Medical Group   |       | 2,100         |       |                      |       |                                                                                              |       |
| **Sub-Total—Prospect**                 | ** ** | **52,900**    | ** ** | ** **                | **1.1**    | **%**                                                                                             | ** ** |
| **Grand Totals**                            | ** ** | **4,784,090** | ** ** | ** **                | **100**    | **%**                                                                                             | ** ** |

 

InOrange County, California our largest competitors include:

| **Competition**                            | ** ** | ** **    | ** ** | **Estimated  Enrollment** | ** ** | **% of Total Enrollment  of Major Competition  Including Prospect** | ** ** |
|--------------------------------------------|------------|---------------|------------|---------------------------|------------|---------------------------------------------------------------------------------------------------|------------|
| St. Joseph Heritage  Healthcare            |       | 191,900       |       |                      | 13.2       | %                                                                                                 |       |
| Monarch Healthcare                         |       | 158,400       |       |                      | 10.9       | %                                                                                                 |       |
| Greater Newport  Physicians Medical Group  |       | 115,300       |       |                      | 7.9        | %                                                                                                 |       |
| Bristol Park Medical  Group                |       | 109,000       |       |                      | 7.5        | %                                                                                                 |       |
| All Others including  Kaiser Foundation    |       | 734,150       |       |                      | 51.2       | %                                                                                                 |       |
| **Sub-Total**                              | ** ** | **1,308,750** | ** ** | ** **                | **90.7**   | **%**                                                                                             | ** ** |
| **Prospect Affiliates**                    |       |          |       |                      |       |                                                                                              |       |
| Prospect Medical Group                     |       | 34,500        |       |                      |       |                                                                                              |       |
| AMVI/Prospect Health  Network              |       | 12,800        |       |                      |       |                                                                                              |       |
| Prospect Professional  Care Medical Group  |       | 28,900        |       |                      |       |                                                                                              |       |
| Prospect NWOC Medical  Group               |       | 12,400        |       |                      |       |                                                                                              |       |
| Star Care Medical Group                    |       | 26,900        |       |                      |       |                                                                                              |       |
| APAC Medical Group                         |       | 3,500         |       |                      |       |                                                                                              |       |
| Genesis HealthCare of  Southern California |       | 16,000        | ** ** | ** **                | ** ** | ** **                                                                                        | ** ** |
| **Sub-Total—Prospect**                | ** ** | **135,000**   | ** ** | ** **                | **9.3**    | **%**                                                                                             | ** ** |
| **Grand Totals**                           | ** ** | **1,443,750** | ** ** | ** **                | **100**    | **%**                                                                                             | ** ** |

 

According to Cattaneo andStroud, between 1996 and December 1, 2005, 183 medical groups andindependent physician associations throughout California have closed, with 47%of the closures due to financial problems. This has reduced the number ofcompetitors in our service area and in our opinion, this consolidation amongphysician organizations will likely continue. Cattaneo and Stroud reports that,at December 1, 2005, there were 292 medical groups and independentphysician associations in California, including 158 small, medium and large,independent physician associations.

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Additionally, the California Department of ManagedHealth Care (“DMHC”) has mandated certain financial statement solvencyrequirements of medical groups and independent physician associations includingcash equal to claims plus IBNR reserves, $1.00 of positive working capital and$1.00 of positive tangible net worth for all groups. We believe a number ofsmaller groups will not be able to achieve the financial solvency requirementsof the DMHC, which will create additional consolidation opportunities for us.

Basedon the December 2005 statewide Cattaneo and Stroud statistics, we believethat the combined enrollment of our affiliated physician organizations is theseventh largest in California.

| **Physician Organization**             | ** ** | ** **                                                                                                      | ** ** | **Service Area** | ** ** | **Estimated Enrollment** |
|---------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------------------|
| Kaiser Foundation                           |       | California                                                                                                      |       | 6,200,000             |       |
| HealthCare Partners  Medical Group          |       | Los Angeles  County  Orange County                                                                              |       | 425,000               |       |
| Hill Physicians Medical  Group              |       | Alameda County  Contra Costa County  Placer County  Sacramento County  San Francisco County  Solano County |       | 393,000               |       |
| Heritage Provider Network                   |       | Los Angeles  County  Riverside County  San Bernardino County                                                    |       | 251,000               |       |
| Primecare Medical Network                   |       | Los Angeles  County  Riverside County  San Bernardino County                                                    |       | 236,000               |       |
| St. Joseph Heritage Medical                 |       | San Bernardino  County  Orange County                                                                           |       | 192,000               |       |
| Prospect Medical Group  and Subsidiaries    |       | Los Angeles  County  Orange County                                                                              |       | 191,000               |       |
| Brown & Toland  Medical Group |       | Marin County  San Mateo County San Francisco                                                               |       | 190,000               |       |
| Sharp Community Medical Group          |       | San Diego County                                                                                                |       | 171,000               |       |
| La Vida Medical Group                       |       | Los Angeles County                                                                                              |       | 168,000               |       |

 

Some of our competitors are larger than us, havegreater resources and may have longer-established relationships withbuyers of their services, giving them greater leverage in contracting withphysicians and HMOs. Such competition may make it difficult to enter intoaffiliations with physician organizations on acceptable terms and to sustainprofitable operations.

Los Angeles and OrangeCounties are very large regions, and there are areas or cities within eachcounty that may have IPAs larger than our affiliated physician organizations.

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**Regulation**

Both we and our affiliatedphysician organizations are subject to numerous federal and state statutes andregulations that are applicable to the management and provision of health careservices and to business generally, as summarized below.

*Practice ofMedicine and Professional Licensing*

Federal and state laws specify who may practicemedicine and limit the scope of relationships between medical practitioners andother parties. Under these laws, we are prohibited from practicing medicine orexercising control over the provision of medical services. We do not employphysicians to provide medical services, exert control over medical decision-makingor represent to the public that we offer medical services. We have entered intomanagement services agreements with our affiliated physician organizations thatreserve exclusive control and responsibility for all aspects of the practice ofmedicine and the delivery of medical services to the physician organizations.Some states have interpreted management agreements with physicians as unlawfulfee splitting. We do not believe that our contractual arrangements withphysician networks, hospitals, or physician groups will subject us to thesetypes of claims. Changes in the laws may require modifications in ourrelationships with our clients.

State law also imposeslicensing requirements on individual physicians and on facilities operated byphysicians. Federal and state laws regulate HMOs and other managed careorganizations with which physician organizations may have contracts. Somestates also require licensing of third-party administrators andcollection agencies. This may affect our operations in states in which we mayseek to do business in the future. In connection with our existing operations,we believe we are in compliance with all such laws and regulations and currentinterpretations thereof. Our ability to operate profitably will depend, inpart, upon our ability and the ability of our affiliated physicianorganizations to obtain and maintain all necessary licenses and other approvalsand operate in compliance with applicable health care laws and regulations,including any new laws and regulations or new interpretations of existing lawsand regulations.

*Anti-Kickback*

Federal law commonly known as the “Anti-kickbackStatute” prohibits the knowing or willful offer, solicitation, payment orreceipt of anything of value (direct or indirect, overt or covert, in cash orin kind) which is intended to induce the referral of patients covered byfederal reimbursement programs, or the ordering of items or servicesreimbursable under those programs. This law also prohibits remuneration that isintended to induce the recommendation of, or furnishing, or the arranging for,the provision of items or services reimbursable under federal reimbursementprograms. This law has been broadly interpreted by a number of courts toprohibit remuneration that is offered or paid for otherwise legitimate purposesif the circumstances show that one purpose of the arrangement is to inducereferrals. The penalties for violations of this law include criminal sanctionsand exclusion from federal healthcare programs.

To address concerns about the implementation of theAnti-kickback Statute, the federal government adopted regulations withexceptions, or “safe harbors,” for some transactions and activities that willnot be deemed to violate the Anti-kickback Statute, such as sales of physicianpractices, management and personal services agreements, employee relationships,and referrals within group practices consisting of “active” investors. Thefailure to qualify under a safe harbor, while potentially subjecting theactivity to greater regulatory scrutiny, does not render the activity illegalper se. One safe harbor on which we rely applies to management contractsmeeting specified criteria.

There are several aspects of our relationships withphysicians to which the Anti-kickback Statute may be relevant. The governmentmay construe some of the marketing and managed care contracting activities 

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that we historicallyperformed as arranging for the referral of patients to the physicians with whomwe had a management agreement.

We believe our business activities are not inviolation of the Anti-kickback Statute. Further, we believe that the businessoperations of our affiliated physician organizations do not involve the offer,payment, solicitation or receipt of remuneration to induce referrals of patients,because compensation arrangements between the physician organizations and theprimary care physicians who make referrals are designed to discourage referralsto the extent they are medically unnecessary. These physicians are paid eitheron a sub-capitation or fee-for-service basis and do not receive any financialbenefit from making referrals.

Noncompliance with, orviolation of, the Anti-kickback Statute can result in exclusion from theMedicare and Medicaid (Medi-Cal in California) programs and civil and criminalpenalties. Many states, including California, have similar anti-kickbackprohibitions with similar penalties. Although we believe our activities to bein compliance, if we were found to be in violation of the anti-kickbacklegislation, we could suffer civil penalties, criminal fines, imprisonment orpossible exclusion from participation in the reimbursement programs, whichcould reduce our revenues, increase our costs and decrease our profitability.

*Self-Referral*

The Stark Self-Referral Law prohibits a physician fromreferring a patient to a health care provider for some designated healthservices reimbursable by the Medicare or Medicaid programs if the physician hasa financial relationship with that provider, including an investment interest,a loan or debt relationship or a compensation relationship. The designatedservices covered by the law include, among others, radiology services, infusiontherapy, radiation therapy, outpatient prescription drugs and hospital services.In addition to the conduct directly prohibited by the law, the statute alsoprohibits “circumvention schemes” that are designed to obtain referralsindirectly that cannot be made directly. The penalties for violating the lawinclude a refund of any Medicare or Medicaid payments for services thatresulted from an unlawful referral, civil fines and exclusion from the Medicareand Medicaid programs.

On January 4, 2001, the Health Care FinancingAdministration, now known as the Centers for Medicare & MedicaidServices issued a partial final rule, known as the Phase I Final Regulations,regarding certain provisions of the Stark Law with an effective date for therelevant portions of January 4, 2002. The Phase I Final Regulations expandupon the statutory exceptions and contemplate that designated health servicesmay be provided by a physician practice or by another corporation if therelevant exceptions delineated in the regulations apply. Phase II of the StarkLaw regulations were issued by CMS on March 24, 2004 and became effectiveon July 26, 2004. Phase II clarified and amended the Phase IFinal Regulations, and addressed other areas of law that were not covered inPhase I.

The self-referralprohibition applies to our services, and we believe our relationships complywith the law. We believe our business arrangements do not involve the referralof patients to entities with whom referring physicians have an ownershipinterest or compensation arrangement within the meaning of federal and stateself-referral laws, because referrals are made directly to other providersrather than to entities in which referring physicians have an ownershipinterest or compensation arrangement. We further believe our financialarrangements with physicians fall within exceptions to state and federalself-referral laws, including exceptions for ownership or compensationarrangements with managed care organizations and for physician incentive plansthat limit referrals. In addition, we believe that the methods we use toacquire existing physician organizations and to recruit new physicians do notviolate such laws and regulations. Nevertheless, if we were found to haveviolated the self-referral laws, we could be subject to denial ofreimbursement, forfeiture of amounts collected in violation of the law, civilmonetary penalties, and exclusion from the Medicare and Medicaid programs,which could reduce our revenues, increase our 

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costsand decrease our profitability. Many states, including California, have similarself-referral laws that provide for similar penalties.

*Fraud and Abuse*

The Health InsurancePortability and Accountability Act of 1996 (“HIPAA”) broadened the scope offraud and abuse laws by adding several criminal provisions for health carefraud offenses that apply to all health benefit programs. This Act also creatednew enforcement mechanisms to combat fraud and abuse, including the MedicareIntegrity Program and an incentive program under which individuals can receiveup to $1,000 for providing information on Medicare fraud and abuse that leadsto the recovery of at least $100 of Medicare funds. In addition, federalenforcement officials now have the ability to exclude from Medicare andMedicaid any investors, officers and managing employees associated withbusiness entities that have committed health care fraud, even if the officer ormanaging employee had no knowledge of the fraud. HIPAA was followed by theBalanced Budget Act of 1997, which created additional fraud and abuseprovisions, including civil penalties for contracting with an individual orentity that the provider knows or should know is excluded from a federal healthcare program.

*HIPAAAdministrative Simplification and Privacy Requirements*

The Administrative Simplification Provisions of HIPAArequire the use of uniform electronic data transmission standards for health careclaims and payment transactions submitted or received electronically. Theseprovisions are intended to encourage electronic commerce in the health careindustry. On August 17, 2000, the Department of Health and Human Services(“HHS”) published final regulations establishing electronic data transmissionstandards that all health care providers must use when submitting or receivingcertain health care transactions electronically. Compliance with theseregulations became mandatory on October 16, 2002. However, entities thatfiled for an extension before October 16, 2002 had until October 16,2003 to comply with the regulations. We filed for the extension before October 16,2002, and contracted with health plan designated clearinghouses to ensurecompliance with the standards by October 16, 2003.

HIPAA also requires HHS to adopt standards to protectthe privacy and security of individually identifiable health-relatedinformation. HHS released final regulations containing privacy standards in December 2000and published revisions to the final regulations in August 2002.Compliance with these regulations was required by April 14, 2003. Theprivacy regulations regulate the use and disclosure of individuallyidentifiable health-related information, whether communicatedelectronically, on paper or orally. The regulations also provide patients withsignificant new rights related to understanding and controlling how theirhealth information is used or disclosed. HHS released final securityregulations on February 20, 2003. The security regulations becamemandatory on April 20, 2005 and require health care providers to implementadministrative, physical and technical practices to protect the security ofindividually identifiable health information that is maintained or transmittedelectronically.

Our affiliated physician organizations are coveredentities subject to these regulations. As a business associate of such entitiesand contracted health plans, we are also subject to many HIPAA requirementspursuant to a business associate contract required between covered entities andtheir business associates. We are also subject to state regulations regardingprivacy and medical information.

Violations of HIPAA could result in civil penalties ofup to $25,000 per type of violation in each calendar year and criminalpenalties of up to $250,000 per violation. In addition, there are numerouslegislative and regulatory initiatives at the federal and state levelsaddressing patient privacy concerns. We will continue to remain subject to any federalor state privacy-related laws that are more restrictive than the privacyregulations issued under HIPAA. These statutes vary and could impose additionalpenalties.

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We believe we haveachieved compliance with the privacy and electronic health care transactionstandards of HIPAA. To date, the cost of compliance with these regulations hasnot been material. We believe that the ongoing cost of compliance with theseregulations will not have a material adverse effect on our business, financialposition, results of operations or cash flows.

*False Claims Act*

We are also subject tofederal and state laws prohibiting individuals or entities from knowingly andwillfully making claims for payment to Medicare, Medicaid, or other third partypayers that contain false or fraudulent information. These laws provide forboth criminal and civil penalties. Health care providers submitting claims thatthey knew or should have known were false or fraudulent, or for items orservices that were not provided as claimed, may be excluded from Medicare andMedicaid participation, may be required to repay previously collected amounts,and may be subject to substantial civil monetary penalties.

*Antitrust*

Federal and stateantitrust laws prohibit agreements in restraint of trade, the exercise ofmonopoly power and other practices that are considered to be anti-competitive.We believe that we are in material compliance with federal and state antitrustlaws in connection with the operation of our physician relationships.

**HealthPlan Licensing and Regulation**

On January 1, 2001, legislation was adopted tocreate a new Department of Managed Health Care, in California. On July 1,2001, the Department of Managed Health Care became responsible for licensingand regulating health plans in California under the Knox-Keene Health CareService Plan Act of 1975.

Our affiliated physician organizations contract withhealth plans (also known as “”HMOs’’) to provide physician and certainancillary services to the health plans’ enrollees. The Knox-Keene Act imposes numerousrequirements on health plans regarding the provision of care to health planenrollees. HMOs, in turn, require their contracted physician organizations tocomply with those requirements where applicable. Health plans also requiretheir contracted physician organizations to ensure compliance with applicableKnox-Keene Act requirements on the part of the organizations’ sub-contractedphysicians. Thus, our physician organizations are indirectly subject to many ofthe requirements of the Knox-Keene Act. While health plans are bound by theprovisions of the Knox-Keene Act directly our physician organizations are boundby many of these same provisions as embodied in their contracts with plans.

Our affiliated physicianorganizations typically enter into contracts with HMOs, pursuant to which theaffiliated physician organizations are paid on a capitated (per member/per month)basis. Under capitation arrangements, health care providers bear the risk,subject to specified loss limits, that the total costs of providing medicalservices to members will exceed the premiums received. Because they arecompensated on a prepaid basis in exchange for providing or arranging for theprovision of health care services to assigned patients, the physicianorganizations may be deemed, under state law, to be in the business ofinsurance. If the physician organizations are deemed to be insurers, they willbe subject to a variety of regulatory and licensing requirements applicable toinsurance companies or HMOs, resulting in increased costs and correspondingreduced revenue for us.

*Financial SolvencyRegulations*

The California Department of Managed Health Care (“DMHC”)has instituted financial solvency regulations mandated by California SenateBill 260. The regulations are intended to provide a formal mechanism formonitoring the financial solvency of capitated physician groups. Managementbelieves that our affiliated physician organizations that are subject to theseregulations will be able to comply with them. 

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However, these regulationscould limit the company’s ability to use its cash resources to make futureacquisitions.

Under theregulations, our affiliated physician organizations are required to comply withspecific criteria, including:

·       Maintain,at all times, a minimum “cash-to-claims ratio” (where “cash-to-claims ratio”means the organization’s cash, marketable securities and certain qualifiedreceivables, divided by the organization’s total unpaid claims liability. Theregulations require a cash-to-claims ratio of 0.60 beginning January 1,2006; 0.65 beginning July 1, 2006; and 0.75 beginning January 1,2007.

·       Submitperiodic reports to the DMHC containing various data and attestations regardingperformance and financial solvency, including IBNR (incurred but not reported)calculations and documentation, and attestations as to whether or not theorganization was in compliance with Knox-Keene Act requirements related toclaims payment timeliness, had maintained positive tangible net equity; and hadmaintained positive working capital.

In a case where an organization is not in compliancewith any of the above criteria, the organization would be required to describein the report submitted to the DMHC the reasons for non-compliance and actionsto be taken to bring the organization into compliance.

Further, under these regulations, the DMHC will makepublic some of the information contained in the reports, including, but notlimited to, whether or not a particular physician organization met each of thecriteria.

In the event we are not able to meet certain of thefinancial solvency requirements, and fail to meet subsequent corrective actionplans, we could be subject to sanction, or limitations on, or removal of, ourability to do business in California.

Our cash-to-claims ratioat September 30, 2005, was 1.58.

*GovernmentInvestigations*

The government increasingly examines arrangementsbetween health care providers and potential referral sources to ensure thatthey are not designed to exchange remuneration for patient care referrals.Investigators are increasingly willing to look behind formalities of businesstransactions to determine the underlying purpose of payments. Enforcementactions have increased and are highly publicized.

In addition to investigations and enforcement actionsinitiated by governmental agencies, we could become the subject of an actionbrought under the False Claims Act by a private individual on behalf of thegovernment. Actions under the False Claims Act, commonly known as “whistleblower”lawsuits, are generally filed under seal to allow the government adequate timeto investigate and determine whether it will intervene in the action, anddefendant health care providers often have no knowledge of such actions untilthe government has completed its investigation and the seal is lifted.

To our knowledge, we, andour affiliated physician organizations, are not currently the subject of anyinvestigation or action under the False Claims Act. Any such futureinvestigation or action could result in sanctions and unfavorable publicitythat could reduce potential revenues and profitability.

*Balanced Budget Act*

Each state operates a Medicaid (Medi-Cal inCalifornia) program funded in part by the federal government. The states maycustomize their programs within federal limitations. Each state program has itsown payment formula and recipient eligibility criteria. In recent years,changes in Medicare and Medicaid programs have resulted in limitations on, andreduced levels of, payment and reimbursement for 

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a substantial portion ofhealth care goods and services. For example, the federal Balanced Budget Act of1997 (even after the restoration of some funding in 1999) continues to causesignificant reductions in spending levels for the Medicare and Medicaidprograms.

Laws governing Medicare,Medicaid and other governmental programs may change, and various administrativerulings, interpretations and determinations make compliance difficult. Anychanges could materially increase or decrease program payments or the cost ofproviding services. Final determinations of government program reimbursementoften take years because of audits, providers’ rights of appeal and numeroustechnical requirements. We believe we make adequate provision for adjustments.However, future reductions in reimbursement could reduce our revenues andprofitability.

*Health Care Reform*

The U.S. health careindustry continues to attract much legislative interest and public attention.In recent years, an increasing number of legislative proposals have beenintroduced or proposed in Congress and in some state legislatures that wouldeffect major changes in the health care system. Proposals that have beenconsidered include changes in Medicare, Medicaid and other programs, costcontrols on hospitals and mandatory health insurance coverage for employees.The costs of implementing some of these proposals would be financed, in part,by reduction of payments to health care providers under Medicare, Medicaid, andother government programs. We cannot predict the course of future health carelegislation or other changes in the administration or interpretation ofgovernmental health care programs. However, future legislation,interpretations, or other changes to the health care system could reduce ourrevenues and profitability.

**General Regulatory Requirements**

In addition to theregulations referenced above, our operations and the operations of ouraffiliated physician organizations are subject to state and federal statutesand regulations governing workplace health and safety, dispensing of controlledsubstances and the disposal of medical waste. Our operations may also beaffected by changes in ethical guidelines and operating standards ofprofessional and trade associations such as the American Medical Association.Changes in existing laws and regulations, adverse judicial or administrativeinterpretations of such laws and regulations, or enactment of new legislationcould require us to make costly changes to our business that would reduce ourprofitability.

**Insurance**

We maintain general liability, property, automobileand workers’ compensation insurance as well as directors and officersinsurance, which includes employee practices liability insurance. Our annualpolicy limits are $1,000,000 per occurrence and $2,000,000 in the aggregate forgeneral liability coverage, $5,200,000 for property coverage, $1,000,000 forautomobile coverage, the amounts required by state law for workers’compensation, $1,000,000 for employment practices liability and $7,000,000 inthe aggregate (primary and excess) for directors and officers liability.

Our affiliated physician organizations, ProspectProfessional Care Medical Group, Inc., AMVI/Prospect Health Network,Antelope Valley Medical Associates, Nuestra Familia Medical Group, Inc.,APAC Medical Group, Inc., Prospect Health Source Medical Group, Inc.,Prospect NWOC Medical Group, Inc., Santa Ana-Tustin Physicians Group, Inc.and Prospect Medical Group, Inc. maintain managed care errors andomissions insurance (professional liability) in a minimum coverage amount of$1,000,000 per claim and $1,000,000 in the aggregate. The managed care errorsand omissions policy also provides directors and officers insurance for thecorporate entity in a minimum coverage amount of $1,000,000 per claim and$1,000,000 in the aggregate. Our affiliated organizations StarCare MedicalGroup, Inc., Pegasus Medical Group, Inc. Sierra Primary Medical Group, Inc.,Pinnacle Health 

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Resources, Inc. andSierra Medical Management maintain managed care errors and omissions insurance(professional liability) in a minimum coverage amount of $1,000,000 per claimand $3,000,000 in the aggregate. The managed care errors and omissions policiescover the professional services provided by our affiliated physicianassociations.

We also require the physicians that our affiliatedphysician organizations contract with as independent contractors to maintainmalpractice insurance with minimum policy limits of $1,000,000 million perclaim and $3,000,000 in the aggregate. The employed physicians at SierraMedical Group and Pegasus Medical Group are currently insured under policieswith annual policy limits of $1,000,000 per claim and $3,000,000 in theaggregate, that cover malpractice on a “claims made” basis, which includesvicarious coverage for each entity (covers the corporate entity as well as thephysician).

Our insurance, and the insurance of our affiliatedphysician organizations, contain customary exclusions and exceptions fromcoverage. Additionally, we are at risk for our self-insured retention (“deductible”)on certain policies such as $1,000 for our property policy and $25,000 for themanaged care errors and omissions insurance for Prospect Professional CareMedical Group, Inc., AMVI/Prospect Health Network, Antelope Valley MedicalAssociates, Nuestra Familia Medical Group, Inc., APAC Medical Group, Inc.,Prospect Health Source Medical Group, Inc., Prospect NWOC Medical Group, Inc.,Santa Ana-Tustin Physicians Group, Inc. and Prospect Medical Group, Inc.,and $100,000 for the managed care errors and omissions insurance for StarCareMedical Group, Pegasus Medical Group, and Sierra Primary Care Medical Group.

We believe that the linesand amounts of insurance coverage that we and our affiliated physicianorganizations maintain, and that we require our contracted physician providersto maintain, are customary in our industry and adequate for the risks insured.We cannot assure, however, that we will not become subject to claims notcovered or that exceed our insurance coverage amounts.

**Historyand Development of Our Business**

In October 1986 Prospect Medical Group was formedby physician shareholders of another professional corporation called YorbaLinda Medical Group to provide a vehicle for the physician shareholders tofocus on managed care, while Yorba Linda Medical Group continued its focus onfee-for-service patients. Our Chief Executive Officer prior to Dr. Terner,Dr. DeNicola, was a shareholder of Yorba Linda Medical Group and ProspectMedical Group. In 1996 the shares of Prospect Medical Group owned by all of theYorba Linda Medical Group physicians (other than Dr. DeNicola) wereredeemed and the former shareholders were issued shares of common stock ofProspect Medical Systems, which is now one of our management subsidiaries.Prospect Medical Systems had been formed in 1995 to acquire all of ProspectMedical Group’s non-professional assets and assume all of its administrativeand management functions. Prospect Medical Systems had nominal operations until1996.

As part of the 1996 transaction with Prospect MedicalGroup and Prospect Medical Systems, a wholly owned subsidiary of the companywas merged into Prospect Medical Systems, with Prospect Medical Systems beingthe surviving corporation and a wholly owned subsidiary of the company. Thecompany, then called Med-Search, Inc., changed its name to ProspectMedical Holdings. Med-Search, Inc. was incorporated on May 12, 1993as a Delaware corporation and was the successor by merger to a corporationcalled Energy Search Inc., a Utah public corporation. Prior to the 1996merger, we, as Med-Search, provided managed care and medical practicemanagement services to a California professional corporation, Interstate CareProviders, doing business in Ventura County, California.

The physician shareholders of Prospect Medical Systemsultimately exchanged their shares in Prospect Medical Systems with those ofProspect Medical Holdings. The exchange of shares was treated as areorganization of companies under common control. As the shareholders ofProspect Medical Group became the majority stockholders in the merged companythrough these transactions, under applicable 

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financial reportingrequirements, Prospect Medical Group is considered the predecessor entity tothe company for periods prior to July 31, 1996 for financial statementreporting purposes.

Following the 1996 merger, we began to implement ourgrowth strategy through a series of acquisitions and affiliations, primarilythrough Prospect Medical Group.

Since the 1996 merger, Prospect Medical Group hasacquired twelve physician organizations for the aggregate consideration ofapproximately $48,608,000 in cash, promissory notes in the aggregate principalamount of $3,500,000 and the issuance of approximately 830,000 shares of ourcommon stock. These acquisitions, summarized below, have provided us withsubstantial concentration of managed care enrollees in our three service areasof Southern California—North and Central Orange County, West Los Angeles andthe Antelope Valley region of Los Angeles County.

On July 14, 1997, Prospect Medical Group acquiredSanta Ana-Tustin Physicians Group for cash consideration of $5,000,000. At thattime, Santa Ana-Tustin Physicians Group had approximately 12,000 HMO enrollees.Concurrent with the acquisition, Santa Ana-Tustin Physicians Group executed amanagement services agreement with Prospect Medical Systems.

In August 1997, Prospect Medical Group purchaseda small independent physician association, Sequoia Medical Group, withapproximately 800 HMO enrollees, which was fully consolidated into ProspectMedical Group for cash consideration of $24,750 and an assumption ofliabilities in the approximate aggregate amount of $35,000.

On September 25, 1997, Prospect Medical Groupacquired all of the outstanding stock of Sierra Primary Care Medical Group for$5,625,000 in cash, a promissory note in the principal amount of $2,250,000,and options to purchase 31,500 shares of our common stock at an exercise priceof $5.00 per share. At that time, Sierra Primary Care Medical Group hadapproximately 15,000 HMO enrollees. Concurrently, through the merger of SierraMedical Management with a wholly owned subsidiary of the company, we acquiredSierra Medical Management, which provided the non-physician related managementservices for Sierra Primary Care Medical Group, for consideration of $625,000in cash, a promissory note in the principal amount of $250,000, 600,000 sharesof our common stock then valued at $2.00 per share, and options to purchase3,500 shares of our common stock. Sierra Medical Management became a whollyowned subsidiary of Prospect Medical Holdings as a result of the merger.

On October 31, 1997, Prospect Medical Groupcreated a wholly owned subsidiary, Pegasus Medical Group, to acquire the assetsof A.V. Western Medical Group, Inc. for aggregate cash consideration of$700,000. A.V. Western Medical Group, Inc. had approximately 5,000 HMOenrollees. Concurrently, Pegasus Medical Group signed a management servicesagreement with Sierra Medical Management.

On June 1, 1998, Prospect Medical Group formedAntelope Valley Medical Associates, in order to acquire the assets of AntelopeValley Medical Group, Inc. for cash consideration of $25,000. AntelopeValley Medical Group, Inc. had approximately 12,000 HMO enrollees and someexclusive contracts with primary care physicians. At the time of theacquisition of Antelope Valley Medical Group, we through our managementsubsidiary, Sierra Medical Management, acquired certain assets of the relatedmanagement company of Antelope Valley Medical Associates for cash considerationof $475,000, a promissory note in the principal amount of $500,000 and theissuance of 200,000 shares of common stock of Prospect Medical Holdings valuedat a price of $5.00 per share. Antelope Valley Medical Associates signed amanagement contract with Sierra Medical Management.

On January 1, 1999 and May 1, 1999, ProspectMedical Group divested its medical clinics located in Orange County and SantaBarbara County, California. The medical clinics had been acquired as part ofthe original Prospect Medical Group acquisition.

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On June 1, 1999, Prospect Medical Group completedits acquisition of the assets of Premier Medical Group, Inc., a CentralOrange County, California independent physician association for considerationof $630,000 in cash. Concurrent with its closing, approximately 3,200 HMOenrollees were transferred to and consolidated with Prospect Medical Group.

On July 1, 1999, Prospect Medical Group issuednotice to HMOs and contracted providers in Ventura County and Santa BarbaraCounty, California that it was terminating all activities in both counties.This decision was based upon management’s determination that we could notobtain a material share of, or earn a profit in, those regions.

On December 6, 1999, Prospect Medical Groupcompleted an acquisition of assets from Sherman Oaks Affiliated Physicians, Inc.,located in the San Fernando Valley section of Los Angeles County for payment of$28,000 in cash and assumption of $151,800 in debt owed to Sherman OaksHospital and Health Center by Sherman Oaks Affiliated Physicians. ProspectMedical Group also assumed the provider contracts and the name of this start-upindependent physician association venture, which had no HMO contracts and noenrollees at the time of acquisition.

On December 10, 2000, the U.S. Bankruptcy Courtin the Central District of California approved the sale of the assets of HealthSource Medical Group to Prospect Medical Group for consideration of $1,000,000,and the sale was effective on January 1, 2001. Concurrent with theacquisition of the assets, Prospect Health Source Medical Group was formed as asubsidiary of Prospect Medical Group and the assets of Health Source MedicalGroup were transferred to Prospect Health Source Medical Group. At the sametime, Prospect Health Source Medical Group entered into a management agreementwith Prospect Medical Systems. At that time, Prospect Health Source MedicalGroup had approximately 35,000 HMO enrollees.

Health Source Medical Group owned two medical clinicsthat Prospect Medical Group acquired as part of the asset purchase. We soldthese medical clinics in May and July of 2001 for nominal cashconsideration, with an agreement by the purchasing physicians to assume allliabilities for the medical clinics and an agreement to maintain an exclusive contractwith Prospect Health Source Medical Group.

On September 30, 2003, Prospect Medical Groupcompleted the acquisition of Professional Care Medical Group for cashconsideration of $7,050,000. As a result of the acquisition, Professional CareMedical Group became a wholly owned subsidiary of Prospect Medical Groupoperating under the name “Prospect Professional Care Medical Group.” At thesame time, Prospect Professional Care Medical Group entered into a managementagreement with Prospect Medical Systems. At the time of the acquisition,Prospect Professional Care Medical Group had approximately 45,000 HMOenrollees.

On February 1, 2004, Prospect Medical Groupcompleted the acquisition of Northwest Orange County Medical Group forconsideration of $50,000 in cash and Prospect Medical Systems completed theacquisition of the related management company rights of the manager ofNorthwest Orange County Medical Group for cash consideration of $1,950,000. Asa result of the acquisition, Northwest Orange County Medical Group became awholly owned subsidiary of Prospect Medical Group operating under the name “ProspectNWOC Medical Group. At the same time, Prospect NWOC Medical Group entered intoa management agreement with Prospect Medical Systems. At the time of theacquisition, Prospect NWOC Medical Group had approximately 14,000 HMOenrollees.

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On February 1, 2004, Prospect Medical Groupcompleted the acquisitions of StarCare Medical Group and APAC Medical Group,which were “sister” medical groups owned by the same physician for an aggregatecash consideration of $4,050,000, and Prospect Medical Systems acquired therelated management company named Pinnacle Health Resources and its managementcontract rights for cash consideration of $4,450,000 (collectively the “GatewayAcquisition”). As a result of the Gateway Acquisition, StarCare Medical Groupand APAC Medical Group became wholly owned subsidiaries of Prospect MedicalGroup and Pinnacle Health Resources became a wholly owned subsidiary ofProspect Medical Systems. Management of StarCare Medical Group and APAC MedicalGroup was transferred from Pinnacle Health Resources to Prospect MedicalSystems during fiscal 2004. At the time of the Gateway Acquisition, thecombined enrollment of StarCare Medical Group and APAC Medical Group wasapproximately 44,000 HMO enrollees.

StarCare Medical Group owned three clinics at the timeof the acquisition. On April 1, 2004, we sold the three clinics for cashconsideration of $300,000, promissory notes in the aggregate amount of$1,068,247 and the assumption by the buyers of all operating commitments pertainingto the medical clinics. We retained StarCare Medical Group in its capacity asan IPA. As a condition of StarCare Medical Group’s sale of the medical clinics,the acquiring buyer executed a provider agreement with StarCare Medical Groupin StarCare’s capacity as an IPA, which includes, among other things, specificnon-diversion and non-solicitation language as to the enrollees served byStarCare Medical Group.

On November 1, 2005,Prospect Medical Group completed the acquisition of Genesis HealthCare ofSouthern California for consideration of $8,000,000 in cash. As a result of theacquisition, Genesis HealthCare of Southern California became a wholly ownedsubsidiary of Prospect Medical Group. At the same time, Genesis HealthCare ofSouthern California entered into a management agreement with Prospect MedicalSystems. At the time of the acquisition, Genesis HealthCare of SouthernCalifornia had approximately 16,000 HMO enrollees.

**Executive Officers**

The following tablesummarizes the name, age, title and business experience for the past five yearsof each of our executive officers. Other than as described below, no familyrelationships exist between or among any of our officers and directors.
| Name                        | ** ** | ** ** | ** ** | **Age**                                                                   | ** ** | **Position** |
|-----------------------------|------------|------------|------------|---------------------------------------------------------------------------|------------|--------------|
| Jacob Y. Terner, M.D.       |       | 71         |       | Chairman, Chief  Executive Officer and Director                           |
| Catherine S. Dickson        |       | 36         |       | President, Chief  Operating Officer and Director                          |
| Mike Heather                |       | 47         |       | Chief Financial Officer                                                   |
| R. Stewart Kahn             |       | 54         |       | Executive Vice President  and Secretary                                   |
| Linda Hodges                |       | 61         |       | Executive Vice President  of Compliance                                   |
| Howard H. Levine            |       | 56         |       | Executive Vice  President, Prospect Hospital Advisory Services, Inc. |
| Michael A. Terner           |       | 44         |       | Vice President, HMO  Contracting and Health Plan Relations                |
| Donna Vigil                 |       | 57         |       | Vice President, Finance                                                   |
| Karunyan Arulanantham, M.D. |       | 64         |       | President of Sierra Medical Management                                    |

 

**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, where 

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Dr. Terner serves asChief Executive Officer, Treasurer and a Director; and Nuestra Familia MedicalGroup, where Dr. Terner serves as Secretary and a Director.Dr. Terner held the position of Clinical Professor of Obstetrics andGynecology at the University of Southern California, School of Medicine from1972 to 2001. Dr. Terner is currently Emeritus Clinical Professor ofObstetrics and Gynecology. Dr. Terner also served as Chairman and ChiefExecutive Officer of Century MediCorp, Inc., a publicly-traded,integrated health-management organization from June 24, 1988 untilits October 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 whichhe joined in 1980, and was the founder and Partner-in-Charge of the HealthCareServices Practice of Deloitte & Touche in Orange County fromJune 1992 to June 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.

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**HowardH. Levine.****  **HowardH. Levine has been with the Company since 1998, and currently serves asExecutive Vice President of our subsidiary, Prospect Hospital AdvisoryServices, Inc. Mr. Levine has over twenty-five years of hospitalmanagement experience, having managed hospitals in both the for-profit andnon-profit sectors. Mr. Levine’s hospital career includes nine years atBeth Israel Medical Center in New York City (934 beds), where he served asSenior Associate Director for Operations, Staten Island University Hospital inNew York (650 beds), where he served as Senior Vice President & ChiefOperating Officer, The Robert Wood Johnson Jr. Rehabilitation Institute of theJohn F. Kennedy Medical Center in Edison, New Jersey (415 beds), where heserved as Administrator, Chapman Medical Center in Orange, California (135beds), where he served as Chief Executive Officer, and Columbia West HillsMedical Center in West Hills, California (250 beds), where he served as ChiefExecutive Officer. Mr. Levine received his BBA Degree in Marketing fromBernard M. Baruch College in New York City and his MPH Degree in HealthCare Administration from UCLA. Mr. Levine has served on the faculty of theNYU Graduate School of Public Administration and the Bernard M. BaruchCollege/Mount Sinai School of Medicine.

**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, fromOctober 1997 to 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.

**Karunyan Arulanantham,M.D.****  **KarunyanArulanantham, M.D. has served as the President of Sierra Primary Care MedicalGroup and President of Sierra Medical Management since September 1997.Dr. Arulanantham was a shareholder, practicing physician and officer ofSierra Primary Care Medical Group from its formation in 1984 to the date of itsacquisition by Prospect Medical Group. Dr. Arulanantham is Board-certifiedin Pediatrics, Pediatric Endocrinology and Quality Assurance and UtilizationReview. Dr. Arulanantham is a Fellow of the American Academy of Pediatricsand the American College of Endocrinologists.

**Terms of Office**

Officers are elected byand serve at the discretion of our Board of Directors. They hold office untiltheir successors are chosen and qualified, or until they resign or have beenremoved from office. The Board of Directors may appoint, or empower the ChiefExecutive Officer to appoint or terminate, such other officers and agents asthe business of the corporation may require, each of whom shall hold office forsuch period, and have such authority, and perform such duties as are providedin our Bylaws, or as the Board of Directors may from time to time determine.

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**Item 1A.**                RiskFactors

Our business is subject toa number of risks, including those described below.

**Decreasesin the number of HMO enrollees using our provider networks reduce our profitabilityand inhibit future growth.**

During recent periods, thenumber of HMO enrollees using our provider networks has declined (not takinginto account our recent acquisitions of additional affiliated physicianorganizations), and management currently anticipates that this trend willcontinue. The profitability and growth of our business depends largely on thenumber of HMO members who use our provider networks. We seek to maintain andincrease the number of HMO enrollees using our provider networks by monitoringenrollment of the HMOs with which our affiliated physician organizations havecontracts, affiliating with additional IPAs and acquiring other managementcompanies. If we are not successful, we may not be able to maintain ourprofitability or to continue to grow our business in the future. For the yearsended September 30, 2001, 2002, 2003, 2004, and 2005, the decrease in thenumber of HMO enrollees using our provider networks was 21,400, 3,600, 1,400,20,700, and, 26,500 respectively. Estimated revenue reductions associated withthe enrollment decreases for those periods were approximately, $5,500,000,$3,500,000, $400,000, $8,200,000 and $11,100,000, respectively. These estimatesassume that enrollment decreased ratably during the indicated periods and, assuch, represent approximately 50% of the lost revenue that will be experiencedin subsequent periods, when the enrollment decline is in effect for the wholeperiod.

**Ourworking capital deficit could adversely affect our ability to satisfy our obligationsas they come due.**

We have historically beenin a negative working capital position. Having a working capital deficit maysignal an impaired ability to pay debts as they come due.

We had negative workingcapital of $16,695,740, $3,141,414, and $681,960 as of September 30, 2003,2004 and 2005, respectively. This represents the difference between our currentassets and our current liabilities. The negative working capital is the resultof a reduction in cash and cash equivalents that have been used to reduce ourbank debt and current liabilities incurred in operations and acquisitions,primarily related to medical expense claims.

As of the fiscal yearsended 2003, 2004, and 2005, our indebtedness for capital leases, subordinatedseller notes, loans from our Chief Executive Officer, and notes to our banktotaled $6,267,710, $15,008,554 and $8,166,667. We have historically used cashreserves and cash flow from operations and equity offerings to reduce ourindebtedness and fund acquisitions. This, and our recording of reserves forincurred but not reported healthcare expense claims, have been the primaryreasons for our negative working capital position at September 30, 2003,2004, and 2005.

**If the value of our goodwill and intangible assetswith indefinite useful lives becomes impaired, the impaired portion will haveto be written off, which could materially reduce the value of our assets andreduce our net income for the year in which the write-off occurs.**

Our intangible assets represent a substantial portionof our assets. As of September 30, 2005, goodwill totaled $31,404,328 andother intangible assets totaled $1,317,614 for a combined total of $32,721,942,and represented approximately 57% of our total assets.

In June 2001, the Financial Accounting StandardsBoard (“FASB”) issued two standards related to business combinations. The firststatement, SFAS No. 141, “Business Combinations,” requires all businesscombinations after June 30, 2001 to be accounted for using the purchasemethod and prohibits the pooling-of-interest method of accounting. SFAS No. 141also states that acquired intangible assets should be separately recognizedupon meeting certain criteria. Such intangible assets include, but are notlimited to, trade and service marks, non-compete agreements, customer lists andlicenses.

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The second statement, SFAS No. 142 “Goodwill andOther Intangible Assets,” requires that upon adoption, amortization of goodwilland indefinite life intangible assets will cease and instead, the carryingvalue of goodwill and indefinite life intangible assets will be evaluated forimpairment at least on an annual basis, or more frequently if certainindicators are encountered. We have adopted SFAS No. 142. A two-stepimpairment test is to be used to identify potential goodwill impairment and tomeasure the amount of goodwill impairment loss to be recognized (if any). Thefirst step of the goodwill impairment test, which is used to identify potentialimpairment, compares the fair value of a reporting unit with its carryingamount, including goodwill. If the fair value of a reporting unit exceeds itscarrying amount, goodwill of the reporting unit is considered not impaired,thus the second step of the impairment test is unnecessary.

Any finding that the valueof our goodwill and intangible assets has been impaired would require us towrite off the impaired portion, which could significantly reduce the value ofour assets and reduce our net income for the year in which the write-offoccurs. To date, since we adopted SFAS No. 142 for our fiscal year ended September 30,2002, no impairment has been found and no write-off has been required.

**Wemay not be able to make any additional significant acquisitions without firstobtaining additional financing and obtaining the consent of our commerciallender.**

Although we have no specific agreements for additionalacquisitions of affiliated physician organizations pending, the implementationof our long-term growth strategy depends on additional acquisitions in thefuture. These future acquisitions may require additional capital resources. Noassurance can be given that needed capital will be made available to us.

To finance our ongoingcapital requirements, we may, from time to time, issue additional equitysecurities or incur additional debt. A greater amount of debt or additionalequity financing could be required to the extent that our common stock fails toachieve or to maintain a market value sufficient to warrant its use in futureacquisitions or to the extent that physician organizations or their relatedmanagement companies are unwilling to accept common stock in exchange for theirbusinesses. Our ability to issue debt instruments or equity securities in apublic or private sale is restricted by the loan agreement with our commerciallender, Residential Funding Corporation. The loan agreement restricts us fromusing any loan proceeds for acquisitions and prohibits us from borrowingoutside of the loan agreement, for acquisitions or otherwise, without the priorwritten consent of the lender. The loan agreement also prohibits us from usingthe proceeds of any sale of equity securities except to pay down indebtednessunder the loan agreement. Thus, we must obtain the written consent of ourlender before we use any loan proceeds for acquisitions and before we issue anydebt or equity securities to raise financing for acquisitions. Our lender maygrant or withhold such consent in the lender’s sole discretion. If ourcommercial lender is unwilling to consent to our use of loan proceeds or ourissuance of debt or equity securities to finance acquisitions, we may have toabort any growth plan that depends on the use of funds from such debt or equitysecurities. Even if we obtain required consents from our lender, we may not beable to obtain additional required capital on acceptable terms, if at all. Tothe extent that additional capital is not available, we may be required tolimit our plans for growth. In addition, any capital we may be able to raisecould result in increased leverage on our balance sheet, additional interestand financing expense, decreased operating income to fund future expansion,and/or dilution of existing equity owners.

**If weare not able to comply with the financial covenants and other conditionsrequired by our loan agreement with our commercial lender, our lender couldrequire full repayment of the loan, which would negatively impact our liquidityand preclude us from making further acquisitions.**

We are subject to certainfinancial covenants and other conditions required by our loan agreement withResidential Funding Corporation (“RFC”), including a maximum senior debt/EBITDAratio, minimum fixed charge coverage ratio, minimum consolidated net worth,minimum liquidity and a limit on 

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capitalexpenditures. We exceeded the 1.50 maximum senior debt/EBITDA ratio as of September 30,2004 and December 31, 2004. Our actual senior debt/EBITDA ratio as ofthose two dates was 1.57 and 1.51, respectively. RFC has waived these covenantviolations effective April 7, 2005. RFC has, in addition, agreed toexclude certain items from the covenant computations for a twelve month period.The exclusion of certain items enabled us to meet the minimum fixed chargecoverage ratio at December 31, 2004. The company was in compliance withall of its loan covenants as of September 30, 2005. However, there can beno assurance that we will be able to meet all of the financial covenants andother conditions required by our loan agreement. RFC may not grant waivers offuture covenant violations and could also require full repayment of the loan,which would negatively impact our liquidity and preclude us from making furtheracquisitions.

**Substantiallyall of our revenues are generated from contracts with a limited number of HMOs,and if our affiliated physician organizations were to lose HMO contracts or torenew HMO contracts on less favorable terms, our revenues and profitabilitycould be significantly reduced.**

After a recent consolidation of HMOs, there are nowonly four large and five smaller HMOs doing business in California, whichmagnifies the risk of loss of any HMO contract by our affiliated physicianorganizations. The potential for risk is also magnified because HMO contractsgenerally have only a one year term, may be terminated earlier without causeupon notice, and, upon renewal, are subject to annual negotiation of capitationrates, covered benefits and other terms and conditions.

We are particularly atrisk with respect to the potential loss or renewal on less favorable terms ofcontracts that our affiliated physician organizations have with four of theseHMOs—PacifiCare of California, Blue Cross of California, Health Net ofCalifornia and Blue Shield of California.

For the fiscal year ended September 30, 2005,contracts with our four largest HMO clients accounted for approximately 75% ofour enrollment, of which our contract with PacifiCare of California accountedfor approximately 22% of our enrollment, our contract with Health Net ofCalifornia accounted for approximately 18% of our enrollment, our contract withBlue Cross of California accounted for approximately 19% of our enrollment, andour contract with Blue Shield of California accounted for approximately 16% ofour enrollment. During the fiscal year ended September 30, 2005, our contractwith PacifiCare of California accounted for $40,155,679 in revenue, or 31% ofour total capitation revenue, our contract with Health Net of Californiaaccounted for $25,224,324 in revenue, or 20% of our total capitation revenue,our contract with Blue Cross accounted for $21,365,598 in revenue, or 17% ofour total capitation revenue and our contract with Blue Shield of Californiaaccounted for $14,802,756 in revenue, or 12% of our total capitation revenue.For the fiscal year ended September 30, 2005, PacifiCare, Blue Cross,Health Net and Blue Shield accounted for combined revenue of $101,548,357, orapproximately 80% of our total capitation revenue.

For the fiscal year ended September 30, 2004,contracts with our four largest HMO clients accounted for approximately 81% ofour enrollment, of which our contract with PacifiCare of California accountedfor approximately 25% of our enrollment, our contract with Health Net ofCalifornia accounted for approximately 21% of our enrollment, our contract withBlue Cross of California accounted for 22% of our enrollment, and our contractwith Blue Shield of California accounted for approximately 13% of ourenrollment. During the fiscal year ended September 30, 2004, our contractwith PacifiCare of California accounted for $40,903,464 in revenue, or 32% ofour total capitation revenue, our contract with Health Net of Californiaaccounted for $25,933,742 in revenue, or 21% of our total capitation revenue,our contract with Blue Cross accounted for $19,899,135 in revenue, or 16% ofour total capitation revenue and our contract with Blue Shield of Californiaaccounted for $13,467,152 in revenue, or 11% of our total capitation revenue.For the fiscal year ended September 30, 2004, PacifiCare, Blue Cross,Health Net and Blue Shield accounted for combined revenue of $100,203,493, or80% of our total capitation revenue.

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The loss of contracts with any one of these HMOs couldsignificantly reduce our revenues and profitability.

We have one yearautomatically renewable contracts with PacifiCare of California, Blue Cross ofCalifornia, Health Net of California and Blue Shield of California, unlesseither party provides the other party with 180-days’ notice of such party’sintent not to renew. Under limited circumstances, the HMOs may immediatelyterminate the contracts for cause; otherwise, termination for cause requires90 days’ prior written notice with an opportunity to cure. There can be noassurance that we will be able to renew any of these contracts or, if renewed,that they will contain terms favorable to us and our affiliated physicianorganizations.

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

Our success depends in large part on our effectivemanagement of health care costs, through control over our affiliated physicianorganizations through the single shareholder ownership model, controllingutilization of specialty care and other ancillary care and purchasing servicesat competitive prices. Under the single shareholder model, we have the right,under an assignable option agreement, to designate the sole owner of all of thestock of Prospect Medical Group, which is one of our affiliated physicianorganizations and also serves as a holding company for all of our otheraffiliated physician organizations. Our ability to designate the sole owner ofProspect Medical Group gives us the ability to control the management andbusiness policies of our affiliated physician organizations (except for one inwhich we have only a 50% joint venture ownership interest), including policiesfor the management of health care costs.

We attempt to control the health care costs of ouraffiliated physician organizations’ HMO enrollees by emphasizing preventivecare, monitoring compliance with pharmacy formularies (i.e., a list of approvedpharmaceutical drugs that the HMOs will provide an enrollee at a lesser costthan other drugs), entering into risk sharing agreements with hospitals thathave favorable rate structures, and requiring prior authorization forspecialist physician referrals. If we cannot continue to improve our managementof health care costs, our business, results of operations, financial condition,and ability to satisfy our obligations could be adversely affected.

Under all current HMOcontracts, our affiliated physician organizations accept the financial risk forthe provision of primary care and specialty physician services, and someancillary health care services. If we are unable to negotiate favorable pricesor rates in contracts with providers of these services on behalf of ouraffiliated physician organizations, or if our affiliated physicianorganizations are unable to effectively control the utilization of theseservices, our profitability could be reduced or eliminated. Our ability tomanage health care costs is also diminished to the extent that we are unable tosub-capitate the specialists in our service areas at competitive rates. To theextent that our HMO enrollees require more frequent or extensive care, ouroperating margins may be reduced and the revenues derived from our capitationcontracts may be insufficient to cover the costs of the services provided. Ifour medical costs substantially exceed our revenues we may be required toinfuse additional capital to maintain our provider network and HMO contracts,and there are no assurances that we will achieve profitability after theinfusion of capital.

**Ouroperating results could be adversely affected if our actual health care claimsexceed our reserves.**

Historically, we have not had adequate cash resourcesto retire one hundred percent (100%) of our incurred but not reported (i.e.,accrued or “IBNR”) medical claims. As of September 30, 2003, 2004 and 2005we could retire approximately 60%, 156%, and 147%, respectively, of our accruedmedical claims and other health care costs payable using all of our cash andcash equivalents. This percentage will fluctuate as of the particular cut-offdates depending on the IBNR calculations as of each date, the timing of theactual 

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disbursement of claimschecks near those dates, the status of specifically reserved items as of thosedates, the level of borrowings made as of the given dates and whether therehave been any recent acquisitions, and the amount of cash included as part ofthose acquisitions.

Historically, we have been able to satisfy our claimspayment obligations each month out of cash flows from operations and existingcash reserves. However, due to the historical inadequacy of our aggregate cashreserves, in the event that our revenues are substantially reduced due to aloss of a significant HMO contract or other factors, our cash flow may not besufficient to pay off claims on a timely basis, or at all. If we are unable topay claims timely we may be subject to HMO de-delegation wherein the HMO wouldtake away our claims processing functions and perform the functions on ourbehalf, charging our affiliated physicians a fee per enrollee, a requirement bythe HMO to comply with a corrective action plan, and/or a termination of theHMO contract, which could have a material adverse effect on our operations andresults of operations.

We estimate the amount ofour reserves for submitted claims and IBNR claims primarily using standardactuarial methodologies based upon historical data. The estimates for submittedclaims and IBNR claims liabilities are made on an accrual basis, arecontinually reviewed and are adjusted in current operations as required. As of September 30,2003, 2004 and 2005, we estimated our IBNR at $10,557,426, $13,323,622 and$11,532,328 respectively. Given the uncertainties inherent in such estimates,the reserves could materially understate or overstate our actual liability forclaims payable. Any increases to these prior estimates could adversely affectour results of operations in future periods.

**Wemay be exposed to liability or fail to estimate IBNR claims accurately if wecannot process our increased volume of claims accurately and timely.**

We have regulatory riskfor the timely processing and payment of claims. If we are unable to handleincreased claims volume, or if we are unable to pay claims timely we may becomesubject to an HMO corrective action plan or de-delegation (which means that anHMO takes away the claims processing function of the affiliated physicianorganization and performs that work itself, charging the affiliated physicianorganization a fee per HMO enrollee per month during which the service ishandled by the HMO) until the problem is corrected, and/or termination of theHMO agreement, which could have a material adverse effect on our operations andprofitability. In addition, if our claims processing system is unable toprocess claims accurately, the data we use for our IBNR estimates could beincomplete and our ability to estimate claims liabilities and establishadequate reserves could be adversely affected.

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

The health care industryis experiencing a continuing trend toward cost containment as government andprivate third-party payers seek to impose lower reimbursement andutilization rates and to negotiate reduced payment schedules with health careproviders. Changes in Medicare payment rates have reduced fee-for-servicepayments to physicians. These trends may result in a reduction from historicallevels in per patient revenue received by our affiliated physicianorganizations.

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

Most of our affiliated physician organizations’agreements with HMOs and hospitals contain risk-sharing arrangementsunder which the affiliated physician organizations can earn additionalcompensation by coordinating the provision of high quality, cost-effectivehealth care to enrollees, but they may also be required to assume a portion ofany loss sustained from these arrangements, thereby reducing 

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our net income.Risk-sharing arrangements are based upon the cost of hospital services or otherservices for which our physician organizations are not capitated. The terms ofthe particular risk-sharing arrangement allocate responsibility to therespective parties when the cost of services exceeds a budget, which results ina “deficit,” and permit the parties to share in any amounts remaining in thebudget, known as a “surplus,” which occurs when actual cost is less than thebudgeted amount. The amount of non-capitated and hospital costs in anyperiod could be affected by factors beyond our control, such as changes intreatment protocols, new technologies and inflation. To the extent that suchnon-capitated and hospital costs are higher than anticipated, revenue paid toour affiliated physician organizations may not be sufficient to cover therisk-sharing deficits they are responsible for, which could reduce our revenuesand profitability. It is our experience that “deficit” amounts for hospitalcosts are applied to offset any future “surplus” amount we would otherwise beentitled to receive. We have historically not been required to reimburse theHMOs for any hospital cost deficit amount. Most of our contracts with HMOsspecifically provide that we will not have to reimburse the HMO for hospitalcost deficit amounts.

HMOs often insist on withholding negotiated amountsfrom the affiliated physician organizations’ professional capitation payments,which the HMOs are permitted to retain, in order to cover the affiliatedphysician organizations’ share of any risk-sharing deficits; and hospitalsoften demand cash settlements of risk sharing deficits as a “quid pro quo” forjoining in these arrangements. Net risk-pool surpluses (deficits) were $(285,154),$(21,610), and $1,151,373 for the fiscal years ended September 30, 2003,2004 and 2005, respectively.

In addition to hospital risk-sharing arrangements,many HMOs also provide a risk-sharing arrangement for pharmaceutical costs.Unlike hospital pools where nearly all of the HMO contracts mandateparticipation by our affiliated physician organizations in the risk sharing forhospital costs, a lesser number of the HMO contracts mandate participation in apharmacy risk-sharing arrangement, and although (unlike hospital pools) ouraffiliated physician organizations are generally responsible for their 50%allocation of pharmacy cost deficits, the deficit amounts of pharmacy costshave to date not had a material effect on our revenue.

To date, we have notsuffered any losses due to hospital risk arrangements other than offsets (fordeficit amounts) against any future surpluses we otherwise would have received.To date our aggregate losses in connection with our pharmacy risk sharingarrangements have been insignificant. Whenever possible, we seek tocontractually reduce or eliminate our affiliated physician organizations’liability for risk-sharing deficits and with respect to pharmacy pools,eliminate their participation in such pools. Notwithstanding the foregoing,risk-sharing deficits could have a significant impact on our futureprofitability.

**If we do not successfullyintegrate the operations of acquired physician organizations into our servicenetwork, our costs could increase, our business could be disrupted, and we maynot be able to realize the anticipated benefits from those acquisitions.**

Our strategy for growth isprimarily to acquire additional IPAs that specialize in managed care and torealize economies of scale from those acquisitions. However, even if we aresuccessful in acquiring a new physician organization, we may not be successfulin integrating its operations into our operating systems. It may be difficult andtime consuming to integrate the acquired organization’s management services,including information systems, claims administration, and case management, aswell as administrative functions, and, while at the same time managing a largerentity with a differing history, business model and culture. Management may berequired to develop working relationships with providers with whom they havehad no previous business experience. Management also may not be able to obtaineconomies of scale from utilizing existing specialists for enrollees in oursame service networks. Integration of acquired entities is vital for us to beable to operate effectively and to control medical and administrative costs. Ifwe are not successful in integrating acquired operations on a timely basis, orat all, our business could be 

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disruptedand we may not be able to realize the anticipated benefits of our acquisitions,including cost savings. There may be substantial unanticipated costs associatedwith acquisition and integration activities, any of which could result insignificant one-time charges to earnings or otherwise adversely affect ouroperating results.

**Whenwe acquire operations that have historically operated at a loss, we may not beable to reverse those losses and operate those businesses at a profit, whichcould reduce our earnings.**

From time to time,Prospect Medical Group may acquire the assets of a physician organization thathas historically operated at a loss, such as the acquisition of the assets ofHealth Source Medical Group. We have instituted measures intended to reduce anyoperating losses and to operate acquired businesses profitably, such as we havedone with the acquisition of the assets of Health Source Medical Group. Weattempt to reduce operating losses of such acquired businesses by negotiatingbetter capitation rates from the HMOs, negotiating better pricing with thespecialist physicians by trading patient volume in exchange for asub-capitation payment or discounted pricing, and consolidating administrativeand back-office functions. Although we were successful in the turn-around ofHealth Source by employing these strategies, no assurance can be given that wecan repeat our performance in the event we acquire another physicianorganization that has historically operated at a loss. In the event we are notable to reverse those trends and operate the assets profitably, our netearnings could be reduced.

**If weare unable to identify suitable acquisition candidates or to negotiate orcomplete acquisitions on favorable terms, our prospects for growth could belimited.**

Although we are regularlyin discussions with potential acquisition candidates, it may be difficult toidentify suitable acquisition candidates and to negotiate satisfactory termswith them. If we are unable to identify suitable acquisition candidates atfavorable prices our ability to grow could be limited.

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

If we issue common stockor other equity securities as consideration for future acquisitions, theissuance of equity could have a dilutive effect on the earnings and marketprice of our common stock. If we borrow to finance future acquisitions, ourindebtedness and cost of debt service could increase, which would reduce ournet income and profitability.

**Weoperate in a competitive market; increased competition could adversely affectour revenues.**

The managed care industry is highly competitive and issubject to continuing changes in the ways in which services are provided andproviders are selected and paid. We are subject to significant competition bothwith respect to physicians affiliating with our affiliated physicianorganizations, and in seeking contracts to manage other IPAs.

Some of our competitorshave substantially greater financial, technical, managerial, marketing andother resources and experience than we do and, as a result, may compete moreeffectively than we can. Companies in other health care industry segments, someof which have financial and other resources greater than we do, may becomecompetitors in providing similar services. We may not be able to continue tocompete effectively in this industry. Additional competitors may enter ourmarkets and this increased competition may have an adverse effect on ourbusiness, financial condition, and results of operations.

 

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**Failureto comply with federal and state regulations could result in substantialpenalties and changes in business operations.**

We and our affiliated physician organizations aresubject to numerous federal and state statutes and regulations that are applicableto health care organizations and businesses generally, including the corporatepractice of medicine prohibition, federal and state anti-kickback laws andfederal and state laws regarding the use and disclosure of patient healthinformation. If our business operations are found to be in violation of any ofthe laws and regulations to which we are subject, we may be subject to theapplicable penalty associated with the violation, including civil and criminalpenalties, damages, fines, and increased legal expenses, we may be required tomake costly changes to our business operations, and we may be excluded fromgovernment reimbursement programs. The laws and regulations that we and ouraffiliated physician organizations are subject to are complex and subject tovarying interpretations. Any action against us or our affiliated physicianorganizations for violation of these laws or regulations, even if wesuccessfully defended against it, could cause us to incur significant legalexpenses and divert management’s attention from the operation of our business.All of these consequences could have the effect of reducing our revenues,increasing our costs, decreasing our net income, profitability and curtailingour growth.

For a more detaileddiscussion of the various federal and state regulations to which we aresubject, see Item 1, “Business—Regulation.”

**Futurereforms in health care legislation and regulation could reduce our revenues andprofitability.**

Although we cannot predict what future reforms may beproposed or adopted with respect to health care legislation and regulation,proposals that have been considered include changes in Medicare, Medicaid andother programs, a prescription drug benefit for Medicare, cost controls onhospitals and mandatory health insurance coverage for employees. The costs ofimplementing some of these proposals could be financed, in part, by reductionof payments to health care providers under Medicare, Medicaid, and othergovernment programs. Future legislation, regulations, interpretations, or otherchanges to the health care system could reduce our revenues and profitability.

The California Department of Managed Health Care(“DMHC”) has instituted financial solvency regulations mandated by CaliforniaSenate Bill 260. The regulations are intended to provide a formal mechanism formonitoring the financial solvency of capitated physician groups. Managementbelieves that our affiliated physician organizations that are subject to theseregulations will be able to comply with them. However, these regulations couldlimit the company’s ability to use its cash resources to make futureacquisitions.

Under theregulations, our affiliated physician organizations are required to comply withspecific criteria, including:

·       Maintain,at all times, a minimum “cash-to-claims ratio” (where “cash-to-claims ratio”means the organization’s cash, marketable securities and certain qualifiedreceivables, divided by the organization’s total unpaid claims liability. Theregulations require a cash-to-claims ratio of 0.60 beginning January 1,2006; 0.65 beginning July 1, 2006; and 0.75 beginning January 1,2007.

·       Submitperiodic reports to the DMHC containing various data and attestations regardingperformance and financial solvency, including IBNR (incurred but not reported)calculations and documentation, and attestations as to whether or not theorganization was in compliance with Knox-Keene Act requirements related toclaims payment timeliness, had maintained positive tangible net equity; and hadmaintained positive working capital.

In a case where anorganization is not in compliance with any of the above criteria, theorganization would be required to describe in the report submitted to the DMHCthe reasons for non-compliance and actions to be taken to bring theorganization into compliance.

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Further, under theseregulations, the DMHC will make public some of the information contained in thereports, including, but not limited to, whether or not a particular physicianorganization met each of the criteria.

In the event we are notable to meet certain of the financial solvency requirements, and fail to meetsubsequent corrective action plans, we could be subject to sanction, orlimitations on, or removal of, our ability to do business in California.

Our cash-to-claims ratioat September 30, 2005, was 1.58.

**Wheneverwe seek 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.**

IPA contracts with HMOstypically include provisions requiring the physician group to obtain the HMO’sconsent to the transfer of their contract with the IPA before effecting anychange in control of the IPA. As a result, whenever we seek to acquire an IPA,the acquisition may be conditioned upon the IPA’s ability to obtain suchconsent from the HMOs with which it has contracted. Therefore, an acquisitioncould be delayed while an HMO seeks to determine whether it will consent to thetransfer of the IPA. While in our experience the HMOs limit their review tosatisfying their regulatory responsibility to ensure that, following theacquisition, the IPA post-acquisition will meet certain financial andoperational thresholds, the language in many of the HMO agreements give the HMOthe ability to decline to give their consent if they simply do not want to dobusiness with the acquiring entity. If an HMO is unwilling for any reason togive its consent, this could deter us from completing the acquisition, or, ifwe complete an acquisition without obtaining an HMO’s consent, we could losethe benefit of the enrollees and revenues associated with that HMO’s contract.

**Ourprofitability could be adversely affected by any changes that would reducepayments to HMOs under government-sponsored health care programs.**

Although our affiliatedphysician organizations do not directly contract with the Centers forMedicare & Medicaid Services (a federal agency within the U.S.Department of Health and Human Services), during the fiscal year endedSeptember 30, 2003 our affiliated physician organizations received$18,410,213 in revenues, or approximately 29% of capitation revenues, derivedfrom payments made to the affiliated physician organizations from HMOs thatcontract with Medicare, Medicaid and other government-sponsored healthcare programs. Consequently, any change in the regulations, policies,practices, interpretations or statutes adversely affecting payments made toHMOs under these government-sponsored health care programs could reduceour profitability. A continuing decline in enrollees in Medicare Advantagecould also have a material adverse effect on our profitability.

For the year endedSeptember 30, 2004, our affiliated physician organizations received$43,490,025 in revenues from HMOs that contract with Medicare, Medicaid andother government-sponsored health care programs, which representsapproximately 35% of capitation revenues.

For the year endedSeptember 30, 2005, our affiliated physician organizations received$46,791,854 in revenues from HMOs that contract with Medicare, Medicaid andother government-sponsored health care programs, which representsapproximately 37% of capitation revenues

**Ourrevenues and profits could be diminished if we lose the services of keyphysicians in our affiliated physician organizations.**

Substantially all of ourrevenues are derived from management agreements with our affiliated physicianorganizations. Key physicians in an affiliated physician organization couldretire, become 

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disabled,terminate their employment agreements or provider contracts, or otherwisebecome unable or unwilling to continue generating revenues at the currentlevel, or practicing medicine within the physician organization. Enrollees whohave been served by such physicians could choose to enroll with competitorsphysician organizations, reducing our revenues and profits. Moreover, we maynot be able to attract other physicians into our affiliated physicianorganizations to replace the services of such physicians.

**Becauseour business is currently limited to the Southern California area, anyreduction in our revenues and profitability from a local economic downturnwould not be offset by operations in other geographic areas.**

To date, we have developedour business within only one geographic area to take advantage of economies ofscale and the mature managed care market of Southern California. Due to thisconcentration of business in a single geographic area, we are exposed topotential losses resulting from the risk of an economic downturn in SouthernCalifornia. If economic conditions deteriorate in Southern California, our enrollmentand our revenues may decline, which could significantly reduce ourprofitability.

**We are required to upgrade and modify our managementinformation systems to accommodate growth in our business and changes intechnology and to satisfy new government regulations. As we seek to implementthese changes, we may experience complications, delays and increasing costs,which could disrupt our business and reduce our profitability.**

We have developedsophisticated management information systems that process and monitor patientcase management and utilization of physician, hospital and ancillary services,claims receipt and claims payments, patient eligibility and other operationaldata required by management. These systems may require modifications, improvementsor replacements as we expand and as new technologies become available. We mayalso be required to modify our management information systems in order tocomply with new government regulations. For example, regulations adopted underthe federal Health Insurance Portability and Accountability Act of 1996beginning in August 2000 have required us to begin complying with newelectronic health care transactions and conduct standards, new uniformstandards for data reporting, formatting and coding, and new standards forensuring the privacy of individually identifiable health information. Thisrequired us to make significant changes to our management information systems,at substantial cost. Similar modifications, improvements and replacements maybe required in the future at additional substantial cost and could disrupt ouroperations during periods of implementation. Moreover, implementation of suchsystems is subject to the availability of information technology and skilledpersonnel to assist us in creating and implementing the systems. Thecomplications, delays and cost of implementing these changes could disrupt ourbusiness and reduce our profitability. During the years ended September 30,2003, 2004 and 2005, we estimate that the costs incurred by us to upgrade andmodify our management information system exclusive of any employee expense havetotaled approximately $230,000, $540,000 and $230,000. These amounts do notinclude any of the costs associated with running our company’s informationsystems department, which currently approximate $2 million annually.

**If wewere to lose the services of Dr. Terner or other key members ofmanagement, we might not be able to replace them in a timely manner withqualified personnel, which could disrupt our business and reduce ourprofitability and revenue growth.**

The success of our business depends, in part, on thecontinued contributions of key members of our management, including ourChairman and Chief Executive Officer, Jacob Y. Terner, M.D., our President andChief Operating Officer, Catherine Dickson and our Chief Financial Officer,Mike Heather. If for any reason we were to lose the services of any key memberof management, we would need to find and recruit a qualified replacementquickly to avoid disrupting our business and reducing our profitability andrevenue growth. We compete with other companies for executive talent, and itmay not be possible for us to recruit a qualified candidate on a timely basis,or at all. Currently, we do not maintain any life insurance on our 

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key management personnel,and the only members of our management team that have employment agreements atthis time are Dr. Terner and Mr. Heather. Although we have notentered into an employment agreement with Ms. Dickson, our Board ofDirectors has approved the payment to her of six months’ salary as a severancepackage in the event we terminate her employment.

On June 30, 1997, Dr. Ternerconsented, without admitting or denying any of the allegations in a complaintrelating to an insider trading investigation by the SEC, except as specificallyset forth therein, to the entry of a final judgment of permanent injunction andother relief. The SEC’s investigation involved the trading of Century MediCorpstock in June and July 1992 by persons other than Dr. Ternerprior to the public announcement of Century MediCorp’s merger with FoundationHealth, a California Health Plan. The judgment permanently restrained andenjoined Dr. Terner from employing any fraudulent device, scheme orartifice, making material misstatements or omitting material statements of factor engaging in fraudulent or deceitful acts, practices or courses of businessin violation of Section 10(b) of the 1934 Act and Rule 10b-5thereunder. No allegations were made that Dr. Terner had personallyengaged in the trading of Century MediCorp stock, or that Dr. Ternerpersonally profited from any such alleged trading. Dr. Terner was furtherordered to pay a civil penalty in the amount of $225,750 under the InsiderTrading and Securities Fraud Enforcement Act of 1988.

**Weand our affiliated physician organizations may become subject to claims ofmedical malpractice or HMO bad-faith liability claims for which our insurancecoverage may not be adequate. Such claims could materially increase our costsand reduce our profitability.**

Each of our affiliated physician organizations isinvolved in the delivery of health care services to the public and, therefore,is exposed to the risk of professional liability claims. The HMOs require ouraffiliated physician organizations to indemnify the HMOs for losses resultingfrom the negligence of physicians who were employed by or contracted with thephysician organization. Claims of this nature, if successful, could result insubstantial damage awards to the claimants, which may exceed the limits of anyapplicable insurance coverage. Insurance against losses related to claims ofthis type can be expensive. Moreover, in recent years, physicians, hospitalsand other participants in the health care industry have become subject to anincreasing number of lawsuits alleging medical malpractice, HMO bad-faithliability and related types of claims based on the withholding of approval foror reimbursement of necessary medical services. Many of these lawsuits involvelarge claims and substantial defense costs. Although we do not engage in thepractice of medicine or the provision of medical services, we may also becomesubject to legal claims alleging that we have committed medical malpractice orwe may become a defendant in an HMO bad-faith liability claim.

Our employed physicians atSierra Medical Group and Pegasus Medical Group are currently insured underpolicies that cover malpractice on a “claims made” basis, which includesvicarious coverage for each entity. We also carry a policy of managed careerrors and omissions insurance, in amounts management deems appropriate, basedupon historical claims and the nature and risk of our business. In addition,each of the independent physicians that contract with our affiliated physicianorganizations is required to maintain professional liability insurance coverageof the physician and of each employee, servant and agent of the physician.Nevertheless, there are exclusions and exceptions to coverage under eachinsurance policy that may make coverage for any claim unavailable, futureclaims could exceed the limits of available insurance coverage, existinginsurers could become insolvent and fail to meet their obligations to providecoverage for such claims, and such coverage may not always be available oravailable with sufficient limits and at reasonable cost to adequately andeconomically insure us and our affiliated physician organizations’ operationsin the future. A malpractice or an errors and omissions judgment against us orany of our affiliated physician organizations could materially increase ourcosts and reduce our profitability.

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

Our results of operationsfor any quarter are not necessarily indicative of results of operations for anyfuture period or full year. Our quarterly results of operations may fluctuatefor a number of reasons. Our annual and interim financial statements containaccruals that are calculated quarterly for estimates of incentive payments tobe made by the HMOs to our affiliated physician organizations based uponhospital utilization to budgeted costs. Quarterly results have in the past, andmay in the future, be affected by adjustments to such estimates for actualcosts incurred. We are subject to quarterly variations in our medical expensesdue to fluctuations in patient utilization, legislative and regulatorydevelopments, general economic conditions, and the capitated nature of ourrevenues. Historically, the affiliated physician organizations and HMOsgenerally reconcile differences between actual and estimated amounts relatingto HMO incentive payment arrangements by the third quarter of each calendaryear. In the event that the affiliated physician organizations and HMOs areunable to reconcile such differences, extensive negotiation, arbitration orlitigation relating to the final settlement of these amounts may occur. Anydelay in the settlement of these amounts may result in our being unable torecord anticipated income. As our network expands to include additional IPAs,the timing of these reconciliations may vary; this variation in timing maycause our results not to be directly comparable to corresponding quarters inother years. Our financial statements also include estimates of costs forcovered medical benefits incurred by enrollees, which costs have not yet beenreported by the providers (incurred but not reported claims). While theseestimates are based on information available to us at the time of calculation,actual costs may differ from our estimates of such amounts. If the actual costsdiffer significantly from the amounts we have estimated, adjustments will berequired and quarterly results may be affected. Quarterly results may also beaffected by movements of HMO members from one HMO to another, particularlyduring periods of open enrollment for HMOs, which occur primarily in September,October and January of each year. Additionally, the completion ofacquisitions causes fluctuations in our quarterly results, as results of theacquired entities are consolidated with our results for periods following theacquisitions. These factors can make our quarterly results not be directlycomparable to the results in corresponding quarters of other years, making itdifficult to predict our future results of operations. As a result, our resultsof operations may fluctuate significantly from period to period, which coulddecrease the value of our common stock.

**TheNASD has conducted an informal inquiry regarding trading in our common stock.**

On February 3, 2004,we received a notice of inquiry from the National Association of SecuritiesDealers, Inc., concerning trading in our common stock that took placearound the time that we announced the first closing of a private placement ofour Series A Preferred Stock. We responded to an NASD request fordocuments on February 12, 2004 and have received no further contacts fromthe NASD since that date. However, it is possible that the NASD could continueits inquiry or open a formal investigation the NASD, or other governmentagencies, could initiate enforcement proceedings if the NASD concluded thatimproprieties occurred in connection with the trading.

**If weare not able to develop or sustain an active trading market for our commonstock, it may be difficult for stockholders to dispose of their common stock.**

Our common stock was thesubject of limited and sporadic trading on the OTC Bulletin Board from 1996 to1999. No liquid trading market has existed for our common stock since 1999.Trading of our common stock on the American Stock Exchange began on May 11,2005. It is uncertain whether we will be able to continue to meet therequirements for listing on the American Stock Exchange, or an alternativeexchange or market, or that an active trading market for our common stock willdevelop. If we do not maintain our American Stock Exchange listing or listingon another exchange or market and an active 

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marketin our common stock does not develop, it may be more difficult for stockholdersto dispose of their common stock and could diminish significantly the marketvalue of our common stock.

**Evenif an active market develops for our common stock, the market price of ourstock is likely to be volatile.**

Historically, the marketprices for shares of health care companies, and smaller capitalizationcompanies generally, have tended to be volatile. It is likely that the marketprice for our common shares will also be volatile. The price for our commonstock may be influenced by many factors, including announcements of legislationor regulation affecting the health care industry in general and reimbursementfor health care services in particular, the depth and liquidity of the marketfor our common stock, investor perception and fluctuations in our operatingresults and market conditions.

**Ifour common stock becomes subject to the SEC’s penny stock rules, ourstockholders may find it difficult to sell their stock.**

If we do not maintain theAmerican Stock Exchange listing for our common stock or a listing of our commonstock on another national securities exchange or on NASDAQ, and if the tradingprice of our common stock is less than $5.00 per share, our common stock willbecome subject to the SEC’s penny stock rules. Before a broker-dealer can sella penny stock, the penny stock rules require the firm to first approve thecustomer for the transaction and receive from the customer a written agreementto the transaction. The firm must furnish the customer a document describingthe risks of investing in penny stocks. The broker-dealer must tell thecustomer the current market quotation, if any, for the penny stock and thecompensation the firm and its broker will receive for the trade. Finally, thefirm must send monthly account statements showing the market value of eachpenny stock held in the customer’s account. These disclosure requirements tendto make it more difficult for a broker-dealer to make a market in penny stocks,and could, therefore, reduce the level of trading activity in a stock that issubject to the penny stock rules. Consequently, if our common stock becomessubject to the penny stock rules, our stockholders may find it difficult tosell their shares.

**Item 1B.**               UnresolvedStaff Comments

**Not applicable.**

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**Item 2.**                        Properties.

**Properties**

We do not own any realproperty. We, or our affiliated physician organizations, currently lease spacefor administrative and medical offices, some of which is shared space, asfollows:

**Medicalor Independent Practice Association Offices**

| ** **                            | ** ** | ** **         | ** ** | ** **                                                                           | ** ** | **Lease Term;  Renewal** | ** ** | **Current Monthly  Rent** | ** **    |
|---------------------------------------|------------|--------------------|------------|--------------------------------------------------------------------------------------|------------|--------------------------|------------|--------------------------------|---------------|
| Prospect Medical  Group(1)            |       | Santa Ana, CA      |       | Shares space with  Prospect Medical Systems.                                         |       | 6 years; 2010            |       |                           | $             | 41,464  |   |   |
| Sierra Primary Care  Medical Group(3) |       | Lancaster, CA |       | Shares space with Antelope Valley Medical Associates and Sierra Medical  Management. |       | 5 years; 2007            |       |                           | $ 15,415 |   |   |
| Sierra Primary Care  Medical Group(3) |       | Palmdale, CA  |       | Medical Clinic                                                                       |       | 5 years; 2007            |       |                           | $             | 13,906  |   |   |
| Pegasus Medical Group(3)              |       | Palmdale, CA       |       | Medical Clinic                                                                       |       | 5 years; 2007            |       |                           | $             | 7,585  |   |   |

 

**AdministrativeOffices**

| ** **                   | ** ** | ** **            | ** ** | ** **                                                                                   | ** ** | **Lease Term;  Renewal** | ** ** | **Current Monthly  Rent** | ** ** |
|------------------------------|------------|-----------------------|------------|----------------------------------------------------------------------------------------------|------------|--------------------------|------------|--------------------------------|------------|
| Prospect Medical Holdings(4) |       | Culver City,  CA |       | Corporate  headquarters.                                                                     |       | 7 years; 2012            |       |                           | $          | 5,311  |   |   |
| Prospect Medical  Holdings   |       | Santa Ana, CA         |       | Warehouse/  Storage Space                                                                    |       | 5 years; 2009            |       |                           | $          | 17,134  |   |   |
| Prospect Medical  Systems(2) |       | Santa Ana, CA         |       | Shares space with  Prospect Medical Group.                                                   |       | 7 years; 2005            |       |                           | $          | 41,464  |   |   |
| Sierra Medical Management(3) |       | Lancaster, CA         |       | Shares space with  Sierra Primary Care Medical Group and Antelope Valley Medical Associates. |       | 5 years; 2007            |       |                           | $          | 15,415  |   |   |
| Genesis HealthCare           |       | Garden Grove, CA      |       | Administrative  Offices                                                                      |       | 2 Years, 2006            |       |                           | $          | 2,048  |   |   |

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(1)          ProspectMedical Group includes all affiliated physician organizations that are wholly-ownedsubsidiaries of Prospect Medical Group.

(2)          OnJanuary 27, 2004, Prospect Medical Systems executed a 6th Addendum to its office lease that provided foran increase in space of 5,298 square feet effective November 1, 2004, atwhich date, the base rent increased to $41,464.

The Company is currentlynegotiating for additional office space adjacent to its Santa Ana facilities.Lease agreements are expected to be finalized in early 2006, for a 60 monthlease, through 2011, with starting monthly lease payments of approximately$19,000.

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(3)          Sierra Primary CareMedical Group, Antelope Valley Medical Associates and Pegasus Medical Grouphave their own facilities through Sierra Medical Management but they each sharecertain services provided by Prospect Medical Systems.

(4)          On August 31, 2005the Company entered into a new lease for its corporate headquarters. TheCompany moved to these new premises effective October 31, 2005. The priorcorporate headquarters’ lease expired effective September 30, 2005.

We believe that thisoffice space is sufficient for our operational needs for the foreseeablefuture, although we may need to acquire additional space to accommodate ourplans for future growth, if successful.

**Employees**

At September 30,2005, we and our affiliated physician organizations had a total of 349employees. The employees are not subject to any collective bargaining agreements.We believe that employee relations are good.

**Item 3.**                        LegalProceedings.

*St.Jude Medical Center*—In 1998, Prospect initiatedarbitration proceedings against St. Jude Medical Center (“St. Jude”) andPacifiCare of California (“PacifiCare”) for failure by St. Jude to provide anaccurate accounting of hospital incentive pools for the years 1997, 1998 and1999.

In November 2001, the Arbitrator awarded Prospect$1,200,000, plus interest, plus legal fees of approximately $1,000,000.PacifiCare was dismissed from the Prospect claim, and Prospect was ordered topay PacifiCare’s legal fees of approximately $125,000. Approximately $1,200,000was included in fiscal 2000 net patient service revenue, related to thismatter.

In a counter-claim, the Arbitrator awarded St.Jude $275,000, plus interest. These amounts are also included in the fiscal2001 financial statements.

In November 2001, Prospect received a partialpayment of $925,000 related to the above amounts, St. Jude filed apetition to vacate the award, and Prospect filed a cross-petition toconfirm the award. In December 2002, the Orange County Superior Courtgranted Prospect’s petition and entered judgment in favor of Prospect. St. Judefiled an appeal of this judgment.

On January 31, 2003, St. Jude paid Prospectapproximately $1,492,000, reflecting the remaining amount due under thearbitration award, including interest and attorneys’ fees. The payment was madesubject to Prospect’s agreement to repay this amount in the event thearbitration award was ultimately vacated as a result of further judicialproceedings.

Various appeals and other court actions ensued,related to portions of the arbitration award, interest thereon, and legal fees.Pending the final outcome of this matter, at September 30, 2003, we reservedapproximately $700,000 primarily related to those amounts already received fromSt. Jude, but which remained subject to appeal.

During Prospect’s fourth quarter of Fiscal 2005,following rulings by the California Court of Appeals which upheld the Arbitratorawards in favor of Prospect, but ruled that Prospect was responsible to St. Judefor approximately $71,000 of arbitration costs, the parties concluded asettlement agreement as to all disputed matters. That settlement agreement,dated July 7, 2005, stated that, upon Prospect paying the $71,000 to St.Jude (which we did), all portions of the prior litigation would have beensatisfied, the parties would refrain from any further proceedings, and theparties would file the required stipulation with Superior Court, stipulating tothe satisfaction of all prior judgments and the end of proceedings on thematter. On September 13, 2005, the Superior Court entered its orderconfirming these stipulations; 

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following which, Prospectreversed the remaining legal reserve, effective in the fourth quarter ended September 30,2005.

*Other Matters*—Weand our affiliated physician organizations are parties to other legal actionsarising in the ordinary course of business. We believe that liability, if any,under these claims will not have a material adverse effect on our consolidatedfinancial position or results of operations.

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

No matter was submitted to a vote of stockholdersthrough the solicitation of proxies or otherwise during the fourth quarter ofour fiscal year ended September 30, 2005.

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**PART II**

**Item 5.**                        Marketfor Registrant’s Common Equity, Related Stockholder Matters and IssuerPurchases of Equity Securities

Our common stock began trading on the American StockExchange under the symbol “PZZ” on May 11, 2005.

Prior to our listing on the American Stock Exchange,there was a limited market for our common stock. From 1996 to 1999, our commonstock was the subject of very limited and sporadic trading on the OTC BulletinBoard. During the year 2000 through the end of 2003, there was virtually notrading in our common stock. The Pink Sheets reported that limited trading ofour common stock resumed in January 2004 and continued on a limited basisuntil our stock became listed on the American Stock Exchange.

Thefollowing table sets forth the quarterly high and low sales prices for ourcommon stock since trading on the American Stock Exchange commenced:

| **Date Range**                          | ** ** | ** ** | ** ** | **High Sales Price** | ** ** | **Low Sales Price** | ** ** |
|----------------------------------------------|------------|------------|------------|--------------------------------|------------|-------------------------------|------------|
| 2005                                         |       |       |       |                           |       |                          |       |   |   |
| Third Quarter  (beginning May 11, 2005) |       |       | $          | 6.50                           |       |                          |       | $ | 5.45 |   |   |
| Fourth Quarter                               |       |       | $          | 5.74                           |       |                          |       | $ | 4.00 |   |   |

 

As of December 12, 2005, we had approximately 319record owners of our common stock.

On February 3, 2004, we received a notice ofinquiry from the National Association of Securities Dealers, Inc.,concerning the recent trading in our common stock. We responded to an NASDrequest for documents on February 12, 2004 and have received no furthercontacts from the NASD since that date.

We have not paid any cashdividends in the past and do not plan to do so in the near future. Under ourcredit facility, we are prohibited from declaring or paying any dividends ordistributions of earnings to our stockholders.

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**Item 6.**                        SelectedFinancial Data

**Selected Financial Data**

Setforth below is our selected consolidated financial data for the five fiscal yearsended September 30, 2005 derived from our audited consolidated financialstatements. You should read the selected consolidated financial data inconjunction with our consolidated financial statements and related notesincluded herein and with “Management’s Discussion and Analysis of FinancialCondition and Results of Operations.” Amounts are in thousands except for pershare and enrollment data:

| ** **                                                      | ** ** | **Year Ended September 30** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                      | ** ** | **2001**                                   | ** ** | **2002** | ** ** | **2003(1)** | ** ** | **2004(2)** | ** ** | **2005** | ** ** |
| **Statement  of Operations Data:**                              |       |                                       |       |   |   |   |   |   |   |   |   |
| Revenues                                                        |       | $                                          | 74,235     |   | $ | 69,170 |   | $ | 66,542 |   | $ | 129,516 |   | $ | 133,518 |   |
| Cost of Revenues                                                |       | 54,886                                     |       | 49,929 |   | 46,740 |   | 95,975 |   | 96,371 |   |
| Gross Margin                                                    |       | 19,349                                     |       | 19,241 |   | 19,802 |   | 33,541 |   | 37,147 |   |
| Operating Expenses                                              |       |                                       |       |   |   |   |   |   |   |   |   |
| General and Administrative                                      |       | 16,364                                     |       | 17,248 |   | 18,200 |   | 24,335 |   | 27,229 |   |
| Depreciation and Amortization                                   |       | 1,718                                      |       | 580 |   | 540 |   | 733 |   | 948 |   |
|                                                            |       | 18,082                                     |       | 17,828 |   | 18,740 |   | 25,068 |   | 28,177 |   |
| Operating income  from  unconsolidated joint venture            |       | 801                                        |       | 511 |   | 728 |   | 207 |   | 88 |   |
| Operating Income                                                |       | 2,068                                      |       | 1,924 |   | 1,790 |   | 8,680 |   | 9,058 |   |
| Interest Income                                                 |       | 169                                        |       | 151 |   | 59 |   | 76 |   | 400 |   |
| Interest Expense                                                |       | (815                                       | )          | (322 | ) | (195 | ) | (91 | ) | (958 | ) |
| Interest Expense,  net                                          |       | (646                                       | )          | (171 | ) | (136 | ) | (15 | ) | (558 | ) |
| Equity in losses,  and write down, of unconsolidated investment |       | —                                     |       | — |   | — |   | — |   | (1,000 | ) |
| Income Before Income Taxes                                      |       | 1,422                                      |       | 1,753 |   | 1,654 |   | 8,665 |   | 7,500 |   |
| Income Tax  Provision                                           |       | (997                                       | )          | (483 | ) | (683 | ) | (3,525 | ) | (3,415 | ) |
| Minority Interest                                               |       | (12                                        | )          | (9 | ) | (16 | ) | (13 | ) | (12 | ) |
| Net Income                                                      |       | $                                          | 413        |   | $ | 1,261 |   | $ | 955 |   | $ | 5,127 |   | $ | 4,073 |   |
| Basic Earnings  Per Share                                       |       | $                                          | 0.08       |   | $ | 0.26 |   | $ | 0.23 |   | $ | 1.19 |   | $ | 0.83 |   |
| Diluted Earnings Per  Share                                     |       | $                                          | 0.08       |   | $ | 0.26 |   | $ | 0.22 |   | $ | 0.68 |   | $ | 0.48 |   |

 

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| ** **                                       | ** ** | **As of September 30** | ** ** |
|--------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                       | ** ** | **2001**                              | ** ** | **2002** | ** ** | **2003(1)** | ** ** | **2004(2)** | ** ** | **2005(2)** | ** ** |
| **Balance Sheet Data:**                          |       |                                  |       |   |   |   |   |   |   |   |   |
| Assets:                                          |       |                                  |       |   |   |   |   |   |   |   |   |
| Cash and Cash  Equivalents                       |       | $                                     | 6,451      |   | $ | 4,566 |   | $ | 6,517 |   | $ | 20,330 |   | $ | 16,949 |   |
| Other Current  Assets                            |       | 3,708                                 |       | 2,931 |   | 2,151 |   | 4,218 |   | 5,702 |   |
| Fixed Assets                                     |       | 1,170                                 |       | 1,114 |   | 1,022 |   | 1,606 |   | 1,202 |   |
| Other Assets  (Primarily Goodwill)               |       | 17,368                                |       | 17,300 |   | 24,899 |   | 34,134 |   | 33,878 |   |
| Total Assets                                     |       | $                                     | 28,697     |   | $ | 25,911 |   | $ | 34,589 |   | $ | 60,288 |   | $ | 57,731 |   |
| Liabilities and  Shareholders’  Equity:     |       |                                  |       |   |   |   |   |   |   |   |   |
| Current  Liabilities                             |       | $                                     | 18,845     |   | $ | 17,075 |   | $ | 25,364 |   | $ | 27,689 |   | $ | 23,332 |   |
| Long-Term  Liabilities                           |       | 5,176                                 |       | 2,861 |   | 2,003 |   | 9,648 |   | 7,398 |   |
| Minority Interest                                |       | 76                                    |       | 74 |   | 80 |   | 64 |   | 65 |   |
| Total  Shareholders’ Equity                 |       | 4,600                                 |       | 5,901 |   | 7,142 |   | 22,887 |   | 26,936 |   |
| Total Liabilities  and Shareholders’ Equity |       | $                                     | 28,697     |   | $ | 25,911 |   | $ | 34,589 |   | $ | 60,288 |   | $ | 57,731 |   |
| **HMO  Enrollment:(3)**                          |       |                                  |       |   |   |   |   |   |   |   |   |
| Commercial                                       |       | 105,000                               |       | 102,000 |   | 136,200 |   | 168,500 |   | 144,900 |   |
| Medicare                                         |       | 9,800                                 |       | 7,000 |   | 11,200 |   | 15,500 |   | 12,500 |   |
| Medi-Cal                                         |       | 6,300                                 |       | 8,500 |   | 13,700 |   | 14,400 |   | 14,500 |   |
| **Total Enrollment**                             | ** ** | **121,100**                           | ** ** | **117,500** | ** ** | **161,100** | ** ** | **198,400** | ** ** | **171,900** | ** ** |

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(1)          The balance sheet andoperating results of Prospect Professional Care Medical Group have beenincluded in the consolidated balance sheet as of September 30, 2003, thedate of acquisition, and in the consolidated financial statements as of and forperiods after September 30, 2003.

(2)          The balance sheet andoperating results of Prospect NWOC Medical Group, Inc., StarCare MedicalGroup, Inc., APAC Medical Group, Inc. and Pinnacle Health Resourceshave been included in the consolidated financial statements for periods aftertheir February 1, 2004 date of acquisition.

(3)          Enrollment as of September 30,2003 includes approximately 45,000 enrollees acquired through the purchase ofProspect Professional Care Medical Group that occurred on that date.

(4)          The Medi-Cal enrollmentstatistics above include both enrollees that we manage for our own economicbenefit, and enrollees that, starting in 1999, we manage for the economic benefitof our partner in the AMVI/Prospect Health Network joint venture. The number ofenrollees included in the above table for which we provide management servicesto our joint venture partner, but in which we have no beneficial ownershipinterest, was 4,000, 5,600, 7,100, 7,100 and 7,300 as of September 30,2001, 2002, 2003, 2003, and 2005, respectively.

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**Item7.**                        Management’sDiscussion and Analysis of Financial Condition and Results of Operations

Thefollowing discussion of our financial condition and results of operationsshould be read together with the financial statements and related notesincluded in this registration statement. This discussion and analysis containsforward-looking statements that involve risks and uncertainties. Ouractual results may differ significantly from the results discussed in theforward-looking statements. Factors that might cause or contribute tosuch a difference include, but are not limited to, those discussed under “RiskFactors” and elsewhere in this registration statement.

***Executive Overview***

**General Operations**

We are a SouthernCalifornia health care company that provides management and administrativeservices to affiliated physician organizations that have entered intoagreements with HMOs to provide medical services to approximately 171,900 HMOenrollees (as of September 30, 2005) in Orange and Los Angelescounties.

In managing the affiliatedphysician organizations, we remain sensitive to local custom and practice,while centralizing, for the most part, the management functions in our SantaAna, California operations center.

**Highlights of Performance (Year Ended September 30,2005 as compared to 2004)**

·       Themember months increased 2% compared to the prior year.

·       Revenueincreased by approximately 3% compared to the prior year.

·       Themedical cost ratio decreased from 75% to 73% compared to the prior year.

·       Generaland administrative expenses increased approximately 12% compared to the prioryear.

·       Operatingincome increased by approximately 4% compared to the prior year.

·       Dilutedearnings per share decreased by 29% compared to the prior year.

·       Totalcash and cash equivalents decreased by $3,381,450, or approximately 17%compared to the prior year.

·       Total bank term loan debtand capital equipment lease obligations decreased by $6,841,887 orapproximately 46% compared to the prior year.

**Highlights of Performance (Year Ended September 30,2004 as compared to 2003)**

·       Themember months increased 71% compared to the prior year.

·       Revenueincreased by approximately 95% compared to the prior year.

·       Themedical cost ratio increased from 71% to 75% compared to the prior year.

·       Generaland administrative expenses increased approximately 34% compared to the prioryear.

·       Operatingincome increased by approximately 385% compared to the prior year.

·       Dilutedearnings per share increased by 209% compared to the prior year.

·       Totalcash and cash equivalents increased by $14,066,663, an increase ofapproximately 208% compared to the prior year.

·       Totalbank term loan debt and capital equipment lease obligations increased by$8,741,344, an increase of approximately 139% compared to the prior year.

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We consider thefollowing economic or industry-wide factors relevant to our business:

·       TheMedicare Prescription Drug, Improvement, and Modernization Act of 2003, whichwas signed into law on December 8, 2003 and made significant changes to theMedicare program, particularly by increasing drug reimbursement rates, appearsto be creating a renewed energy on the part of the HMOs to recruit seniorenrollees. Since senior enrollees have traditionally been profitable, if thistrend persists, it would have a positive effect on our gross revenues andoperating profit.

·       HMOsare making attempts to lower medical insurance costs to businesses byintroducing a variety of Preferred Provider Organizations (“PPO”) and PPO-likeproducts. These products, which carry lower premiums, but higher out of pocketcosts, tend to reduce HMO enrollment and could negatively affect our grossrevenue and operating profit.

·       Ifunemployment in Southern California went up, or a major employer scaled backlocal operations, or relocated the HMOs would have lower enrollment andrevenues, which in turn would impact our operations.

Additionally, the central element of our business planis to grow both revenues and profits by acquisition of IPAs. In Californiathere are approximately 160 IPAs (including IPAs that may also operate amedical clinic) that have managed care membership. Identification andsuccessful pursuit of the appropriate acquisition candidates presents materialopportunities, challenges and risks.

In the short term, shouldwe fail to identify suitable acquisition candidates and consummate theacquisitions such failure would negatively impact our growth. Over the longterm, should we be unable to successfully integrate acquisitions into ourbusiness, thereby losing significant portions of the value anticipated from theacquisitions, or should we consummate acquisitions that turn out to beunsuitable or unprofitable our earnings and goodwill value would be diminished.

**Operating Revenues**

Approximately 97% of our fiscal 2005 revenues werefrom the capitation payments made each month by HMOs to our affiliatedphysician organizations, for HMO enrollees who have chosen or been assigned toone of our affiliated physician organizations, to provide for theirprofessional medical care. The predominant method of receiving our capitationpayments is by a ready funds wire into the accounts of our affiliated physicianorganizations, generally between the 10th and 25th day of each month.

We receive management fees from non-affiliated physicianorganizations; the fee is either a fixed percentage of revenue of thenon-affiliated physician organization, or a fixed per-member-per-month payment.

Our two group medical practices, Sierra Primary CareMedical Group and Pegasus Medical Group also generate fee-for-service billings,which are reimbursed by Medicare, Medicaid (Medi-Cal in California), privateindemnity health insurance, and cash payments by patients.

For the year ended September 30, 2005, ascompared to 2004, we experienced a slight increase in revenues, primarily dueto net increases in our Medicare enrollees’ Risk Adjustment factors. These rateincreases were offset by declines in enrollment.

For the year ended September 30, 2004, ascompared to 2003, we experienced a large growth in revenues due to severalacquisitions completed between September 2003 and February 2004.

**Medical Expenses**

Our medical costs include monthly sub-capitation andfee-for-service payments to primary care and specialist physicians, andancillary service providers, who have executed contracts with our affiliatedphysician organizations; fee-for-service payments to physicians who providecare for our patients and do 

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not have a contract withour affiliated physician organizations; and salaries, benefits and othercompensation paid to physicians that are employees of our affiliated physicianorganizations (Sierra Primary Care Medical Group and Pegasus Medical Group).Our medical expenses also include an estimate of claims that have been incurredbut not reported (“IBNR”) to us.

We have establishedsystems to monitor the availability, appropriateness and effectiveness of thepatient care provided through out affiliated physician organizations. Wecollect utilization data for each of our affiliated physician organizationsthat we use to analyze over-utilization or under-utilization of servicesand assist our contracted and employed physicians in providing appropriate carefor their patients, and improving patient outcomes in a cost efficient manner.

**Operating Expenses**

Our operating expenses arethe general and administrative costs of managing our physician organizations.These costs include salaries, benefits and other compensation for ouremployees, insurance, rent, operating supplies, legal and accounting, and marketing.

**Cash Flow**

Our primary source of cash is derived from HMOcapitation payments to our affiliated physician organizations. Because ourcapitation payments are paid between the 10th and the 25th day of each month,and a substantial portion of our expenses are paid in arrears, we tend toaccumulate cash. Our primary use of cash is to pay medical expenses.

In order to complete acquisitions and fund our growth,we have, from time to time, borrowed money from commercial banks and othersources, and sold shares in our company.

Since 1996, when we made our first acquisition, wehave borrowed a total of $12.5 million from Comerica Bank,$3.0 million from sellers of acquired businesses and $1.76 millionfrom certain of our shareholders. Through August 2004, substantially allof the Comerica borrowings and all of the seller and shareholder borrowings hadbeen repaid, primarily using cash flow generated by operations. In September 2004we entered into a new $15 million credit facility with GMAC Residential FundingCorporation. This facility was increased by $4 million in connection with the November 2005acquisition of Genesis HealthCare. See “—Liquidity and Capital Resources—CreditFacilities” below.

On March 31, 2004, wecompleted a private offering of our Series A Convertible Preferred Stock (“Series APreferred Stock”) at $5.50 per share, raising total gross proceeds of$12,458,802 ($10,019,741, net of offering costs) from an aggregate of 182investors, all of whom were accredited. Each share of Series A PreferredStock sold in the offering automatically converted into common stock on July 27,2005 when the common stock underlying the Series A Preferred Stock becameregistered for resale under the Securities Act of 1933.

***Critical Accounting Policies***

The accounting policiesdescribed below are considered critical in preparing our consolidated financialstatements. Critical accounting policies require difficult, subjective orcomplex judgments, often as a result of the need to make estimates about theeffect of matters that are inherently uncertain. The judgments anduncertainties affecting the application of these policies include significantestimates and assumptions made by us using information available at the timethe estimates are made. Actual results could differ materially from thoseestimates.

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**Consolidation ofFinancial Statements**

As discussed further inNote 1 to our consolidated financial statements, under applicablefinancial reporting requirements, the financial statements of the affiliatedphysician organizations with which we have management services agreements areconsolidated with our own financial statements. This consolidation is requiredunder EITF Issue No. 97-2, “Application of FASB Statement No. 94and APB Opinion No. 16 to Physician Practice Management Entities andCertain Other Entities with Contractual Management Arrangements” issued by theEmerging Issues Task Force of the Financial Accounting Standards Board becausewe are deemed to hold a controlling financial interest in such organizationsthrough a nominee shareholder. We can, through an assignable option agreement,change the nominee shareholder at will on an unlimited basis and for nominalcost. There is no limitation on our designation of a nominee shareholder exceptthat any nominee shareholder must be a licensed physician or otherwisepermitted by law to hold shares in a professional medical corporation. We havealso concluded that under FIN 46 we are required to consolidate our affiliatedphysician organizations. The operations of our affiliated physicianorganizations have a significant impact on our financial statements. All inter-companyaccounts and balances have been eliminated in consolidation.

**Revenue Recognition**

Our revenue consists primarily of capitation paymentsfor medical services provided by our affiliated physician organizations undercontracts with various HMOs, or under fee-for-service arrangements. Capitationrevenue under HMO contracts is prepaid monthly to the affiliated physicianorganizations based on the number of enrollees assigned to physicians in ouraffiliated physician organizations.

Capitation revenue paid by HMOs is recognized in themonth in which the affiliated physician organization is obligated to provideservices. Capitation revenue may be subsequently adjusted to reflect changes inenrollment as a result of retroactive terminations or additions. Suchretroactive terminations or additions have not had a material effect oncapitation revenue. Capitation with respect to Medicare enrollees is subject tosubsequent adjustment by CMS for the acuity of the enrollees to whom serviceswere provided. We received and recorded as revenue approximately$4 million in the fourth quarter of fiscal 2005 from HMOs for riskadjustment factors. Since this revenue could previously not be estimated by us,we recorded it upon receipt from the HMOs.

Fee-for-service revenues are recognized when theservices have been performed, net of allowances to reduce billed amounts toestimated contractually entitled amounts. The effect of changes in estimatesfor contractual allowances has not had a material effect on fee-for-servicerevenues. All receivables are recorded net of an allowance for bad debts.

Management fee revenue is earned in the month theservices have been delivered.

Uncollectible amounts arereported as bad debt expense and included in general and administrativeexpenses.

**Accrued MedicalClaims**

Our affiliated physician organizations are responsiblefor the medical services their contracted or employed physicians provide to anassigned HMO enrollee. The cost of health care services is recognized in theperiod in which it is provided and includes an estimate of the cost of serviceswhich have been incurred but not reported.

Accrued medical claims, which do not include paymentsto our sub-capitated physicians, consist of actual claims reported but not paidand estimates of claims incurred but not reported (“IBNR”). We, together withour independent actuaries, estimate IBNR using estimates and assumptions thatconsider, among other things, contractual requirements, historical utilizationtrends and payment patterns, medical 

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inflation, product mix(HMO commercial, senior and Medi-Cal enrollees), enrollment and other relevantfactors.

These accruals are continually monitored and reviewed,and as claims settlements are made or accruals adjusted, differences arereflected in current operations. Changes in assumptions for medical costscaused by changes in actual experience could cause these estimates to change inthe near term. Our reserve models use lag-based incurred claim estimates andtrended per member per month estimates.

Thefollowing table presents the components of the change in accrued medical claimsfor the three years ended September 30, 2005:

| ** **                                            | ** ** | **Year Ended September 30** | ** **     |
|-------------------------------------------------------|------------|--------------------------------------------|----------------|
| ** **                                            | ** ** | **2003**                                   | ** **     | **2004** | ** ** | **2005** | ** ** |
| **IBNR at  Beginning of Year**                        | ** ** | **$**                                      | **6,965,969**  | ** ** | **$** | **10,557,426** | ** ** | **$** | **13,323,622** | ** ** |
| Health Care Claims  Expense Incurred During the Year: |       |                                       |           |   |   |   |   |
| Related to Current Year                               |       | 22,240,501                                 |           | 44,699,711 |   | 46,030,847 |   |
| Related to Prior Year                                 |       | (983,140                                   | )              | (2,327,044 | ) | (855,164 | ) |
| **Total Incurred**                                    | ** ** | **21,257,361**                             | ** **     | **42,372,667** | ** ** | **45,175,683** | ** ** |
| **Health Care Claims Paid During  the Year**          | ** ** | ** **                                 | ** **     | ** ** | ** ** | ** ** | ** ** |
| Related to Current Year                               |       | (18,630,639                                | )              | (33,295,082 | ) | (35,266,828 | ) |
| Related to Prior Year                                 |       | (4,535,265                                 | )              | (7,268,752 | ) | (11,700,149 | ) |
| **Total Paid**                                        | ** ** | **(23,165,904**                            | **)**          | **(40,563,834** | **)** | **(46,966,977** | **)** |
| **IBNR  Acquired During the Year, net**               | ** ** | **5,500,000**                              | ** **     | **957,363** | ** ** | **—** | ** ** |
| **IBNR at End of Year**                               | ** ** | **$**                                      | **10,557,426** | ** ** | **$** | **13,323,622** | ** ** | **$** | **11,532,328** | ** ** |

 

Acquisition balances represent medical claimsliabilities as of the applicable acquisition date. Our strategy of growth byacquisition increases the complexity and variability already inherent in ourclaims estimation process. Our business in general, and this area of ourbusiness in particular, is subject to uncertainty as to the outcome andestimation of medical claims, which uncertainty is additionally impacted by ouracquiring and integrating businesses previously not operated by us. Followingan acquisition, we ensure that the IBNR methodology and calculations for theacquired business are consistent with our own methodology and calculations. OurIBNR models consider claims payment data for the current month and the prior24 months. During the 25-month period following our acquisition, andto the extent that the prior owners’ experience and management of medicalexpenses was different from ours, actual experience under our management andcontracting will be reflected in the IBNR calculations. We attempt to beconsistently conservative in reserving for known and anticipated medical claimsliabilities. This requires additional emphasis for recently acquiredbusinesses.

We believe that the amount of our accrued medicalclaims is adequate to cover our ultimate liability for incurred claims as of September 30,2005 however, actual claims payments may differ from our estimate. Assuming ahypothetic 1% variance in our estimate of accrued medical claims, our pre-taxprofit for the years ended September 30, 2003, 2004, and 2005, would increaseor decrease by approximately $105,574, $133,236, and $115,323, respectively.

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Thefollowing table reflects the combined impact in our estimate of claimsliability as of September 30, 2005 had we changed: (i) our completionfactors for all applicable months of service included in our IBNR calculation(i.e., for the preceding 5th through 25th months) by thepercentages indicated; and (ii) changed our trended PMPM factors for allapplicable months of service included in our IBNR calculation (i.e., for the preceding1st through 4th months) by the percentages indicated.

| **Increase (Decrease) in   Estimated   Completion Factors** | ** ** | ** ** | ** ** | **Increase (Decrease) in   Accrued Medical Claims  Payable** | ** ** |
|--------------------------------------------------------------------------------------|------------|------------|------------|---------------------------------------------------------------------------------------|------------|
| (3)%                                                                                 |       |       | $          | (3,300,000                                                                            | )          |   |
| (2)%                                                                                 |       |       | $          | (2,200,000                                                                            | )          |   |
| (1)%                                                                                 |       |       | $          | (1,100,000                                                                            | )          |   |
| 1%                                                                                   |       |       | $          | 1,100,000                                                                             |       |   |
| 2%                                                                                   |       |       | $          | 2,200,000                                                                             |       |   |
| 3%                                                                                   |       |       | $          | 3,300,000                                                                             |       |   |

 

We also regularly evaluatethe need to establish premium deficiency reserves for the probability thatanticipated future health care costs could exceed future capitation paymentsfrom the HMOs. To date, we have determined that no premium deficiency reserveshave been necessary.

**Goodwill andIntangible Assets**

In June 2001, the Financial Accounting StandardsBoard (“FASB”) issued two standards related to business combinations. The firststatement, SFAS No. 141, “Business Combinations,” requires all businesscombinations after June 30, 2001 to be accounted for using the purchasemethod and prohibits the pooling-of-interest method of accounting. SFAS No. 141also states that acquired intangible assets should be separately recognizedupon meeting certain criteria. Such intangible assets include, but are notlimited to, trade and service marks, non-compete agreements, customer lists andlicenses.

The second statement, SFAS No. 142, “Goodwill andOther Intangible Assets,” requires that upon adoption, amortization of goodwilland indefinite life intangible assets will cease and instead, the carryingvalue of goodwill and indefinite life intangible assets will be evaluated forimpairment on at least an annual basis, or more frequently if certainindicators are present. Such indicators include adverse changes in market valueand/or stock price, laws and regulations, profitability, cash flows, ourability to maintain enrollment and renew payor contracts on favorable terms. Atwo-step impairment test is used to identify potential goodwill impairment andto measure the amount of goodwill impairment loss to be recognized (if any).The first step consists of estimating the fair value of the reporting unitbased on recognized valuation techniques, which include a weighted combinationof (i) the guideline company method that utilizes revenue multiples forcomparable publicly-traded companies, and (ii) a discounted cash flowmodel that utilizes future cash flows, the timing of those cash flows, and adiscount rate (or weighted average cost of capital which considers the cost ofequity and cost of debt financing expected by a representative marketparticipant) representing the time value of money and the inherent risk and uncertaintyof the future cash flows. If the estimated fair value of the reporting unit isless than its carrying value, a second step is performed to compute the amountof the impairment by determining the “implied fair value” of the goodwill,which is compared to its corresponding carrying value.

The affiliated physicianorganizations, which share similar economic and operational characteristics,comprise a sole reporting unit. The Company’s valuations have concluded thatthe fair value of Prospect Medical Holdings exceeded its carrying value, thusgoodwill of Prospect Medical Holdings was not considered impaired during eachfiscal year test, since we adopted SFAS No. 142 for our fiscal year ended September 30,2002.

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**Legal and OtherLoss Contingencies**

We are subject tocontingencies, such as legal proceedings and claims arising out of ourbusiness. In accordance with SFAS No. 5, Accounting for Contingencies, werecord accruals for such contingencies when it is probable that a liabilitywill be incurred and the amount of loss can be reasonably estimated. Asignificant amount of management estimation is required in determining when, orif, an accrual should be recorded for a contingent matter and the amount ofsuch accrual, if any.

**Acquisitions**

During the three years ended September 30, 2005,we completed several business combinations. These business combinations are allaccounted for using the purchase method of accounting, and accordingly, theoperating results of each acquisition have been included in our consolidatedfinancial statements since their effective date of acquisition. The purchaseprice for each business combination was allocated to the assets, including theidentifiable intangible assets, and liabilities, based on estimated fairvalues. The excess of purchase price over the net identifiable assets acquiredwas allocated to goodwill and other intangible assets. Prior to October 1,2001, goodwill was amortized over a useful life of 20 years. In accordancewith SFAS No. 142, we no longer amortize goodwill. In accordance with SFASNo. 141, the allocation to identifiable intangible assets was originallybeing amortized over a useful life of seven to ten years. During 2005,management determined that the useful life of identified intangibles wasshorter than originally expected and the useful life was reduced to five years.The reduction in estimated useful life and related amortization period,resulted in increased amortization of approximately $135,000 in fiscal 2005.

Thefollowing table summarizes all business combinations for the five years ended September 30,2005.

| **Business Combinations**                                                             | ** ** | ** **              | ** ** | **Effective Date** | ** **       | **Purchase Price** | ** ** | **Location**                        | ** **            |
|--------------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------------|-------------------------|------------|-------------------------------------|-----------------------|
| Prospect Health  Source Medical Group, Inc.                                           |       | January 1,  2001   |       |                    | $                | 1,000,000               |       |                                | West  Los Angeles     |   |
| Prospect  Professional Care Medical Group, Inc.                             |       | September 30, 2003 |       |                    | $ 7,050,000 |                    |       | Orange County and  East Los Angeles |                  |
| Prospect NWOC  Medical Group, Inc.                                                    |       | February 1,  2004  |       |                    | $                | 2,000,000               |       |                                | North  Orange County  |   |
| StarCare Medical  Group, Inc. APAC Medical Group, Inc. Pinnacle Health Resources |       | February 1,  2004  |       |                    | $                | 8,500,000               |       |                                | North  Orange County  |   |
| Genesis HealthCare of  Southern California                                                 |       | November 1, 2005   |       |                    | $                | 8,000,000               |       |                                | Central Orange County |   |

 

The assets we acquire inour acquisitions include cash, and HMO and provider contracts. We require thatcash or a combination of cash and current assets equal current liabilities, andtangible net worth. The difference between the net worth of each acquisitionand our purchase price is allocated to goodwill and identifiable intangible assets.

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**Enrollment**

Thefollowing table presents our enrollment, inclusive of Medi-Cal lives we managefor the AMVI/Prospect Health Network joint venture, as of September 30,2004 and 2005, and the percentage change in enrollment between these dates:

| ** ** | ** ** | **2004**    | ** ** | **2005**    | ** ** | **% Change** | ** ** |
|------------|------------|-------------|------------|-------------|------------|-------------------|------------|
| Commercial |       | 168,500     |       | 144,900     |       |              | (14)       | % |   |
| Medicare   |       | 15,500      |       | 12,500      |       |              | (19)       | % |   |
| Medi-Cal   |       | 14,400      |       | 14,500      |       |              | 1          | % |   |
| **Total**  | ** ** | **198,400** | ** ** | **171,900** |       | ** **        | **(13)**   | **%** |   |

 

Thefollowing table presents our enrollment, inclusive of Medi-Cal lives we managefor the AMVI/Prospect Health Network joint venture, as of September 30,2003 and 2004, and the percentage change in enrollment between these dates:

| ** ** | ** ** | **2003**    | ** ** | **2004**    | ** ** | **% Change** | ** ** |
|------------|------------|-------------|------------|-------------|------------|-------------------|------------|
| Commercial |       | 136,200     |       | 168,500     |       |              | 24         | % |   |
| Medicare   |       | 11,200      |       | 15,500      |       |              | 38         | % |   |
| MediCal    |       | 13,700      |       | 14,400      |       |              | 5          | % |   |
| **Total**  | ** ** | **161,100** | ** ** | **198,400** | ** ** | ** **        | **23**     | **%** | ** ** |

 

The decrease in enrollment as of September 30,2005 compared to September 30, 2004 is attributable primarily to decreasedmembership associated with physicians contracted to our IPAs, with the largestdecreases being in the recently acquired IPAs were assimilation and integrationinto the Prospect operations platform continued in fiscal 2005.

The increase in enrollment as of September 30,2004 compared to September 30, 2003 is attributable primarily to theacquisitions of Prospect NWOC Medical Group, StarCare Medical Group and APACMedical Group. These groups had combined HMO enrollees of approximately 53,200as of September 30, 2004.

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**Results of Operations**

Thefollowing tables are provided to facilitate the discussion of our operationsfor each of the three years in the period ended September 30, 2005.

| ** **                                                          | ** ** | **Year Ended September 30** | ** **  |
|---------------------------------------------------------------------|------------|--------------------------------------------|-------------|
| ** **                                                          | ** ** | **2004**                                   | ** **  | **2005** | ** ** | **Increase  (Decrease)** | ** ** | **%** | ** ** |
| **Revenues:**                                                       |       |                                       |        |   |   |   |   |   |   |
| Capitation Revenue                                                  |       | $                                          | 125,860,567 |   | $ | 129,143,656 |   | $ | 3,283,089 |   | 3 | % |
| Fee for Service Revenue                                             |       | 2,546,444                                  |        | 2,232,059 |   | (314,385 | ) | (12 | )% |
| Management Fees                                                     |       | 841,152                                    |        | 806,788 |   | (34,364 | ) | (4 | )% |
| Other Operating Revenue                                             |       | 268,274                                    |        | 1,335,876 |   | 1,067,602 |   | 398 | % |
| **Total Revenues**                                                  |       | 129,516,437                                |        | 133,518,379 |   | 4,001,942 |   | 3 | % |
| **Operating Expenses:**                                             |       |                                       |        |   |   |   |   |   |   |
| Medical Costs                                                       |       | 95,975,041                                 |        | 96,371,197 |   | 396,156 |   | 0 | % |
| General and Administrative                                          |       | 24,335,510                                 |        | 27,228,736 |   | 2,893,226 |   | 12 | % |
| Depreciation and Amortization                                       |       | 732,806                                    |        | 948,017 |   | 215,211 |   | 29 | % |
| **Total Operating Expenses**                                        |       | 121,043,357                                |        | 124,547,950 |   | 3,504,593 |   | 3 | % |
| **Operating Income from Unconsolidated Joint  Venture**             |       | 206,634                                    |        | 87,516 |   | (119,118 | ) | (58 | )% |
| **Operating Income**                                                |       | 8,679,714                                  |        | 9,057,945 |   | 378,231 |   | 4 | % |
| **Interest Expense, net**                                           |       | (15,086                                    | )           | (558,278 | ) | (543,192 | ) | 3601 | % |
| **Equity in losses, and write down, of  unconsolidated investment** |       | —                                     |        | (1,000,000 | ) | (1,000,000 | ) | (100 | )% |
| **Income Before Taxes**                                             |       | 8,664,628                                  |        | 7,499,667 |   | (1,164,961 | ) | (13 | )% |
| **Income Tax Provision**                                            |       | 3,524,704                                  |        | 3,415,178 |   | (109,526 | ) | (3 | )% |
| **Minority Interest**                                               |       | 12,681                                     |        | 11,930 |   | (751 | ) | (6 | )% |
| **Net Income**                                                      |       | $                                          | 5,127,243   |   | $ | 4,072,559 |   | $ | (1,054,684 | ) | (21 | )% |
| **Diluted Earnings Per Share**                                      |       | $                                          | 0.68        |   | $ | 0.48 |   | $ | (0.20 | ) | (29 | )% |
| **Medical  Cost Ratio**                                             |       | 75                                         | %           | 73 | % |   |   |   |   |

 

| ** **                                              | ** ** | **Year Ended September 30** | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                              | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **Increase  (Decrease)** | ** ** | **%** | ** ** |
| **Revenues:**                                           |       |                                       |       |   |   |   |   |   |   |
| Capitation Revenue                                      |       | $                                          | 63,512,597 |   | $ | 125,860,567 |   | $ | 62,347,970 |   | 98 | % |
| Fee for Service Revenue                                 |       | 2,084,132                                  |       | 2,546,444 |   | 462,312 |   | 22 | % |
| Management Fees                                         |       | 793,667                                    |       | 841,152 |   | 47,485 |   | 6 | % |
| Other Operating Revenue                                 |       | 151,306                                    |       | 268,274 |   | 116,968 |   | 77 | % |
| **Total Revenues**                                      |       | 66,541,702                                 |       | 129,516,437 |   | 62,974,735 |   | 95 | % |
| **Operating  Expenses:**                                |       |                                       |       |   |   |   |   |   |   |
| Medical Costs                                           |       | 46,739,820                                 |       | 95,975,041 |   | 49,235,221 |   | 105 | % |
| General and Administrative                              |       | 18,200,250                                 |       | 24,335,510 |   | 6,135,260 |   | 34 | % |
| Depreciation and Amortization                           |       | 539,846                                    |       | 732,806 |   | 192,960 |   | 36 | % |
| **Total Operating Expenses**                            |       | 65,479,916                                 |       | 121,043,357 |   | 55,563,441 |   | 85 | % |
| **Operating Income from Unconsolidated Joint  Venture** |       | 728,549                                    |       | 206,634 |   | (521,915 | ) | (72 | )% |
| **Operating Income**                                    |       | 1,790,335                                  |       | 8,679,714 |   | 6,889,379 |   | 385 | % |
| **Interest Income (Expense), Net**                      |       | (136,280                                   | )          | (15,086 | ) | (121,194 | ) | (89 | )% |
| **Income Before Taxes**                                 |       | 1,654,055                                  |       | 8,664,628 |   | 7,010,573 |   | 424 | % |
| **Income Tax Provision**                                |       | 683,056                                    |       | 3,524,704 |   | 2,841,648 |   | 416 | % |
| **Minority Interest**                                   |       | 16,357                                     |       | 12,681 |   | (3,676 | ) | (22 | )% |
| **Net Income**                                          |       | $                                          | 954,642    |   | $ | 5,127,243 |   | $ | 4,172,601 |   | 437 | % |
| **Diluted Earnings Per Share**                          |       | $                                          | 0.22       |   | $ | 0.68 |   | $ | 0.46 |   | 209 | % |
| **Medical  Cost Ratio**                                 |       | 71                                         | %          | 75 | % |   |   |   |   |

 

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***Fiscal Year Ended September 30, 2005 Comparedwith Fiscal Year Ended September 30, 2004***

Our total revenues for 2005, the largest portion ofwhich is capitation revenue, increased to $133,518,379 compared to $129,516,437for 2004, or an increase of 3%, primarily as a result of acquisitions duringthe fiscal year 2004 being included for the full twelve months of 2005 andincreases in capitation rates for senior enrollees arising from Medicare’smoving to paying capitation on a risk adjusted basis. We received and recordedas revenue approximately $4 million in the fourth quarter of fiscal 2005from HMOs for risk adjustment factors. Since this revenue could not previouslybe estimated by us, we recorded it upon receipt from the HMOs. Rate increaseswere partially offset by a decline in revenue associated with decreasedenrollment in the current period. During the year ended September 30,2005, the number of enrollees decreased by approximately 26,500, resulting inan estimated revenue decrease of $11,100,000 during the year.

Management fees, which represent approximately 1% oftotal revenues for both 2005 and 2004 decreased by approximately 4% primarilyas a result of matching the pricing of competitor’s bids for performing thesemanagement functions.

Other operating revenue was $1,335,876 during 2005,compared to $268,274 for 2004, which increase primarily results from increasedpay for performance monies received from our contracted HMOs for providing,then demonstrating, higher levels of care to their enrollees.

The cost of medical services for 2005 increased to$96,371,197 compared to $95,975,041 for 2004, or an increase of $396,156. Theoverall increase in medical costs is the result of the acquisitions of fourphysician organizations during 2004, which were owned in eight months for 2004and twelve months in 2005. Our medical cost ratio for the 2005 period wasapproximately 73% and the medical cost ratio for the 2004 period wasapproximately 75%. Approximately 1% of the net decrease in our medical costratio resulted from lower capitation expense incurred on our primary carephysician providers and approximately 2% of the net decrease resulted fromlower capitation expense incurred on our specialist providers. Our non-capitatedmedical costs increased in relation to revenues and increased the medical costratio by approximately 1% compared to the prior period.

General and administrative expenses for 2005 increasedto $27,228,736 from to $24,335,511 in 2004, or an increase of 12%. As apercentage of our total revenues, our general and administrative expense was20% for 2005 compared to 19% for 2004. The increase in general andadministrative expenses was primarily the result of increases in staffing andfringe benefit costs, related primarily to staffing increases being tointegrate prior acquisitions and prepare for future acquisitions.

Operating income increased to $9,057,945, or anincrease of approximately 4%, for 2005, as compared to $8,679,714 for 2004,primarily as the result of economies of scale we were able to achieve with theacquisition of four physician organizations.

Depreciation and amortization expense for 2005 was$948,017 compared to $732,806 for 2004, or an increase of 29%, as a result ofincreased amortization of certain assets acquired in connection with theacquisitions that were completed in 2004.

Interest expense (net of interest income) for 2005increased to $558,278 compared to $15,086 for 2004, as a result of the GMACcredit facility entered into primarily to fund the acquisition of fourphysician organizations. Partially offsetting this increase was an increase ininterest income as a result of increased cash balances in investment accountsand money market funds.

Our income tax expense for 2005 decreased to$3,415,178 compared to $3,524,704 for 2004, or a decrease of approximately 3%,as a result of decreased taxable income. Our effective tax rate was 46% in 2005and 41% in 2004. The increase in our tax rate is primarily related to thevaluation allowance we established against any potential benefit we may derivefrom the capital losses we sustained from our unconsolidated equity investment.

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Our net income for 2005was $4,072,559, or $0.48 per diluted share, as compared to $5,127,243 or $.68per diluted share, for 2004, which decrease is the result of the changesdiscussed above.

***Fiscal Year Ended September 30, 2004 Comparedwith Fiscal Year Ended September 30, 2003***

Our total revenues for 2004 increased to $129,516,437compared to $66,541,702 for 2003, or an increase in total revenues of 95%,primarily as a result of acquisitions. This increase in revenue from acquisitionswas partially offset by a decline in revenue associated with decreasedenrollment during this and prior periods. During the year ended September 30,2004, the number of enrollees decreased by approximately 20,700, resulting inan estimated revenue decrease of $8,200,000 during the year.

Due to the acquisition of four physicianorganizations, our net patient service revenues (capitation andfee-for-service) increased to $128,407,011 from $65,596,729 for 2004 comparedto 2003, or an increase of approximately 96%. During the year ended September 30,2004, revenue attributable to the four acquired physician organizations totaled$66,198,697.

Management fees and other revenues accounted forapproximately 1% of our total revenues for both 2004 and 2003. Our managementfees and other revenues were $1,109,426, during 2004, compared to $944,973 for2003, which increase corresponds to a comparable increase in the enrollmentlevels for the business on which we earn management fees.

The cost of medical services for 2004 increased to$95,975,041 compared to $46,739,820 for 2003, or an increase of 105%. Theincrease in medical costs is the result of the acquisitions of four physicianorganizations. Our medical cost ratio for the 2004 period was 75% and the medicalcost ratio for the 2003 period was 71%. Approximately 1% of the net increase inour medical cost ratio resulted from higher capitation expense incurred on ourprimary care physician providers and 2% of the net increase resulted fromhigher capitation expense incurred on our specialist providers. Ournon-capitated medical costs also increased in relation to revenues andincreased the medical cost ratio by 2% compared to the prior period. This waspartially offset by a favorable change in estimate in 2004 related to 2003 andprior years, which lowered our medical cost ratio by approximately 2%. Ourphysician bonuses and salaries increased at a faster rate than our revenues,which had the effect of increasing our medical cost ratio by approximately 1%.

General and administrative expenses for 2004 increasedto $24,335,511 compared to $18,200,250 for 2003, or an increase of 34%. As apercentage of our total revenues, our general and administrative expense was19% for 2004 compared to 27% for 2003. General and administrative expensesincreased due to the acquisition of four physician organizations, but decreasedas a percentage of revenues due to the economies of scale realized inconsolidating the acquisitions.

Operating income increased to $8,679,714, or an increaseof approximately 385%, for 2004, as compared to $1,790,335 for 2003, primarilyas the result of economies of scale we were able to achieve with theacquisition of four physician organizations.

Depreciation and amortization expense for 2004 was$732,806 compared to $539,846 for 2003, or an increase of 36%, as a result ofincreased capital expenditures subsequent to the 2003 period and amortizationof certain assets acquired in connection with the recent acquisitions.

Interest expense (net of interest income) for 2004decreased to $15,086 compared to $136,280 for 2003, as a result of increasedcash balances in investment accounts and money market funds, and due to thecontinued principal reductions of our bank debt during 2004.

Our income tax expense for 2004 increased to$3,524,704 compared to $683,056 for 2003, or an increase of approximately 416%,as a result of increased profits following the acquisition of four physicianorganizations. Our effective tax rate was 41% in 2004 and 2003.

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Our net income for 2004was $5,127,243, or $0.68 per diluted share, as compared to $954,642 or $0.22per diluted share, for 2003, which increase is the result of the changesdiscussed above.

**Liquidity and Capital Resources**

*General*

We require capital primarily to facilitate ouracquisition strategy and to develop the infrastructure necessary to effectivelymanage our affiliated physician organizations.

Our primary sources of cash have been funds providedby borrowings under our credit facility, by the issuance of equity securities,and by cash flow from operations.

Our primary sources of cash from operations arehealthcare capitation revenues earned by our affiliated physicianorganizations, fee-for-service revenues earned by our affiliated physicianorganizations and management services revenues earned by our managementsubsidiaries.

Our primary uses of cash include healthcare capitationpayments made by our affiliated physician organizations, healthcare claimspayments made by our management subsidiaries, administrative expenses,repayment of borrowings, acquisitions, costs associated with the integration ofacquired businesses and information systems development costs. Our affiliatedphysician organizations generally receive capitation revenue in advance ofhaving to make capitation and claims payments to their providers.

Our investment strategiesare designed to provide safety and preservation of capital, sufficientliquidity to meet cash flow needs, the integration of investment strategy withour business operations and objectives, and attainment of a competitiveafter-tax total return. A substantial portion of our recurring cashrequirements is funded by advances from our management subsidiaries andaffiliated physician organizations, some of which are subject to financialstability, tangible net worth and other requirements of the HMOs with which wedo business.

Certain details of cashflows from operating activities, investing activities and financing activitiesfor the fiscal years ended September 30, 2005 and 2004 are describedbelow.

In the future, we expectsome level of increasing cash flow from operations due to the inclusion ofearnings from the November 1, 2005 acquisition of Genesis HealthCare, someadditional savings derived from the elimination of duplicate functions andrelated costs, and some amount of revenue enhancements as a result of increasedrates from HMO contract renewals. These expected positive impacts on operatingcash flows derived from acquisitions will be offset by ongoing loss of memberenrollment, especially at newly acquired medical groups undergoing transitionto our operating model and platform. Also, if our profitably increases, we willincur, and have to fund, an increased tax burden. With each new acquisition, wealso acquire new operating and other obligations, which have to be funded.Since we target profitable companies, we currently expect that the additionalobligations resulting from our recent acquisitions will be serviceable throughcash flow generated by those acquired entities.

Additional liquidity andcapital resource considerations in the future include the anticipation that wewill be investing significantly more in property, improvements and equipment aswe integrate future acquisitions. These additional investments in technologyand automation will be funded from existing cash reserves and cash generatedfrom operations. Because any future acquisitions will be funded through somecombination of cash, borrowings and our stock, we continue to evaluate avariety of equity and borrowing sources.

We are also periodically required to provide lettersof credit in favor of the HMOs with which we do business. Letters of credittotaling approximately $1,100,000 are currently secured by certificates ofdeposit of approximately the same amount. The HMOs may also seek increasedletter of credit levels, which we will have to fund from our cash reserves.Additionally, our Chief Executive Officer has historically provided a personalguarantee in the event of a tangible net equity shortfall at our affiliatedphysician 

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organization, ProspectMedical Group, in order to meet certain contracting requirements with the HMOs.This personal guarantee arrangement was terminated effective January 19,2005, following the Company’s assessment that it was no longer needed in orderfor the Company to meet its tangible net equity requirements. In the event thatwe were challenged to meet the tangible net equity requirements of ProspectMedical Group in the future, the absence of this personal guarantee would impactour liquidity.

As more fully discussed elsewhere in this registrationstatement, we are subject to certain financial covenants and other conditionsrequired by our loan agreement with Residential Funding Corporation (“RFC”),including a maximum senior debt/EBITDA ratio, minimum fixed charge coverageratio, minimum consolidated net worth, minimum liquidity and a limit on capitalexpenditures. We exceeded the 1.50 maximum senior debt/EBITDA ratio as ofSeptember 30, 2004 and December 31, 2004. Our actual seniordebt/EBITDA ratio as of those two dates was 1.57 and 1.51, respectively. RFChas waived those covenant violations effective April 7, 2005. RFC has, inaddition, agreed to exclude certain items from the covenant computations for atwelve month period. The exclusion of certain items enabled us to meet theminimum fixed charge coverage ratio at December 31, 2004. We have met allrequired covenants since that date; however, there can be no assurance that wewill continue to be able to meet all of the financial covenants and otherconditions required by our loan agreement. RFC may not grant waivers of futurecovenant violations and could also require full repayment of the loan, whichwould negatively impact our liquidity and preclude us from making further acquisitions.

In February 2005, we paid $475,000 to renew andexpand the software licenses for our IDX management information system for aten year period.

***Fiscal Year Ended September 30, 2005 Comparedwith Fiscal Year Ended September 30, 2004***

As of September 30, 2005, cash and cashequivalents were $16,949,304, a decrease of $3,381,450 from September 30,2004. The more significant components of this net increase in cash arediscussed below.

Net cash provided by operating activities was$5,073,634 for the year ended September 30, 2005, compared with net cashused by operating activities of $240,085 for the year ended September 30,2004. Net cash provided by operating activities for the year endedSeptember 30, 2005 was comprised primarily of net income of $4,072,559,depreciation and amortization of $948,017 and an increase in accounts payableand other accrued liabilities of $1,776,161, primarily due to an increase inphysician bonus accruals of $2,469,658. These increases were partially offsetby the impact of a decrease in accrued medical claims of $1,791,294 resultingmainly from resolution of prior claims and lower enrollment.

Net cash used in investing activities totaled$1,356,463 for the year ended September 30, 2005, compared with $4,474,334for the year ended September 30, 2004. Net cash used in investingactivities for the year ended September 30, 2005 was comprised primarilyof purchases of property, improvements and equipment of $282,945; cash paid foran investment in Brotman Medical Center, Inc. of $1,000,000; and anincrease in restricted certificates of deposits required by the health plans of$587,313.

Net cash used by financing activities totaled$7,098,621 for the year ended September 30, 2005, compared with net cashprovided by financing activities of $18,528,266 for the year endedSeptember 30, 2004. Net cash used by financing activities for the yearended September 30, 2005 was comprised primarily of repayments ofborrowings under the GMAC credit facility, totaling $1,833,333 of the long termnote and $5,000,000 of the line of credit; and costs related to the priorprivate placement of preferred stock.

***Fiscal Year Ended September 30, 2004 Comparedwith Fiscal Year Ended September 30, 2003***

Asof September 30, 2004, cash and cash equivalents were $20,330,754, anincrease of $13,813,847 over September 30, 2003. The more significantcomponents of this net increase in cash are discussed below.

Netcash used by operating activities was $240,085 for the year endedSeptember 30, 2004, compared with net cash provided of $2,460,343 for theyear ended September 30, 2003. Net cash used by operating 

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activities for the year ended September 30, 2004was comprised primarily of net income of $5,127,243, a net decrease inrisk pool receivables of $1,201,254 resulting mainly from receipt of $1,098,132in risk pool settlements from acquired risk pool receivables, a decrease inaccrued medical claims (exclusive of acquired balances) of $1,579,942 resultingmainly from resolution of prior claims and lower enrollment, and a decrease inaccounts payable and other accrued liabilities of $5,314,932, primarily due tooutstanding checks, which had previously been reflected as a liability, nowbeing reflected as a decrease in cash, as a result of a change in the structureand funding of our checking accounts in conjunction with our new GMAC creditfacility.

Netcash used in investing activities totaled $4,474,334 for the year endedSeptember 30, 2004, compared with $1,979,847 for the year endedSeptember 30, 2003. Net cash used in investing activities for the yearended September 30, 2004 was comprised primarily of purchases of property,improvements and equipment of $767,299; cash paid for the acquisition ofProspect NWOC Medical Group, Starcare Medical Group, APAC Medical Group andPinnacle Health Resources, net of cash received, of $3,318,171; and expensesrelated to these acquisitions, of $305,685.

Netcash provided by financing activities totaled $18,528,266 for the year endedSeptember 30, 2004, compared with net cash used by financing activities of$1,470,593 for the year ended September 30, 2003. Net cash provided byfinancing activities for the year ended September 30, 2004 was comprisedprimarily of borrowings under the new GMAC credit facility, totaling $10,000,000in a long term note and $5,000,000 in a line of credit, and net proceeds of$10,184,163 from a private placement of preferred stock and common stockissuances, less repayment of existing debt of $7,505,949.

OnFebruary 1, 2004, we completed the acquisition of Prospect NWOC MedicalGroup. The purchase price was $2,000,000, and we borrowed $1,750,000 throughour bank line of credit to finance the acquisition. As a part of theacquisition agreement, we required that Prospect NWOC Medical Group have cashequal to its liabilities as of the closing date. On February 2, 2004, werepaid the $1,750,000 we borrowed from our bank.

OnMarch 31, 2004, we completed the final closing of a private offering ofour Series A Preferred Stock at $5.50 per share. We raised total grossproceeds of $12,458,802. We received $10,019,741, net of fees and expensesincurred through September 30, 2004. The proceeds were used by ProspectMedical Group to complete the acquisitions of StarCare Medical Group and APACMedical Group, and we used a portion of the net proceeds to acquire PinnacleHealth Resources, which were all owned by the same stockholder. The purchaseprice was $8,500,000 for the three entities. The acquisitions were completed onFebruary 1, 2004 and we required that the consolidated three entities havetangible assets equal to their liabilities. The remaining net proceeds from theprivate offering were used to repay the $1,750,000 to our bank in connectionwith our acquisition of Prospect NWOC Medical Group, and for general workingcapital purposes.

*Working Capital*

We had negativeworking capital of $16,695,740, $3,141,414, and $681,960 at September 30,2003, 2004 and 2005, respectively. We had cash and cash equivalents of$6,516,907, $20,330,754, and $16,949,304 at September 30, 2003, 2004 and2005, respectively. Our working capital ratio (current assets divided bycurrent liabilities) was .34, .89, and .97 at September 30, 2003,2004 and 2005, respectively.

As of the fiscal years ended 2003, 2004, and 2005 ourindebtedness for capital leases, subordinated seller notes, loans from ourChief Executive Officer, and notes to our bank totaled $6,267,210, $15,008,554and $8,166,667, respectively. We have historically used cash reserves and cashflow from operations and equity offerings to reduce our indebtedness and fundacquisitions. This, and our recording of reserves for incurred but not reportedhealthcare expense claims, has been the primary reasons for our negativeworking capital position.

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*Credit Facilities*

Until the last remaining portion was repaid on September 28,2004, we had a credit facility with Comerica Bank—California that originallyconsisted of a term loan and a $11,500,000 revolving credit facility.

Additionally, in connection with the GatewayAcquisition effective February 1, 2004, we entered into a $500,000revolving credit facility with Wells Fargo Bank, bearing interest at primeminus 1% and maturing on July 1, 2005.

On September 27, 2004, we entered into a newsenior secured credit facility with Residential Funding Corporation (RFC, asubsidiary of General Motors Acceptance Corporation) that consists of a$10,000,000 term loan and a $5,000,000 revolving credit facility.

The term loan requires repayment of principalinstallments of $166,667 per month until September 27, 2007, at which timethe entire remaining unpaid balance is due. Amounts outstanding under the termloan bear interest at a rate of prime plus 2% per annum.

We may borrow, make repayments and re-borrow under therevolving credit facility until September 27, 2007. Amounts outstandingunder the revolving credit facility bear interest at a rate of prime plus 0.5%per annum. The company is charged an unused line fee of 0.25% per annum payablemonthly, calculated on the difference between the average daily usage of therevolving credit facility during each month and $5,000,000, the maximum amountof the revolving credit commitment.

We may borrow under the revolving credit facility anamount based on a percentage of capitation payments received by the companyover the prior two months, as reduced by the principal amount then outstandingunder the term loan as well as by amounts already outstanding under therevolving credit facility. In no event may total borrowings under the revolvingcredit facility exceed $5,000,000.

Both the term loan and the revolving credit facilityare secured by substantially all of the company’s assets, including the rightsto receive capitation payments under HMO contracts.

A portion of the proceeds of our new credit facilitywere used to pay off our prior credit facility with Comerica Bank. Prior toentering into our new credit facility, we also retired our revolving creditfacility with Wells Fargo Bank.

We are also allowed to use the proceeds of the newfacility for our ordinary working capital and general corporate needs. We maynot use loan proceeds for acquisitions, stock repurchases or dividend paymentswithout the prior written consent of the lender.

We are subject to certain financial covenants underthe loan agreement, including a maximum senior debt/EBITDA ratio, minimum fixedcharge coverage ratio, minimum consolidated net worth, minimum liquidity and alimit on capital expenditures. We are also restricted, without the lender’sconsent, from using net proceeds of any sale of equity securities except to paydown indebtedness under the loan agreement.

We exceeded the 1.50 maximum senior debt/EBITDA ratioas of September 30, 2004 and December 31, 2004. Our actual seniordebt/EBITDA ratio as of those two dates was 1.57 and 1.51, respectively.Effective April 7, 2005, RFC waived these covenant violations. RFC has, inaddition, agreed to exclude certain items from the covenant computations for atwelve month period. The exclusion of certain items enabled us to meet theminimum fixed charge coverage ratio at December 31, 2004. We havesubsequently been in compliance with all required RFC covenants.

In November 2005, in connection with theacquisition of Genesis Healthcare of Southern California, RFC provided us withadditional term loan debt financing of $4,000,000, on terms identical to ourexisting 

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term loan. This additionalterm loan requires monthly principle payments of $66,667 until September 27,2007, at which time the remaining unpaid balance is due.

Since 1997, we haveprimarily funded our acquisition program with draws on our credit facility, thesale of our common stock, and cash flow from operations. The assets that we andour affiliated physician organizations have acquired have been largely goodwilland intangible assets. The acquisition of physician organizations consistsprimarily of HMO contracts, primary care and specialist physician contracts andthe right to manage each physician organization through a management servicesagreement. The physician organizations we acquire generally do not havesignificant tangible net equity; therefore, our acquired assets arepredominantly goodwill.

*AdditionalFinancing*

As we continue to pursue our acquisition strategy,additional financing will be required and we intend to seek additional orexpanded credit facilities from banks or other sources of term and revolvingdebt.

We anticipate financing future acquisitions andpotential business expansion with a combination of debt, the issuance of ourcommon stock and cash flow from operations.

In addition, in order tomeet our long-term liquidity needs, we may incur, from time to time, additionalbank indebtedness. Banks and traditional commercial lenders do not generallymake loans to companies without substantial tangible net worth. Since, by thevery nature of our business segment, we develop substantial goodwill on ourbalance sheet, it may be difficult for us to obtain this type of financing inthe future. We may issue additional equity and debt securities, theavailability and terms of which will depend upon market and other conditions.Our ability to issue any debt or equity instruments in a public or private salemay also be restricted under certain circumstances pursuant to contractual restrictionsin agreements with our commercial lender. There can be no assurance that suchadditional financing will be available upon terms acceptable to us, if at all.The failure to raise the funds necessary to finance our future cashrequirements could adversely affect our ability to pursue our strategy andcould adversely affect our results of operations for future periods.

*ContractualObligations*

In thetable below, we set forth our contractual obligations, including long term debtand other obligations and commitments, as of September 30, 2005, which arepayable in our fiscal years ending September 30:

| ** **                        | ** ** | **Total**                        | ** **   | **2006** | ** ** | **2007**     | ** ** | **2008** | ** **   | **2009** | ** ** | **2010 and  Thereafter** | ** ** |   |
|-----------------------------------|------------|----------------------------------|--------------|----------|------------|--------------|------------|----------|--------------|----------|------------|-------------------------------|------------|--------|
| ** **                        | ** ** | **(000’s eliminated)** | ** **   |     |
| Line of credit(1)                 |       | $                                | —  |     | $          | —  |       | $        | —  |     | $          | —                   |       | $      | —  |   |   | $ | —  |   |   |
| Long term debt(1)                 |       | 8,167                            |         | 2,000    |       | 6,167        |       | —   |         | —   |       |                          | —     |   |   |
| Due to equipment  finance company |       | —                           |         | —   |       | —       |       | —   |         | —   |       |                          | —     |   |   |
| Operating lease  commitments(2)   |       | 4,456                            |         | 1,101    |       | 1,032        |       | 882      |         | 805      |       |                          | 636        |   |   |
| Interest(3)                       |       | 1,094                            |         | 635      |       | 459          |       | —   |         | —   |       |                          | —     |   |   |
|                              |       | $                                | 13,717  |     | $          | 3,736   |       | $        | 7,658   |     | $          | 882                      |       | $      | 805  |   |   | $ | 636  |   |   |
|                                   |            |                                  |              |          |            |              |            |          |              |          |            |                               |            |        |  |  |  |  |  |  |  |  |

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(1)          The line of credit andlong term debt due to our bank matures on September 27, 2007. SeeNote 6 to the consolidated financial statements for a description of ourlong term debt.

(2)          See Note 8 to the September 30,2005 consolidated financial statements for a description of our minimum leasecommitments under non-cancelable operating leases.

(3)          Interestis based on interest rates in effect as of September 30, 2005.

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**Item 7A:**               Quantitativeand Qualitative Disclosures Regarding Market Risks

At September 30,2005, our cash and cash equivalents were invested in money market funds, whichare not typically subject to material market risk. Assuming a hypothetical 10%change in interest rates, there would be no material impact on our futureearnings and cash flows related to these instruments, or their fair value. Ourcredit facility is interest rate sensitive, however. A 100 basis point adversemovement (increase) in interest rates would have decreased our net income forfiscal year 2003, 2004 and 2005 by approximately $25,000, $17,000, and $186,000,respectively.

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**Item8.                        FinancialStatements and Supplementary Data**

Thefollowing financial statements and financial statement schedule are included inthis report beginning on page F-1:
|                                                                                                                   | ** ** | **Page** |
|-------------------------------------------------------------------------------------------------------------------|------------|----------|
| Index to Financial  Statements and Financial Statement Schedule                                                   |       | F-1      |   |
| Report of Independent  Registered Public Accounting Firm                                                          |       | F-2      |   |
| Consolidated Balance Sheets as of  September 30, 2004 and 2005                                               |       | F-3      |   |
| Consolidated Statements of  Income for the Years Ended September 30, 2003, 2004 and 2005                     |       | F-4      |   |
| Consolidated Statements of  Shareholders’ Equity for the Years Ended September 30, 2003,  2004 and 2005 |       | F-5      |   |
| Consolidated Statements of  Cash Flows for the Years Ended September 30, 2003, 2004  and 2005                |       | F-6      |   |
| Notes to Consolidated  Financial Statements                                                                       |       | F-7      |   |
| Report of Independent  Registered Public Accounting Firm                                                          |       | F-31     |   |
| Schedule  II—Valuation and Qualifying Accounts                                                               |       | F-32     |   |

 

Selected quarterly financial data required by thisitem is included in note 12 to the consolidated financial statements.

All other schedules are omitted because they are notrequired or the information is included elsewhere in the consolidated financialstatements.

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**Item 9.**                        Changesin and Disagreements with Accountants on Accounting and Financial Disclosure.

None.

**Item 9A.**                Controlsand Procedures

***Disclosure Controlsand Procedures:******  ***Our management is responsible forestablishing and maintaining effective internal control over financialreporting as defined in Rules 13a-15(f) under the SecuritiesExchange Act of 1934. Our internal control over financial reporting is designedto provide reasonable assurance to our management and board of directorsregarding the preparation and fair presentation of published financialstatements. We maintain controls and procedures designed to ensure that we areable to collect the information we are required to disclose in the reports wefile with the Securities and Exchange Commission, and to process, summarize anddisclose this information within the time periods specified in the rules ofthe Securities and Exchange Commission.

***Evaluation ofDisclosure Controls and Procedures:******  ***Ourmanagement, with the participation of our Chief Executive Officer and our ChiefFinancial Officer, has concluded, based upon its evaluation as of the end ofthe period covered by this report, that the Company’s “disclosure controls andprocedures” (as defined in Rules 13(a)-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934 (the “Exchange Act”)) are effective toensure that information required to be disclosed in the reports that theCompany files or submits under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the Securities andExchange Commission’s rules and forms.

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

***Changes in InternalControls:******  ***There were no changes in the Company’sinternal control over financial reporting during the quarter ended September 30,2005 that have materially affected, or are reasonably likely to materiallyaffect, the Company’s internal controls over financial reporting.

***Sarbanes-Oxley 404 Compliance:******  ***We have beguna 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 30,2006.

**Item 9B.**               OtherInformation.

Not applicable.

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**PART III**

**Item 10.**                 Directorsand Executive Officers.

The information requiredby this Item with respect to our executive officers is set forth in Part Iof this report. The other information required under this Item is incorporatedby reference from our definitive proxy statement for the 2006 Annual Meeting ofStockholders under the captions “Election of Directors,” “The Board ofDirectors and its Committees” and “Section 16(a) Beneficial OwnershipReporting Compliance.”

**Item 11.**                 ExecutiveCompensation.

The information containedin the section entitled “Executive Compensation” in our definitive ProxyStatement for our 2006 Annual Meeting of Stockholders is incorporated herein byreference.

**Item 12.**                 SecurityOwnership of Certain Beneficial Owners and Management

The information requiredunder this Item is incorporated by reference from our definitive proxystatement for the 2006 Annual Meeting of Stockholders under the caption “SecurityOwnership of Certain Beneficial Owners and Management.”

**Item 13.**                 CertainRelationships and Related Transactions.

The information set forthin the section entitled “Certain Relationships and Related Transactions”contained in our definitive Proxy Statement for our 2006 Annual Meeting ofStockholders is incorporated herein by reference.

**Item 14.**                 PrincipalAccountant Fees and Services

The information required under this Item isincorporated by reference from our definitive proxy statement for the 2006Annual Meeting of Stockholders under the caption “Disclosure of Auditor Fees.”

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**PART IV**

**Item 15.**                 Exhibitsand Financial Statement Schedules

The financial statements and financial statementschedule listed under Item 8 are included in this report beginning on page F-1:
| 2.1    |   | Agreement  for the Purchase and Sale of Assets of Health Source Medical Group, Inc.  dated as of November 7, 2000 between Prospect Medical Group, Inc.  and Health Source Medical Group, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   | Pursuant to Regulation S-K, Item 601(b)(2),  the following schedules to the Agreement for the Purchase and Sale of Assets  will be provided supplementally to the Commission upon request:  Exhibit 1.1 Assets, Exhibit 1.1(a)(i) Prospect Health Source  Medical Group, Inc. Exclusive Primary Care Physician Services Agreement,  Exhibit 1.1(a)(ii) Prospect Health Source Medical Group, Inc.  Nonexclusive Specialist Physician Services Agreement, Exhibit 1.1  (g) Management Services Agreement, Exhibit 1.3 Assumed Liabilities,  Exhibit 2.2 Purchase Price Allocation, Exhibit 5.1 Noncompetition  Agreement, Exhibit 7.2(a) Bill of Sale/Assignment and Assumption  Agreement, Exhibit 7.5(i) Guaranty of Purchaser’s Obligations by  Prospect Medical Holdings, Inc., Exhibit 7.5(j) Prospect  Health Source Medical Group, Inc. Organizational Documents, Schedule 3.3  Consents, Schedule 3.5 Accounts Receivable, Schedule 3.6 Title to Assets,  Schedule 3.7(a) Inventory and Furniture, Fixtures, and Equipment at the  Robertson Clinic, Schedule 3.7(b) Furniture, Fixtures, and Equipment  used at Seller’s Former Administrative Office, Schedule 3.8 Contracts,  Schedule 3.9 Litigation, Schedule 3.10 Violation of Law, Schedule 3.12  Employees and Employee Benefits, Schedule 3.15 Intellectual Property |
| 2.2    |   | Agreement of Purchase and Sale of Assets of Health  Source Medical Group, Inc. dated as of May 1, 2001 among David M.  Frisch, M.D., Prospect Medical Group, Inc., Prospect Health Source  Medical Group, Inc. and Prospect Medical Systems, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   |   | Pursuant to Regulation S-K, Item 601(b)(2),  the following schedules to the Agreement for the Purchase and Sale of Assets  will be provided supplementally to the Commission upon request:  Exhibit 1.1 Assets, Exhibit 1.1(a) Exclusive Primary Care  Physician Services Agreement, Exhibit 1.3 Assumed Liabilities, Schedule  3.3 Consents, Schedule 3.5 Inventory and Furniture, Fixtures and Equipment,  Schedule 3.7 Litigation, Schedule 3.8 Violation of Law, Schedule 3.10  Employees and Employee Benefits                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 2.3    |   | Agreement of Purchase and Sale of Assets of Health  Source Medical Group, Inc. dated as of July 1, 2001 among James  Daniel, M.D. & Dana Eisenman, M.D. Medical Corporation, Prospect  Medical Group, Inc., Prospect Health Source Medical Group, Inc. and  Prospect Medical Systems, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   |   | Pursuant to Regulation S-K, Item 601(b)(2),  the following schedules to the Agreement for the Purchase and Sale of Assets  will be provided supplementally to the Commission upon request:  Exhibit 1.1 Assets, Exhibit 1.1(a) Exclusive Primary Care  Physician Services Agreement, Exhibit 1.3 Assumed Liabilities,  Exhibit 7.2(a) Bill of Sale/Assignment and Assumption Agreement,  Exhibit 7.2 Sublease, Schedule 3.3 Consents, Schedule 3.5 Inventory and  Furniture, Fixtures and Equipment, Schedule 3.5(a) Additional Furniture,  Fixtures and Equipment used in the Sunset Practice, Schedule 3.7 Litigation,  Schedule 3.8 Violation of Law, Schedule 3.10 Prospect Employees Through the  Effective Date, Schedule 4.8 Employees Purchaser will Retain from the  Effective Date Through the Closing Date                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |

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| 2.4    |   | Agreement and Plan of  Reorganization for Professional Care Medical Group, Inc. dated as of  June 30, 2003 among Prospect Medical Group, Inc., Prospect LA  Medical Group, Inc., Professional Care Medical Group, Inc. and the  Shareholders of Professional Care Medical Group, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                                         |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   | Pursuant to Regulation S-K, Item 601(b)(2),  the following schedules to the Agreement and Plan of Reorganization will be  provided supplementally to the Commission upon request:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   |   | Schedule 2.4, ProCare Consent Requirements, Schedule  2.6, List of Holders of Record and Number Held of ProCare Shares, Schedule  2.7, List of ProCare Financial Statements Delivered to Prospect, Schedule  2.12, Intellectual Property, Schedule 2.13, Contracts, Schedule 2.18,  Insurance, Schedule 2.20, Bank Accounts, Schedule 3.3, Prospect/Sub Consent  Requirements, Schedule 11.7, Notices, Exhibit “A,” Shareholders of  ProCare, Exhibit “B,” Agreement of Merger, Exhibit “C,” Acknowledgement  by Escrow Agent                                                                                                                                                     |
| 2.5    |   | Amendment to Agreement and Plan of Reorganization  for Professional Care Medical Group, Inc. dated as of September 30,  2003 among Prospect Medical Group, Inc., Prospect LA Medical  Group, Inc., Professional Care Medical Group, Inc. and the Shareholders  of Professional Care Medical Group, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                       |
| 2.6    |   | Agreement of Merger for Northwest Orange County  Medical Group, Inc. dated as of November 19, 2003 among Prospect  Medical Group, Inc., Prospect NWOC Medical Group, Inc., Northwest  Orange County Medical Group, Inc., the Shareholders of Northwest Orange  County Medical Group, Inc., and Harriman-Jones Medical  Group, Inc.(1)                                                                                                                                                                                                                                                                                                                                                       |
|   |   | Pursuant to Regulation S-K, Item 601(b)(2),  the following schedules to the Agreement of Merger will be provided  supplementally to the Commission upon request:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   |   | Schedule 2.4, Northwest Consent Requirements,  Schedule 2.6, List of Holders of Record and Number Held of Northwest Shares,  Schedule 2.9, Tax Matters, Schedule 2.12, Intangible Property, Schedule 2.13,  Contracts, Schedule 2.14, Legal Proceedings, Schedule 2.16, Officers and  Directors, Schedule 2.17, Insurance, Schedule 2.18, Powers of Attorney,  Schedule 2.24, Inspections, Schedule 2.28, Permits, Schedule 2.29, Fraud and  Abuse, Schedule 2.33, Bank Accounts, Schedule 3.3, Consent  Requirements—Prospect Parties, Schedule 4.7, North West  Enrollees—August 2003 Enrollment, Exhibit “A,” Agreement of Merger,  Exhibit “B,” Form of Escrow Agreement |
| 2.7    |   | Amendment to Agreement of Merger dated as of  January 30, 2004 for Northwest Orange County Medical Group, Inc.  among Prospect Medical Group, Inc., Prospect NWOC Medical  Group, Inc., Northwest Orange County Medical Group, Inc., the  Shareholders of Northwest Orange County Medical Group, Inc., and  Harriman-Jones Medical Group, Inc.(1)                                                                                                                                                                                                                                                                                                                                           |
| 2.8    |   | Stock Purchase Agreement dated as of  January 31, 2004 among Prospect Medical Group, Inc., Prospect  Medical Systems, Inc., StarCare Medical Group, Inc. dba Gateway  Medical Group, Inc, APAC Medical Group, Inc. dba Gateway Physicians Medical  Associates, Inc., Pinnacle Health Resources and David Tsoong, M.D.(1)                                                                                                                                                                                                                                                                                                                                                                         |
|   |   | Pursuant to Regulation S-K, Item 601(b)(2),  the following schedules to the Stock Purchase Agreement will be provided  supplementally to the Commission upon request:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   |   | Schedule 1.2, StarCare Shares, Schedule 1.3, APAC  Shares, Schedule 1.4, Pinnacle Shares, Schedule 1.6, Purchase Price  Allocation, Schedule 2.4, StarCare, APAC and Pinnacle Consent Requirements,  Schedule 2.5, Conflicts and/or Breaches as a Result of the Transaction,  Schedule 2.8,Contingent Liabilities, Schedule 2.9, Actions and Proceedings  for Taxes, Schedule 2.11(b), Leases and Subleases, Schedule 2.12(b),  Aggregate Tangible Personal Property, Schedule 2.12(c), Excluded Tangible  Personal Property, Schedule 2.12(d), Items                                                                                                                                                                     |

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|        |   | Currently in Storage or  Supply Rooms at 710 N. Euclid or Subleased Storage Space at La Mirada Clinic,  Schedule 2.13, Intellectual Property, Schedule 2.13(b), Website Internet  Portal Modem Fee, Schedule 2.14, Contracts, Schedule 2.15, Legal Proceedings:  Existing and Threatened Claims, Schedule 2.17, Employee Information, Schedule  2.17(b), Employee Information, Schedule 2.17(c), Employee Information,  Schedule 2.18, Insurance, Schedule 2.19, Management; Powers of Attorney,  Schedule 2.24, Confidentiality and Non-Compete Agreements, Schedule  2.25, Inspections, Schedule 2.28, Permits, Schedule 2.29(a), Fraud and Abuse,  Schedule 2.29(b), Fraud and Abuse, Schedule 2.35(a), Bank Accounts, Schedule 2.35(b),  Letters of Credit or Other Security Pledged for StarCare Shared Risk  Contracts, APAC Shared Risk Contracts or APAC Full Risk Contracts, Schedule  3.3, Group/Systems Consent Requirements, Schedule 5.2, Employees to Be Hired  By Prospect Parties, Exhibit “A,” October Interim Financial  Statements, Exhibit “B,” Form of Non-Competition Agreement,  Exhibit “C,” Legal Opinion Matters                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.9    |   | Asset Purchase Agreement dated as of March 31,  2004 among StarCare Medical Group, Inc. dba Gateway Medical  Group, Inc., Pinnacle Health Resources, Primary and Multi-Specialty  Medical Clinics of Anaheim, Inc., and the shareholders of Primary and  Multi-Specialty Medical Clinics of Anaheim, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   |   | Pursuant to Regulation S-K, Item 601(b)(2),  the following schedules to the Asset Purchase Agreement will be provided  supplementally to the Commission upon request:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   |   | Schedule 1.2(a), Clinic Assets, Attachment A to  Schedule 1.2(a), Schedule 1.2(b), Excluded Clinic Assets, Schedule 1.3,  Assumed Liabilities, Schedule 1.5, Wells Fargo Loans, Schedule 1.6,  Accumulated PTO as of the Closing Date, Schedule 1.7, Purchase Price  Allocation, Schedule 2.2, Group Consent Requirements, Schedule 2.3, Conflicts  and Breaches, Schedule 2.4, Liens, Schedule 2.5(a), February Financial  Statements, Schedule 2.5(b), March Estimated Partial Financial  Statements, Schedule 2.7, Tangible Personal Property, Schedule 2.7(b), Assets  in Storage, Schedule 2.8, Intellectual Property, Schedule 2.9, Contracts,  Schedule 2.10 Legal Proceedings: Existing and Threatened Claims, Schedule  2.12, Employee Information, Schedule 2.16, Confidentiality, Non-Solicitation  and Non-Compete Arrangements, Exhibit E, Covenant Not To Compete,  Exhibit F-1, Industrial Medicine Client List, Schedule 2.19,  Permits, Schedule 2.22, Insurance, Schedule 2.24, Tax Matters, Schedule 2.25,  Inspection, Schedule 3.3, Buyer Consent Requirements, Schedule 4.1, Gateway  Representations and Warranties, Schedule 4.6(b), Non-Physician  Acknowledgement, Schedule 4.6(c), StarCare Updated Patient Diversion  Provisions, Schedule 4.6(d), Full Time Primary Care Physicians, Schedule  4.13, Prepaid Obligations, Schedule 4.17, Initial Trust Deposits with Cap-MPT,  Exhibit “A,” Secured Promissory Note (Purchase Price Note),  Exhibit “B,” Security Agreement, Exhibit “C,” Guaranty,  Exhibit “D,” Secured Promissory Note (Additional Consideration Note),  Exhibit “E,” Guaranty, Exhibit “F,” Secured Promissory Note (PTO  Note), Exhibit “G,” Guaranty, Exhibit “H,” Form of  Buyer/StarCare Provider Agreement, Exhibit “I,” Form of  Buyer/Prospect Provider Agreement, Exhibit “J,” Form of Specialty  Provider Agreement, Exhibit “K,” Sublease for Anaheim Clinic,  Exhibit “L,” Sublease for Anaheim Hills Clinic, Exhibit “M,”  Sublease for Euclid Clinic and Clinic Corporate Office, Exhibit “N,”  Sublease for Clinic Storage Space, Exhibit “O,” Guaranty,  Exhibit “P,” Bill of Sale/Assignment and Assumption Agreement |

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| 2.10   |   | Omnibus Amendment to  Asset Purchase Agreement and Other Documents Delivered in Connection with The  Transactions Described Therein dated as of April 15, 2004 among StarCare  Medical Group, Inc. d/b/a Gateway Medical Group, Inc., Pinnacle  Health Resources, APAC Medical Group, Inc., Prospect Medical  Group, Inc., Prospect Professional Medical Group, Inc., Prospect  NWOC Medical Group, Inc., Primary and Multi-Specialty Clinics of  Anaheim, Inc., and the Shareholders of Primary and Multi-Specialty  Clinics of Anaheim, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.11   |   | Stock Purchase Agreement dated November 1, 2005  among Prospect Medical Group, Inc., Genesis Healthcare of Southern  California, Inc. and Mitchell W. Lew, M.D.(8)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   | Pursuant to Regulation S-K, Item 601(b)(2), the  following schedules to the Stock Purchase Agreement will be provided  supplementally to the Commission upon request:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   |   | Schedule 1.2, Stock; Schedule 1.6,  Allocation of Purchase Price; Schedule 2.9, Tax Matters;  Schedule 2.11(b), List and Summary of all Leases, Subleases and other  Agreements under which Company uses or has the right to occupy any Real  Property; Schedule 2.12(b), Tangible Personal Property;  Schedule 2.13, Intellectual Property; Schedule 2.14, Contracts;  Attachment to Schedule 2.14, List of PCP Physicians; Attachment to  Schedule 2.14, List of Specialist Physicians; Attachment to  Schedule 2.14, Form of PCP (Individual)—Capitated; Attachment to  Schedule 2.14, Form of PCP (Group)—Capitated; Attachment to  Schedule 2.14, Form of Specialist Physician Agreement—Fee for Service;  Attachment to Schedule 2.14, Form of Specialist Agreement—Capitated;  Attachment to Schedule 2.14, List of Ancillary Service Providers; Attachment  to Schedule 2.14, Form of Ancillary Services Agreement—Fee for Service;  Schedule 2.15, Existing/Threatened Claims; Schedule 2.18,  Insurance; Schedule 2.19, Officers and Directors; Schedule 2.17,  Employee Matters; Schedule 2.24, Confidentiality/Non-Compete;  Schedule 2.25, Inspections, Section 2.28, Permits;  Schedule 2.30(a), Bank Accounts; Schedule 2.30(b), Cash securing  Letters of Credit or Certificates of Deposits pledged as Security for the  Company Health Plans; Schedule 3.3, Consents of Purchaser;  Schedule 5.2, Employees to be offered Employment; Schedule 5.6, IBNR  Formula; Exhibit A, Form of Non-Competition Agreement; Exhibit B,  Management Agreement; Exhibit C, Employment Agreement; Exhibit D,  Legal Opinion Matters |
| 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)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.1   |   | Warrant to Acquire Common Stock between Prospect  Medical Holdings, Inc. and Spencer Trask Venture Investment Partners,  LLC(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.2   |   | Warrant Agreement for Series A Preferred Stock  dated as of January 15, 2004 between Prospect Medical  Holdings, Inc. and Spencer Trask Ventures, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.3   |   | Form of Registration Rights Agreement between  Prospect Medical Holdings, Inc. and each Investor of Series A  Convertible Preferred Stock(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |

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| 10.4  |   | Agreement For The Purchase And Sale of Stock, dated  as of January 13, 2000, between Jacob Y. Terner, M.D., and Gregg  DeNicola, M.D.(1)                                                                                                                   |
|-------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.5  |   | Amended and Restated Assignable Option Agreement,  made as of January 13, 2000, among Prospect Medical Systems, Inc.,  Prospect Medical Group, Inc. and Jacob Y. Terner, M.D.(1)                                                                      |
| 10.6  |   | Form of Amended and Restated Management  Services Agreement, made as of September 15, 1998 and deemed to have  been effective as of June 4, 1996, between Prospect Medical  Systems, Inc. and Prospect Medical Group, Inc.(1)               |
| 10.7  |   | Form of Amendment to Management Services  Agreement, made as of October 1, 1998, between Prospect Medical  Systems, Inc. and Prospect Medical Group, Inc.(1)                                                                                     |
| 10.8  |   | Management Agreement dated as of January 1,  2003 between Pinnacle Health Resources Inc. and StarCare Medical  Group, Inc. dba Gateway Medical Group, Inc.(1)                                                                                         |
| 10.9  |   | Management Agreement dated as of January 1,  2003 between Pinnacle Health Resources Inc. and APAC Medical Group, Inc.  dba Gateway Physicians Medical Associates, Inc.(1)                                                                             |
| 10.10 |   | Form of Management Services Agreement, made as  of August 1, 1999, between Prospect Medical Systems, Inc. and  Nuestra Familia Medical Group(1)                                                                                                       |
| 10.11 |   | Management Services Agreement, made as of  July 1, 1999, between Prospect Medical Systems, Inc. and  AMVI/Prospect Medical Group(1)                                                                                                                        |
| 10.12 |   | Employment Agreement,  dated as of August 1, 1999 between Prospect Medical Holdings, Inc.  and Jacob Y. Terner, M.D.(1)                                                                                                                                    |
| 10.13 |   | Amendment to Employment Agreement, dated as of  August 1, 2002 between Prospect Medical Holdings, Inc. and Jacob Y.  Terner, M.D.(1)                                                                                                                       |
| 10.14 |   | Investment Agreement  dated as of July 31, 1996 between Jacob Y. Terner and Med-Search, Inc.(2)                                                                                                                                                            |
| 10.15 |   | Agreement dated as of July 31, 1996 among Jacob  Y. Terner and Barbara Noble, both individually and as representative of Joseph  W. Noble, M.D., deceased, and the Noble 1992 Family Trust(2)                                                                   |
| 10.16 |   | Amended and Restated Revolving Credit Agreement,  dated as of July 3, 1999, between Prospect Medical Holdings, Inc.  and Imperial Bank(1)                                                                                                                  |
| 10.17 |   | First Amendment to Amended and Restated Revolving  Credit Agreement dated as of October 25, 2002 between Imperial Bank and  Prospect Medical Holdings, Inc.(1)                                                                                             |
| 10.18 |   | Third Amendment to Amended and Restated Revolving  Credit Agreement dated as of November 3, 2001 between Comerica Bank-California,  successor-by-merger to Imperial Bank and Prospect Medical  Holdings, Inc.(1)                                           |
| 10.19 |   | Fourth Amendment to Amended and Restated Revolving  Credit Agreement dated as of February 1, 2002 between Comerica Bank-California,  successor-by-merger to Imperial Bank and Prospect Medical  Holdings, Inc.(1)                                          |
| 10.20 |   | Fifth Amendment to Amended and Restated Revolving  Credit Agreement dated as of July 31, 2002 between Comerica Bank-California,  successor-by-merger to Imperial Bank and Prospect Medical  Holdings, Inc.(1)                                              |
| 10.21 |   | Sixth Amendment to Amended and Restated Revolving  Credit Agreement dated as of September 24, 2003, between Comerica Bank,  successor-by-merger to Comerica Bank-California, successor-by-merger  to Imperial Bank, and Prospect Medical Holdings, Inc.(1) |

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| 10.22 |   | Amended and Restated Security Agreement dated as of  September 24, 2003, between Prospect Medical Holdings, Inc. and  Comerica Bank, successor-by-merger to Comerica Bank-California,  successor-by-merger to Imperial Bank(1)                                           |
|-------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.23 |   | Continuing Guaranty, dated as of July 3, 1997,  executed by Prospect Medical Systems, Inc. in favor of Imperial Bank(2)                                                                                                                                                  |
| 10.24 |   | Amended and Restated Security Agreement (Prospect  Medical Systems, Inc.) dated as of September 24, 2003, between  Prospect Medical Systems, Inc. and Comerica Bank, successor-by-merger  to Comerica Bank-California, successor-by-merger to  Imperial Bank(1)     |
| 10.25 |   | Security Agreement—Stock Pledge, dated as of  July 3, 1997, between Prospect Medical Holdings, Inc. and Imperial  Bank(2)                                                                                                                                           |
| 10.26 |   | Security Agreement (Physician Group), dated as of  July 3, 1997, between Prospect Medical Systems, Inc. and Prospect  Medical Group, Inc.(2)                                                                                                                        |
| 10.27 |   | Amendment Number One to Security Agreement dated as  of July 6, 1999 between Prospect Medical Systems, Inc. and Prospect  Medical Group, Inc.(2)                                                                                                                    |
| 10.28 |   | Amended and Restated Warrant, dated as of  July 3, 1997, issued by Prospect Medical Holdings, Inc. to Imperial  Bank(2)                                                                                                                                                  |
| 10.29 |   | Warrant, dated as of July 3, 1999, issued by  Prospect Medical Holdings, Inc. to Imperial Bancorp(2)                                                                                                                                                                     |
| 10.30 |   | Amended and Restated Assignable Option Agreement  made as of September 2, 1998 and deemed to have been effective as of  July 14, 1997, among Prospect Medical Systems, Inc., Prospect  Medical Group, Inc. and Santa Ana/Tustin Physicians Group, Inc.(2) |
| 10.31 |   | Form of Management  Services Agreement dated as of January 1, 2001 between Prospect Medical  Systems, Inc. and Prospect Health Source Medical Group, Inc.(1)                                                                                                   |
| 10.32 |   | Form of Amendment to Management Services  Agreement dated as of November 1, 2002 between Prospect Medical  Systems, Inc. and Prospect Health Source Medical Group, Inc.(1)                                                                                     |
| 10.33 |   | Form of Management Services Agreement dated as  of October 1, 2003, by and between Prospect Medical Systems, Inc.  and Prospect Professional Care Medical Group, Inc.(1)                                                                                       |
| 10.34 |   | Form of Management Services Agreement dated as  of March 1, 2004 by and between Prospect Medical Systems, Inc. and  Prospect NWOC Medical Group, Inc.(1)                                                                                                       |
| 10.35 |   | Amendment Number One to Security Agreement, dated as  of July 14, 1997, between Prospect Medical Systems, Inc. and  Imperial Bank(2)                                                                                                                                     |
| 10.36 |   | Collateral Assignment of Transaction Documents dated  as of October 1, 2003, by and between Prospect Medical  Systems, Inc. and Comerica Bank(1)                                                                                                                         |
| 10.37 |   | Collateral Assignment of Transaction Documents,  dated as of July 14, 1997, between Prospect Medical Systems, Inc.  and Imperial Bank(2)                                                                                                                                 |
| 10.38 |   | Amendment Number One To Collateral Assignment of  Transaction Documents, dated as of January 26, 2000, between Prospect  Medical Systems, Inc. and Imperial Bank(1)                                                                                                      |
| 10.39 |   | Security Agreement (Physician Group), dated as of  July 14, 1997, between Prospect Medical Systems, Inc. and Santa  Ana/Tustin Physicians Group, Inc.(2)                                                                                                            |
| 10.40 |   | Amendment Number One to Security Agreement dated as  of July 1, 1999 between Santa Ana/Tustin Physicians Group, Inc. and  Prospect Medical Systems, Inc.(1)                                                                                                         |
| 10.41 |   | Security Agreement dated as of October 1, 2003,  between Prospect Professional Care Medical Group, Inc. and Prospect  Medical Systems, Inc.(1)                                                                                                                      |

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| 10.42 |   | Amended and Restated Credit Succession Agreement, dated  as of July 14, 1997, among Prospect Medical Holdings, Inc., Gregg  DeNicola, M.D., Santa Ana/Tustin Physicians Group, Inc., Prospect  Medical Systems, Inc., Prospect Medical Group, Inc. and Imperial  Bank(2)                                                                                      |
|-------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.43 |   | Form of Amendment Number One to Amended and  Restated Credit Succession Agreement, dated as of April 6, 2000, among  Jacob Y. Terner, M.D., Prospect Medical Holdings, Inc., Santa Ana/Tustin  Physicians Group, Inc., Sierra Primary Care Medical Group, Inc.,  Prospect Medical Systems, Inc., Prospect Medical Group, Inc. and  Imperial Bank(1) |
| 10.44 |   | Joinder Agreement, dated as of January 26,  2000, among Sierra Medical Management, Inc., Jacob Y. Terner, M.D.,  Sierra Primary Care Medical Group, Inc., Gregg DeNicola, M.D., Prospect  Medical Systems, Inc., Prospect Medical Group, Santa Ana/Tustin  Physicians Group, Inc.(1)                                                                          |
| 10.45 |   | Amended and Restated Assignable Option Agreement,  made as of September 2, 1998 and deemed to have been effective as of  September 25, 1997, by and among Sierra Primary Care Medical Group, Inc.,  Sierra Medical Management, Inc. and Prospect Medical Group, Inc.(2)                                                                                       |
| 10.46 |   | Assignable Option Agreement dated as of  October 1, 2003, by and among Prospect Medical Holdings, Inc.,  Prospect Professional Care Medical Group, Inc., and Prospect Medical  Group, Inc.(1)                                                                                                                                                                      |
| 10.47 |   | Intentionally Omitted.                                                                                                                                                                                                                                                                                                                                                                 |
| 10.48 |   | Form of Second Amended and Restated Management  Services Agreement, made as of September 15, 1998 and deemed to have  been effective as of September 25, 1997, between Sierra Medical  Management, Inc. and Sierra Primary Care Medical Group, Inc.(1)                                                                                                        |
| 10.49 |   | Amendment to Management Services Agreement, made as  of October 1, 1998, between Sierra Medical Management, Inc. and  Sierra Primary Care Medical Group, Inc.(1)                                                                                                                                                                                                        |
| 10.50 |   | Continuing Guaranty, dated as of September 25,  1997, delivered by Sierra Medical Management, Inc. to Imperial Bank(2)                                                                                                                                                                                                                                                       |
| 10.51 |   | Amended and Restated Security Agreement (Sierra  Medical Management, Inc.), dated as of September 24, 2003, between  Sierra Medical Management, Inc., and Comerica Bank, successor-by-merger  to Comerica Bank-California, successor-by-merger to  Imperial Bank(1)                                                                                                     |
| 10.52 |   | Security Agreement—Stock Pledge, dated as of  September 25, 1997, between Prospect Medical Holdings, Inc. and  Imperial Bank(2)                                                                                                                                                                                                                                         |
| 10.53 |   | Collateral Assignment of Transaction Documents,  dated as of September 25, 1997, between Sierra Medical  Management, Inc. and Imperial Bank(2)                                                                                                                                                                                                                               |
| 10.54 |   | Security Agreement, dated as of September 25,  1997, between Sierra Primary Care Medical Group, Inc. and Sierra Medical  Management, Inc.(2)                                                                                                                                                                                                                            |
| 10.55 |   | Amendment Number One to  Security Agreement dated as of September 6, 1999 between Sierra Primary  Care Medical Group, Inc. and Sierra Medical Management, Inc.(1)                                                                                                                                                                                                       |
| 10.56 |   | Intentionally Omitted.                                                                                                                                                                                                                                                                                                                                                                 |
| 10.57 |   | Form of Amended and Restated Management Services  Agreement, made as of September 15, 1998 and deemed to have been  effective as of October 31, 1997, by and between Sierra Medical  Management, Inc. and Pegasus Medical Group, Inc.(1)                                                                                                                      |
| 10.58 |   | Amendment to Management Services Agreement made as  of October 1, 1998, by and between Sierra Medical Management, Inc.  and Pegasus Medical Group, Inc.(1)                                                                                                                                                                                                              |
| 10.59 |   | Amended and Restated Assignable Option Agreement,  made as of September 2, 1998 and deemed to have been effective as of  October 31, 1997, among Sierra Medical Management, Inc., Pegasus  Medical Group, Inc. and Prospect Medical Group, Inc.(2)                                                                                                            |

 

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| 10.60 |   | Assignment and  Assumption Agreement, by Marvin L. Ginsburg, M.D. Medical Corporation d/b/a  A.V. Western Medical Group, Inc. to Pegasus Medical Group, Inc.(2)                                                                                         |   |
|-------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| 10.61 |   | Collateral Assignment of  Transaction Documents, dated as of October 31, 1997, between Sierra  Medical Management, Inc. and Imperial Bank(2)                                                                                                            |   |
| 10.62 |   | Security Agreement  (Physician Group), dated as of October 31, 1997, between Pegasus Medical  Group, Inc. and Sierra Medical Management, Inc.(2)                                                                                                   |   |
| 10.63 |   | Amendment Number One to  Security Agreement dated as of July 6, 1999 between Pegasus Medical  Group, Inc. and Sierra Medical Management, Inc.(1)                                                                                                   |   |
| 10.64 |   | Intentionally Omitted.                                                                                                                                                                                                                                            |   |
| 10.65 |   | Form of $11,500,000  Amended and Restated Secured Revolving Note, dated July 3, 1999, executed  by Prospect Medical Holdings, Inc. and made payable to Imperial Bank(1)                                                                            |   |
| 10.66 |   | First Amendment to  Amended and Restated Secured Revolving Note dated as of October 25, 2000  between Imperial Bank and Prospect Medical Holdings, Inc.(1)                                                                                              |   |
| 10.67 |   | Third Amendment to  Amended and Restated Secured Revolving Note dated as of October 25, 2000  between Comerica Bank-California, successor by merger to Imperial Bank  and Prospect Medical Holdings, Inc.(1)                                            |   |
| 10.68 |   | Fifth Amendment  to Amended and Restated Secured Revolving Note dated as of September 24,  2003, between Comerica Bank, successor-by-merger to Comerica Bank-California,  successor-by-merger to Imperial Bank, and Prospect Medical  Holdings, Inc.(1) |
| 10.69 |   | Term Loan Note dated  October 25, 2000 in the original principal amount of $5,000,000 by  Prospect Medical Holdings, Inc. in favor of Imperial Bank(1)                                                                                                  |
| 10.70 |   | First Amendment to Term  Loan Note entered into as of November 3, 2001 between Comerica Bank-California,  successor-by-merger to Imperial Bank and Prospect Medical  Holdings, Inc.(1)                                                                  |
| 10.71 |   | Second Amendment to Term  Loan Note entered into as of February 1, 2002 between Comerica Bank-California,  successor by merger to Imperial Bank and Prospect Medical  Holdings, Inc.(1)                                                                 |
| 10.72 |   | Third Amendment to Term  Loan Note dated as of July 12, 2002 between Comerica Bank-California,  successor by merger to Imperial Bank and Prospect Medical  Holdings, Inc.(1)                                                                            |
| 10.73 |   | Fourth Amendment to Term  Loan Note dated as of September 24, 2003, between Comerica Bank,  successor-by-merger to Comerica Bank-California, successor-by-merger  to Imperial Bank, and Prospect Medical Holdings, Inc.(1)                              |
| 10.74 |   | Amended and Restated  Warrant, issued as of February 6, 1998, by Prospect Medical  Holdings, Inc. to Imperial Bank.(2)                                                                                                                                  |
| 10.75 |   | Consulting Agreement,  dated as of March 1, 1998, between Sierra Primary Care Medical  Group, Inc. and Sinnadurai E. Moorthy, M.D.(2)                                                                                                                   |
| 10.76 |   | Employment Agreement  made as of April 8, 2004, but effective on April 19, 2004, between  Prospect Medical Holdings, Inc. and Mike Heather(1)                                                                                                      |
| 10.77 |   | Form of Partnership  Agreement dated July 1, 1999 between AMVI/MC Health Network, Inc.  and Santa Ana/Tustin Physicians Group(1)                                                                                                                   |
| 10.78 |   | Intentionally Omitted.                                                                                                                                                                                                                                            |
| 10.79 |   | Forbearance Agreement,  dated as of January 25, 2002, between Prospect Medical Group, Inc.  and Prospect Medical Holdings, Inc.(1)                                                                                                                 |
| 10.80 |   | Amendment to Forbearance  Agreement, effective May 30, 2003, between Prospect Medical  Group, Inc. and Prospect Medical Holdings, Inc.(1)                                                                                                          |
|       |        |                                                                                                                                                                                                                                                                   |        |  |  |

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| 10.81 |   | Collateral Substitution  Agreement, dated as of January 25, 2002, between Prospect Medical  Group, Inc., Prospect Medical Holdings, Inc., Foothill City,  Ltd.(1)                                                                                                                                                                                                                                                                                                                                                 |
|-------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.82 |   | Continuing Guaranty,  effective May 30, 2003, by Jacob Y. Terner, M.D., in favor of Prospect  Medical Group, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.83 |   | Amendment to Collateral  Substitution Agreement, effective May 30, 2003, among Prospect Medical  Group, Inc., Prospect Medical Holdings, Inc., and Jacob Y. Terner,  M.D.(1)                                                                                                                                                                                                                                                                                                                                      |
| 10.84 |   | Pledge Agreement,  effective May 30, 2003, between Prospect Medical Group, Inc. and  Jacob Y. Terner, M.D.(1)                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.85 |   | Form of Placement  Agency Agreement, dated November 1, 2003, between Prospect Medical  Holdings, Inc. and Spencer Trask Ventures, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                    |
| 10.86 |   | Form of Amendment  No. 1 to Placement Agency Agreement, dated December 30, 2003,  between Prospect Medical Holdings, Inc. and Spencer Trask  Ventures, Inc.(1)                                                                                                                                                                                                                                                                                                                                          |
| 10.87 |   | Form of Finder’s  Fee Agreement, dated January 15, 2004, between Prospect Medical  Holdings, Inc. and Spencer Trask Ventures, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                   |
| 10.88 |   | Intentionally Omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.89 |   | Form of  Stockholders’ Agreement, dated January 15, 2004, by and among Prospect  Medical Holdings, Inc., Spencer Trask Ventures, Inc., private  placement purchasers of Series A Preferred Stock, “management  stockholders” including Jacob Y. Terner, M.D., Catherine Dickson, Donna  Vigil, R. Stewart Kahn and Linda Hodges, and “principal stockholders”  including Spencer Trask Venture Investment Partners LLC, Paul Amir and the  Herta and Paul Amir Family Trust(1) |
| 10.90 |   | Prospect Medical Holdings, Inc.  1998 Stock Option Plan(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.91 |   | First Amendment to  Prospect Medical Holdings, Inc. 1998 Stock Option Plan(1)                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.92 |   | Participating Physician  Group Provider Services Agreement, effective March 1, 1999, between the  Foundation Health Systems Affiliate(s) identified in Addendum A to the  Agreement and Professional Care Medical Group IPA, a Participating Physician  Group (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to  Rule 24b-2 under the Securities Exchange Act of 1934)(1)                                      |
| 10.93 |   | Health Net  Medicare+Choice (M+C) Addendum to the March 1, 1999 Participating  Physician Group Provider Agreement between Health Net and Professional Care  Medical Group IPA, effective October 1, 1999 (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under  the Securities Exchange Act of 1934)(1)                                                                                          |
| 10.94 |   | Amendment to the  March 1, 1999 Participating Physician Group Provider Services Agreement  between Professional Care Medical Group IPA and Foundation Health  Systems, Inc., effective July 1, 2000 (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under  the Securities Exchange Act of 1934)(1)                                                                                          |
| 10.95 |   | Amendment to the  March 1, 1999 Participating Physician Group Provider Services Agreement  and all subsequent Amendments between Professional Care Medical Group IPA and  Health Net Inc. Affiliates, formerly known as Foundation Health Systems  Affiliates, effective October 1, 2002 (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under  the Securities Exchange Act of 1934)(1)          |

85

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| 10.96  |   | Amendment to the  March 1, 1999 Participating Physician Group Provider Services Agreement,  between Professional Care Medical Group, IPA, and Health Net, Inc.  Affiliates, effective April 14, 2003(1)                                                                                                                                                                                                                                                                    |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.97  |   | Assignment and  Delegation of Participating Physician Group Provider Services Agreement and  Consent to Assignment, effective as of October 1, 2003, between  Professional Care Medical Group, IPA, Prospect Medical Group, and Health  Net, Inc. Affiliates(1)                                                                                                                                                                                                                 |
| 10.98  |   | Amendment to the  March 1, 1999 Participating Physician Group Provider Services Agreement  between Professional Care Medical Group, IPA and Health Net, Inc.  Affiliates, as subsequently amended, effective January 1, 2004 (Certain  portions of this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(1)                          |
| 10.99  |   | CaliforniaCare Medical  Services Agreement, effective November 1, 1999, between Blue Cross of  California and Affiliates and Professional Care IPA Medical Group, Inc.  (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to  Rule 24b-2 under the Securities Exchange Act of 1934)(4)                                                                                     |
| 10.100 |   | Amendment to the November 1, 1999 Blue Cross  Medical Services Agreement between Blue Cross of California and its  Affiliates and Professional Care IPA Medical Group executed November 29,  1999 and November 19, 1999, respectively(1)                                                                                                                                                                                                                                   |
| 10.101 |   | Amendment to the  November 1, 1999 CaliforniaCare Medical Services Agreement between Blue  Cross of California and its Affiliates and Professional Care IPA Medical  Group, Inc. executed December 13, 1999 and November 30, 1999,  respectively (Certain portions of this Exhibit have been omitted subject  to an application for confidential treatment filed with the Commission  pursuant to Rule 24b-2 under the Securities Exchange Act of  1934)(1) |
| 10.102 |   | Amendment to the  November 1, 1999 CaliforniaCare Medical Services Agreement between Blue  Cross of California and its Affiliates and Professional Care IPA, effective  as of January 1, 2002 (Certain portions of this Exhibit have been  omitted subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(1)                                                              |
| 10.103 |   | Business Associate  Amendment supplementing November 1, 1999 CaliforniaCare Medical Services  Agreement between Blue Cross of California and Professional Care IPA,  effective April 14, 2003(1)                                                                                                                                                                                                                                                                                |
| 10.104 |   | Assignment and Consent  to Assignment between Professional Care IPA Medical Group, Inc.,  Prospect Medical Group, Inc. and Blue Cross of California and its  Affiliates, effective October 1, 2003(1)                                                                                                                                                                                                                                                                      |
| 10.105 |   | Blue Cross Senior Secure  Medicare+Choice Medical Services Agreement, effective November 1, 1999,  between Blue Cross of California and Affiliates and Professional Care IPA  Medical Group, Inc. (Certain portions of this Exhibit have been  omitted subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(1)                                                          |
| 10.106 |   | Amendment to  November 1, 1999 Blue Cross Senior Secure Medicare Risk Professional  Services executed December 3, 1999 and November 19, 1999,  respectively(1)                                                                                                                                                                                                                                                                                                             |
| 10.107 |   | Assignment and Consent  to Assignment, effective October 1, 2003, between Professional Care IPA  Medical Group, Inc., Prospect Medical Group, Inc. and Blue Cross of  California and its Affiliates(1)                                                                                                                                                                                                                                                                     |

86

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| 10.108 |   | AIM Medical Services  Agreement, effective May 1, 2001, between Blue Cross of California and  Affiliates and Professional Care IPA Medical Group (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under  the Securities Exchange Act of 1934)(4)                                                                                                                   |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.109 |   | PacifiCare of California  Medical Group/IPA Services Agreement (Professional Capitation), effective  June 1, 1999, between PacifiCare of California, Inc. and  Professional Care IPA Medical Group (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under  the Securities Exchange Act of 1934)(3)                                                            |
| 10.110 |   | Amendment Number One to  the June 1, 1999 PacifiCare of California Medical Group/IPA Services  Agreement (Professional Capitation) between PacifiCare of  California, Inc. and Professional Care IPA Medical Group, effective  June 1, 1999 (Certain portions of this Exhibit have been omitted  subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(3)              |
| 10.111 |   | Amendment Number 1 to the June 1, 1999  PacifiCare of California Medical Group/IPA Services Agreement (Professional  Capitation) between PacifiCare of California and Professional Care IPA  Medical Group, effective January 1, 2002 (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under  the Securities Exchange Act of 1934)(3)                         |
| 10.112 |   | Amendment to the  June 1, 1999 PacifiCare of California Medical Group/IPA Services  Agreement (Professional Capitation) between PacifiCare of California and  Professional Care IPA Medical Group, effective January 1, 2003 (Certain  portions of this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                                  |
| 10.113 |   | Claims Management Agreement, among Prospect Medical  Group, Professional Care IPA Medical Group and PacifiCare of California,  effective October 1, 2003(3)                                                                                                                                                                                                                                                                                                                             |
| 10.114 |   | Notice Amendment to the  June 1, 1999 PacifiCare of California Medical Group/IPA Services  (Professional Capitation) Agreement, effective January 1, 2004(3)                                                                                                                                                                                                                                                                                                                       |
| 10.115 |   | HMO IPA Agreement,  effective January 1, 2003, between Professional Care IPA Medical Group  and California Physicians’ Service dba Blue Shield of California (Certain  portions of this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                                                                                                  |
| 10.116 |   | Amendment No. 1 to  HMO IPA/Medical Group Shared Provider Agreement between California  Physicians’ Service dba Blue Shield of California and Professional Care IPA  Medical Group, effective January 1, 2003 (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under  the Securities Exchange Act of 1934)(3)                                            |
| 10.117 |   | Participating Physician  Group Provider Services Agreement, effective January 1, 1998, between  the Foundation Health Systems Affiliate(s) identified in Addendum A to  the Agreement and Prospect Medical Group, Inc., a Participating  Physician Group (Certain portions of this Exhibit have been omitted  subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(4) |
| 10.118 |   | Amendment to the  January 1, 1998 Participating Physician Group Provider Services  Agreement between Prospect Medical Group and Foundation Health Systems  Affiliate(s), effective January 1, 1998(3)                                                                                                                                                                                                                                                                              |

87

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| 10.119 |   | Amendment to the  January 1, 1998 Participating Physician Group Provider Services  Agreement between Prospect Medical Group and Foundation Health Systems  Affiliates, effective July 1, 2000 (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under  the Securities Exchange Act of 1934)(3)      |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.120 |   | Amendment to the  January 1, 1998 Participating Physician Group Provider Services  Agreement, between Prospect Medical Group and Health Net, Inc.  Affiliates, effective February 19, 2001(3)                                                                                                                                                                                                                      |
| 10.121 |   | Amendment to the  January 1, 1998 Participating Physician Group Provider Services  Agreement between Prospect Medical Group and Foundation Health Systems  Affiliate(s), effective October 1, 2001 (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under  the Securities Exchange Act of 1934)(3) |
| 10.122 |   | Amendment to the January 1, 1998 Participating  Physician Group Provider Services Agreement between Prospect Medical Group  and Health Net, Inc. Affiliates, effective April 1, 2003 (Certain  portions of this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)          |
| 10.123 |   | CaliforniaCare Medical  Services Agreement, effective on January 1, 1997, between Blue Cross of  California and Affiliates and Prospect Medical Group (Certain portions of  this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(4)                                                   |
| 10.124 |   | Letter of Agreement  Serving as Addendum to the January 1, 1997 CaliforniaCare Medical  Services Agreement between Blue Cross of California and Prospect Medical  Group, effective January 1, 1997(3)                                                                                                                                                                                                                   |
| 10.125 |   | Letter of Agreement Serving as Addendum to the  January 1, 1997 CaliforniaCare Medical Services Agreement between Blue  Cross of California and Prospect Medical Group, effective January 1,  1997 (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to  Rule 24b-2 under the Securities Exchange Act of 1934)(3)  |
| 10.126 |   | Amendment to the  January 1, 1997 CaliforniaCare Medical Services Agreement between Blue  Cross of California and Affiliates and Prospect Medical Group, effective  May 1, 1997(3)                                                                                                                                                                                                                                      |
| 10.127 |   | Amendment to the  January 1, 1997 CaliforniaCare Medical Services Agreement between Blue  Cross of California and Affiliates and Prospect Medical Group, effective  May 1, 1997(3)                                                                                                                                                                                                                                      |
| 10.128 |   | Amendment to the  January 1, 1997 CaliforniaCare Medical Services Agreement between Blue  Cross of California and its Affiliates and Prospect Medical Group, effective  August 1, 1997 (Certain portions of this Exhibit have been omitted  subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(3)             |
| 10.129 |   | Amendment to the  January 1, 1997 CaliforniaCare Medical Services Agreement by and between  Blue Cross of California and its Affiliates and Prospect Medical Group,  effective July 1, 1999(3)                                                                                                                                                                                                                          |
| 10.130 |   | Amendment to the January 1,  1997 CaliforniaCare Medical Services Agreement by and between Blue Cross of  California and its Affiliates and Prospect Medical Group, effective  January 1, 1999(3)                                                                                                                                                                                                                       |

88

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| 10.131 |   | Amendment to the  January 1, 1997 CaliforniaCare Medical Services Agreement between Blue  Cross of California and its Affiliates and Prospect Medical Group, effective  January 1, 2001 (Certain portions of this Exhibit have been omitted  subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(3)                                                                    |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.132 |   | PacifiCare of California  Medical Group/IPA Services Agreement (Professional Capitation), effective  January 1, 2001, between PacifiCare of California, Inc. and  Prospect Medical Group (Certain portions of this Exhibit have been  omitted subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(3)                                                                   |
| 10.133 |   | First Amendment to January 1, 2001 PacifiCare  of California Medical Group/IPA Services Agreement (Professional Capitation)  between PacifiCare of California, Inc. and Prospect Medical Group,  effective January 1, 2002 (Certain portions of this Exhibit have  been omitted subject to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities  Exchange Act of 1934)(3)                            |
| 10.134 |   | Second Amendment to  January 1, 2001 PacifiCare of California Medical Group/IPA Services  Agreement (Professional Capitation) between PacifiCare of California, Inc.  and Prospect Medical Group, effective January 1, 2003 (Certain portions  of this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                           |
| 10.135 |   | Notice Amendment to the  January 1, 2001 PacifiCare of California Medical Group/IPA Services  Agreement (Professional Capitation)(3)                                                                                                                                                                                                                                                                                                                                                 |
| 10.136 |   | HMO IPA/Medical Group Shared Savings Provider  Agreement between Prospect Medical Group Inc. and California Physicians’  Service, Inc. dba Blue Shield of California dated November 12, 2003  (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to  Rule 24b-2 under the Securities Exchange Act of 1934)(3)                                                          |
| 10.137 |   | HMO IPA Agreement,  effective November 1, 1995, between California Physicians’ Service dba  Blue Shield of California and Prospect Medical Group, Inc. (Certain  portions of this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                                                                                                |
| 10.138 |   | Participating Physician  Group Provider Services Agreement, effective January 1, 1998, between  the Foundation Health Systems Affiliate(s) identified in Addendum A to  the Agreement and Sierra Medical Group, Inc., a Participating Physician  Group (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to  Rule 24b-2 under the Securities Exchange Act of 1934)(3) |
| 10.139 |   | Amendment to the  January 1, 1998 Participating Physician Group Provider Services  Agreement between Prospect Medical Group, Inc. on behalf of Sierra  Medical Group and Foundation Health Systems Affiliate(s), effective  November 1, 2000 (Certain portions of this Exhibit have been  omitted subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(3)          |
| 10.140 |   | Amendment to the  January 1, 1998 Participating Physician Group Provider Services  Agreement between Sierra Medical Group and Health Net, Inc. Affiliates,  effective January 1, 2003 (Certain portions of this Exhibit have  been omitted subject to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities  Exchange Act of 1934)(3)                                                                 |

89

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| 10.141 |   | PacifiCare of California  Medical Group/IPA Services Agreement (Professional Capitation) effective  July 1, 1999, between PacifiCare of California, Inc. and Sierra  Medical Group (Certain portions of this Exhibit have been omitted  subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(3)                                                                         |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.142 |   | 2001 Amendment to the  July 1, 1999 PacifiCare of California Medical Group/IPA Services  Agreement (Professional Capitation) between PacifiCare of  California, Inc. and Sierra Medical Group, effective January 1,  2001 (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to  Rule 24b-2 under the Securities Exchange Act of 1934)(3)                              |
| 10.143 |   | Express Referrals  Amendment to the July 1, 1999 PacifiCare of California Medical Group/IPA  Services Agreement (Professional Capitation) between PacifiCare of  California, Inc. and Sierra Medical Group, effective October 1,  2002(3)                                                                                                                                                                                                                                  |
| 10.144 |   | Third Amendment to the  July 1, 1999 PacifiCare of California Medical Group/IPA Services Agreement  (Professional Capitation) between PacifiCare of California, Inc. and  Sierra Medical Group, effective January 1, 2003 (Certain portions of  this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                             |
| 10.145 |   | Participating Physician Group Provider Services  Agreement, effective June 1, 1998, between the Foundation Health Systems  Affiliate(s) identified in Addendum A to the Agreement and A.V. Medical  Group, a Participating Physician Group (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under  the Securities Exchange Act of 1934)(3)                 |
| 10.146 |   | Amendment to the  June 1, 1998 Participating Physician Group Provider Services Agreement  between A.V. Medical Group and Foundation Health Systems Affiliate(s),  effective July 1, 1999(3)                                                                                                                                                                                                                                                                                     |
| 10.147 |   | Amendment to the  June 1, 1998 Participating Physician Group Provider Services Agreement  between A.V. Medical Group and Foundation Health Systems, effective  November 1, 2000 (Certain portions of this Exhibit have been  omitted subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(3)                                                                            |
| 10.148 |   | Amendment to the  June 1, 1998 Participating Physician Group Provider Services Agreement  between A.V. Medical Group and Health Net, Inc. Affiliates, effective  March 1, 2003 (Certain portions of this Exhibit have been omitted  subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(3)                                                                        |
| 10.149 |   | Participating Physician  Group Provider Services Agreement, effective June 1, 2001, between the  Health Net, Inc. Affiliate(s) identified in Addendum A to the  Agreement and Northwest Orange County Medical Group, a Participating  Physician Group (Certain portions of this Exhibit have been omitted  subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(3) |
| 10.150 |   | CaliforniaCare Medical  Services Agreement, effective January 1, 1997, between Blue Cross of  California and Affiliates and Northwest Orange County Medical Group (Certain  portions of this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                                                                                               |
| 10.151 |   | Amendment to the  January 1, 1997 CaliforniaCare Medical Services Agreement between Blue  Cross of California and Affiliates and Northwest Orange County Medical  Group, Inc., effective January 1, 1998(3)                                                                                                                                                                                                                                                           |

90

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| 10.152 |   | Amendment to the  January 1, 1997 CaliforniaCare Medical Services Agreement between Blue  Cross of California and its Affiliates and Northwest Orange County Medical  Group, effective January 1, 1999(3)                                                                                                                                                                                                                                                      |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.153 |   | Amendment to the January 1, 1997 CaliforniaCare  Medical Services Agreement between Blue Cross of California and its  Affiliates and Northwest Orange County Medical Group, Inc., effective  January 1, 2003 (Certain portions of this Exhibit have been omitted  subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(3)                              |
| 10.154 |   | PacifiCare of California Medical Group/IPA Services  Agreement (Split Capitation), effective January 1, 2001, between  PacifiCare of California, Inc. and Northwest Orange County Medical Group  (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to  Rule 24b-2 under the Securities Exchange Act of 1934)(3)                                                |
| 10.155 |   | Amendment Number 1 to January 1, 2001  PacifiCare of California Medical Group/IPA Services Agreement (Split  Capitation) between PacifiCare of California and Northwest Orange County  Medical Group, effective January 1, 2003 (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under  the Securities Exchange Act of 1934)(3)                |
| 10.156 |   | Amendment Number 4 to PacifiCare of California  Medical Group/IPA Services Agreement (Split Capitation) between PacifiCare of  California and Northwest Orange County Medical Group, effective  January 1, 2004 (Certain portions of this Exhibit have been omitted  subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(3)                                     |
| 10.157 |   | Health Plan and Physician Group Service Agreement,  effective September 1, 1990, between CareAmerica Southern  California, Inc. and Northwest Orange County Medical Group (Certain  portions of this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                                                                      |
| 10.158 |   | Amendment to September 1, 1990 Medicare+Choice  Physician Group Service Agreement between California Physicians’ Service, Inc.  dba Blue Shield of California and Northwest Orange County Medical Group,  effective September 1, 1999(3)                                                                                                                                                                                                                  |
| 10.159 |   | Amendment to September 1, 1990 Medicare+Choice  Physician Group Service Agreement between California Physicians’  Service, Inc. dba Blue Shield of California and Northwest Orange County  Medical Group, effective December 1, 1999(3)                                                                                                                                                                                                                   |
| 10.160 |   | Amendment to September 1, 1990 Medicare+Choice  Physician Group Service Agreement between California Physicians’  Service, Inc. dba Blue Shield of California and Northwest Orange County  Medical Group, effective December 1, 2000 (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under  the Securities Exchange Act of 1934)(3) |
| 10.161 |   | Amendment to September 1, 1990 Medicare+Choice  Physician Group Service Agreement between California Physicians’  Service, Inc. dba Blue Shield of California and Northwest Orange County  Medical Group, effective January 1, 2002 (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under  the Securities Exchange Act of 1934)(3)  |
| 10.162 |   | Amendment  to September 1, 1990 Medicare+Choice Physician Group Service Agreement  between California Physicians’ Service, Inc. dba Blue Shield of  California and Northwest Orange County Medical Group, effective May 1,  2002 (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to  Rule 24b-2 under the Securities Exchange Act of 1934)(3)      |

 

91

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| 10.163 |   | HMO IPA/Medical Group  Shared Savings Provider Agreement, effective February 1, 2003, between  Northwest Orange County Medical Group and California Physicians’  Service, Inc., dba Blue Shield of California (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under  the Securities Exchange Act of 1934)(3) |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

| 10.164 |   | Amendment to HMO IPA/Medical Group Shared Savings  Provider Agreement between California Physicians’ Service dba Blue Shield of  California and Northwest Orange County Medical Group, effective  February 1, 2003 (Certain portions of this Exhibit have been  omitted subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(3)                              |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.165 |   | CaliforniaCare Medical  Services Agreement, effective January 1, 2001, between Blue Cross of  California and Affiliates and Prospect Health Source Medical Group (Certain  portions of this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                                                                                     |
| 10.166 |   | Letter of Agreement  Serving as Addendum to the January 1, 2001 California Care Medical  Services Agreement between Blue Cross of California and Prospect Health  Source Medical Group, effective January 1, 2001 (Certain portions of  this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                               |
| 10.167 |   | Amendment to the  January 1, 2001 CaliforniaCare Medical Services Agreement between Blue  Cross of California and its Affiliates and Prospect Health Source Medical  Group, effective January 1, 2001 (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under  the Securities Exchange Act of 1934)(3)                                           |
| 10.168 |   | PacifiCare of California  Medical Group/IPA Services Agreement (Professional Capitation), effective  January 1, 2001, between PacifiCare of California, Inc. and  Prospect Health Source Medical Group (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under  the Securities Exchange Act of 1934)(3)                                          |
| 10.169 |   | First Amendment to  January 1, 2001 PacifiCare of California Medical Group/IPA Services  Agreement (Professional Capitation) between PacifiCare of  California, Inc. and Prospect Health Source Medical Group, effective  January 1, 2002 (Certain portions of this Exhibit have been omitted  subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(3)  |
| 10.170 |   | Second Amendment to  January 1, 2001 PacifiCare of California Medical Group/IPA Services  Agreement (Professional Capitation) between PacifiCare of  California, Inc. and Prospect Health Source Medical Group, effective  January 1, 2003 (Certain portions of this Exhibit have been omitted  subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(3) |
| 10.171 |   | HMO IPA/Medical Group  Shared Savings Provider Agreement, effective July 1, 2003, between  Prospect Health Source Medical Group and California Physicians’  Service, Inc. dba Blue Shield of California (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under  the Securities Exchange Act of 1934)(3)                                    |
| 10.172 |   | Amendment No. 1 to  July 1, 2003 HMO IPA/Medical Group Shared Savings Provider Agreement  between Prospect Health Source Medical Group and California Physicians’  Service, Inc. dba Blue Shield of California, effective July 1,  2003(3)                                                                                                                                                                                                            |

92

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| 10.173 |   | Participating Physician Group Provider Services  Agreement, effective March 1, 1999, between the Foundation Health  Systems Affiliate(s) identified in Addendum A to the Agreement and  StarCare Medical Group dba Gateway Medical Group, a Participating Physician  Group (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to  Rule 24b-2 under the Securities Exchange Act of 1934)(3) |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.174 |   | Health Net  Medicare+Choice (M+C) Addendum to the March 1, 1999 Participating  Physician Group Provider Services Agreement between Health Net and StarCare  Medical Group dba Gateway Medical Group, effective October 1, 1999(3)                                                                                                                                                                                                                                                              |
| 10.175 |   | Amendment to the  Participating Physician Group Provider Services Agreement between Foundation  Health Systems Affiliates and StarCare Medical Group dba Gateway Medical  Group, effective July 1, 2000 (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under  the Securities Exchange Act of 1934)(3)                                                                        |
| 10.176 |   | Amendment to the  Participating Physician Group Provider Services Agreement between Foundation  Health Systems Affiliates and StarCare Medical Group dba Gateway Medical  Group, effective October 10, 2000 (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under  the Securities Exchange Act of 1934)(3)                                                                    |
| 10.177 |   | Amendment to the  Participating Physician Group Provider Services Agreement between Health Net  Inc., Affiliates and StarCare Medical Group dba Gateway Medical Group,  effective February 1, 2002 (Certain portions of this Exhibit have  been omitted subject to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities  Exchange Act of 1934)(3)                                                                             |
| 10.178 |   | CaliforniaCare Medical  Services Agreement, effective January 1, 1997, between Blue Cross of  California and Affiliates and Gateway Medical Group (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under  the Securities Exchange Act of 1934)(4)                                                                                                                              |
| 10.179 |   | Letter of Agreement  Serving as Addendum to the January 1, 1997 CaliforniaCare Medical  Services Agreement between Blue Cross of California and Gateway Medical  Group, effective January 1, 1997 (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under the  Securities Exchange Act of 1934)(3)                                                                         |
| 10.180 |   | Letter of Agreement  Serving as Addendum to the January 1, 1997 CaliforniaCare Medical  Services Agreement between Blue Cross of California and Gateway Medical Group  (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to  Rule 24b-2 under the Securities Exchange Act of 1934)(3)                                                                                                          |
| 10.181 |   | Amendment to the  January 1, 2000 CaliforniaCare Medical Services Agreement between Blue  Cross of California and StarCare Medical Group dba Gateway Medical  Group, Inc., effective January 1, 2000 (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under  the Securities Exchange Act of 1934)(3)                                                                 |

93

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| 10.182 |   | Amendment to the January 1, 2000 CaliforniaCare  Medical Services Agreement between Blue Cross of California and Gateway  Medical Group, effective July 1, 2000 (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under  the Securities Exchange Act of 1934)(3)                                                                                     |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.183 |   | Amendment to the  January 1, 2000 CaliforniaCare Medical Services Agreement between Blue Cross  of California and StarCare Medical Group dba Gateway Medical  Group, Inc., effective January 1, 2002 (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under  the Securities Exchange Act of 1934)(3)                                           |
| 10.184 |   | Californiakids Medical  Services Agreement, effective February 1, 2000, between Blue Cross of  California and Affiliates and Gateway Medical Group, Inc. (Certain  portions of this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                                                                                            |
| 10.185 |   | Amendment to the  January 1, 2000 Blue Cross Senior Secure Medicare+Choice Medical  Services Agreement between Blue Cross of California and Affiliates and  StarCare Medical Group dba Gateway Medical Group, Inc., effective  January 1, 2002 (Certain portions of this Exhibit have been omitted  subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(3) |
| 10.186 |   | HMO IPA/Medical  Group Shared Savings Provider Agreement, effective January 1, 2002,  between Starcare Medical Group Inc., dba Gateway Medical Group, Inc. and  California Physicians’ Service, Inc., dba Blue Shield of California  (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to  Rule 24b-2 under the Securities Exchange Act of 1934)(3)       |
| 10.187 |   | First Amendment to  January 1, 2002 HMO IPA/Medical Group Shared Savings Provider Agreement  between Starcare Medical Group Inc., dba Gateway Medical Group, Inc. and  California Physicians’ Service, Inc., dba Blue Shield of California  effective February 1, 2002(3)                                                                                                                                                                                 |
| 10.188 |   | PacifiCare of California  Medical Group/IPA Services Agreement (Professional Capitation), effective  January 1, 2001, between PacifiCare of California, Inc. and Gateway  Physicians Medical Associates, Inc. (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under  the Securities Exchange Act of 1934(3)                                   |
| 10.189 |   | Amendment Number 1 to  January 1, 2001 PacifiCare of California Medical Group/IPA Services  Agreement (Professional Capitation) between PacifiCare of California and  Gateway Physicians Medical Associates, Inc., effective January 1,  2002 (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to  Rule 24b-2 under the Securities Exchange Act of 1934)(3)   |
| 10.190 |   | Business Associate  Amendment to the January 1, 2001 PacifiCare of California Medical  Group/IPA Services Agreement between PacifiCare of California, Inc. and  Gateway Physicians Medical Associates, Inc.(3)                                                                                                                                                                                                                                                      |
| 10.191 |   | Letter Amendment to the  January 1, 2001 PacifiCare of California Medical Group/IPA Services  Agreement between PacifiCare of California, Inc. and Gateway Physicians  Medical Associates, Inc., dated November 15, 2002 (Certain portions  of this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                  |

94

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| 10.192 |       | Amendment Number 2 to the January 1, 2001  PacifiCare of California Medical Group/IPA (Professional Capitation) Services  Agreement, between PacifiCare of California and Gateway Physicians Medical  Associates, effective January 1, 2003 (Certain portions of this Exhibit have  been omitted subject to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities  Exchange Act of 1934)(3)                                                                                                                                                                                                                              |
|--------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.193 |       | Form of  Subscription Agreement dated as of January 15, 2004 between Prospect  Medical Holdings and each purchaser of preferred stock(4)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.194 |       | Form of Cash  Management Agreement among Prospect Medical Systems, Inc., Prospect  Medical Holdings, Inc., and Prospect Medical Group, Inc., effective  as of June 6, 1996(4)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.195 |       | Second Amendment to  Prospect Medical Holdings, Inc. 1998 Stock Option Plan(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.196 |       | Amended and Restated Assignable Option Agreement dated  September 27, 2004, by and among Prospect Medical  Systems, Inc., Prospect Medical Group, Inc., and Jacob Y.  Terner, M.D.(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.197 |       | Management  Services Agreement effective as of May 19, 2003, by and between Sierra  Medical Management, Inc. and Antelope Valley Medical  Associates, Inc.(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.198 |       | Amendment to Management  Agreement, effective as of February 1, 2004 to that certain Management  Agreement made and entered into as of January 1, 2003, entered into by  and between Pinnacle Health Resources and StarCare Medical Group, Inc.  dba Gateway Medical Group, Inc.(5)                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.199 |       | Amendment to Management  Agreement, effective as of February 1, 2004 to that certain Management  Agreement made and entered into as of January 1, 2003, entered into by  and between Pinnacle Health Resources and APAC Medical Group, Inc. dba  Gateway Physicians Medical Associates, Inc.(5)                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.200 | ** ** | Security Agreement,  effective as of March 1, 2004, entered into between Prospect NWOC  Medical Group, Inc. dba Prospect Northwest Orange County Medical  Group, Inc., and Prospect Medical Systems, Inc.(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.201 | ** ** | Security Agreement,  effective as of January 1, 2001, entered into between Prospect Health  Source Medical Group, Inc. and Prospect Medical Systems, Inc.(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.202 | ** ** | Security Agreement,  effective as of February 1, 2004, entered into between StarCare Medical  Group, Inc. dba Gateway Medical Group, Inc. and Pinnacle Health  Resources(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.203 | ** ** | Security Agreement  effective as of February 1, 2004, entered into between APAC Medical  Group, Inc. dba Gateway Physicians Medical Associates, Inc. and  Pinnacle Health Resources(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.204 | ** ** | Security Agreement,  effective as of August 1, 1999, entered into between Nuestra Familia  Medical Group and Prospect Medical Systems, Inc.(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.205 |       | Omnibus Amendment to  Security Agreements dated as of September 27, 2004, entered into by and  among Prospect Medical Systems, Inc., Sierra Medical Management, Inc.,  Pinnacle Health Resources, Prospect Medical Group, Inc., Santa/Ana  Tustin Physicians Group, Inc., Sierra Primary Care Medical Group, A  Medical Corporation, Pegasus Medical Group, Inc., Antelope Valley  Medical Associates, Inc., Prospect Health Source Medical  Group, Inc., Prospect Professional Care Medical Group, Inc.,  Prospect NWOC Medical Group, Inc., APAC Medical Group, Inc.,  StarCare Medical Group, Inc., and Nuestra Familia Medical Group(5) |
| 10.206 |       | Loan and Security  Agreement entered into and effective as of September 27, 2004 among  Residential Funding Corporation, Prospect Medical Holdings, Inc.,  Prospect Medical Group, Inc., Prospect Medical Group, Inc., and  each of the other Credit Parties(5)                                                                                                                                                                                                                                                                                                                                                                                                                     |

95

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|        |   | Pursuant to  Regulation S-K, Item 601(b)(2), the following schedules to the Loan and  Security Agreement will be provided supplementally to the Commission upon  request:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   | Exhibit A  Supplemental Terms and Conditions, Exhibit B Advance Request &  Receivables Information Borrowing Certificate, Exhibit C Revolving  Credit Borrowing Base Certificate, Exhibit D Closing Checklist,  Exhibit E Interest Statement, Exhibit F Form of  Secretary’s/Clerk Certificate, Exhibit G Form of Compliance Certificate,  Exhibit H Financial Covenants Calculation Worksheet, Exhibit I-1  Form of Revolving Credit Note, Exhibit I-2 Form of Term  Note, Exhibit I-3 Form of Intercompany Note, Exhibit J  Form of Assignable Option Agreement, Exhibit K Form of Credit  Succession Agreement, Schedule 3.2.2(b) Existing Convertible Stock,  Schedule 8.5 Litigation Matters, Schedule 8.7 Credit Party Information,  Capitated Contracts and Transaction Documents, Schedule 8.9 Tax Matters,  Schedule 8.10 Government And Other Offsets, Schedule 8.12 ERISA Matters,  Schedule 8.13 Authorized Capital/Outstanding Capital, Schedule 8.15 Deposit  Accounts, Schedule 8.16 Environmental Matters, Schedule 8.17 Insurance  Policies, Schedule 8.18 Commercial Tort Claims, Schedule 8.19  Intellectual Properties, Schedule 8.20 Labor Matters, Schedule 8.21  Healthcare Filings, Schedule 9.7 Existing Liens, Schedule  9.8(b) Permitted Indebtedness, Schedule 9.10 Transactions With  Affiliates, Schedule 9.17 Post-Closing Obligations, Schedule 10.1 Leases |
| 10.207 |   | Revolving Credit Note  dated September 27, 2004, executed by Prospect Medical  Holdings, Inc., and Prospect Medical Group, Inc., made payable to  Residential Funding Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.208 |   | Term Note dated  September 27, 2004, executed by Prospect Medical Holdings, Inc.,  and Prospect Medical Group, Inc., made payable to Residential Funding  Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.209 |   | Subordinated  Intercompany Note dated September 27, 2004, executed by Prospect Medical  Holdings, Inc., Prospect Medical Systems, Inc., Pinnacle Health  Resources, Nuestra Familia Medical Group, Inc., Prospect Medical  Group, Inc., Santa Ana/Tustin Physicians Group, Inc., Pegasus  Medical Group, Inc., Antelope Valley Medical Associates, Inc.,  Prospect Health Source Medical Group, Inc., Prospect Professional Care  Medical Group, Inc., Prospect NWOC Medical Group, Inc., APAC  Medical Group, Inc., StarCare Medical Group, Inc., Sierra Medical  Management, Inc., Sierra Primary Care Medical Group, A Medical  Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.210 |   | Credit Succession Agreement, dated September 27, 2004,  entered into by and among Jacob Y. Terner, M.D., Prospect Medical Holdings, Inc.,  Prospect Medical Group, Inc., Prospect Medical Systems, Inc.,  Sierra Medical Management, Inc., Pinnacle Health Resources, the  following subsidiaries of Prospect Medical Group: Sierra Primary Care Medical  Group, A Medical Corporation, Santa Ana/Tustin Physicians Group, Inc.,  Pegasus Medical Group, Inc., Antelope Valley Medical  Associates, Inc., Nuestra Familia Medical Group, Inc., Prospect  Health Source Medical Group, Inc., Prospect Professional Care Medical Group, Inc.,  Prospect NWOC Medical Group, Inc., APAC Medical Group, Inc.,  StarCare Medical Group, Inc. and Residential Funding Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.211 |   | Subordination Agreement dated September 27, 2004, by and  among Prospect Medical Systems, Inc., Sierra Medical  Management, Inc., Pinnacle Health Resources, Prospect Medical  Holdings, Inc., Prospect Medical Group, Inc., each of the  subsidiaries of Prospect Medical Group, Inc., signatory hereto, and Residential Funding  Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.212 |   | Pledge Agreement, dated  as of September 27, 2004 among Jacob Y. Terner, M.D. and Residential  Funding Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.213 |   | Pledge Agreement, dated  as of September 27, 2004 among Prospect Medical Group, Inc., and  Residential Funding Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |

96

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| 10.214 |   | Pledge Agreement, dated  as of September 27,2004 among Prospect Medical Holdings, Inc., and  Residential Funding Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.215 |   | Pledge Agreement, dated  as of September 27,2004 among Prospect Medical Systems, Inc., and  Residential Funding Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.216 |   | Collateral Assignment of Transaction Documents has been executed  and delivered as of September 27, 2004, by and between Sierra  Medical Management, Inc., and Residential Funding Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.217 |   | Collateral Assignment of Transaction Documents has been executed  and delivered as of September 27, 2004, by and between Pinnacle Health  Resources and Residential Funding Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.218 |   | Collateral Assignment of Transaction Documents has been executed  and delivered as of September 27, 2004, by and between Prospect Medical  Systems, Inc., and Residential Funding Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.219 |   | Guaranty Inducement and  Offset Agreement, dated as of September 27, 2004, entered into by and among Prospect Medical  Group, Inc., Prospect Medical Holdings, Inc., Prospect Medical  Systems, Inc., Sierra Medical  Management, Inc., and Pinnacle Health Resources, Sierra Primary  Care Medical Group, A Medical Corporation, Santa Ana/Tustin Physicians  Group, Inc., Pegasus Medical Group, Inc., Antelope Valley Medical  Associates, Inc., Nuestra Familia Medical Group, Inc., Prospect  Health Source Medical Group, Inc., Prospect Professional Care Medical  Group, Inc., Prospect NWOC Medical Group, Inc., APAC Medical  Group, Inc., and StarCare Medical Group, Inc., and Residential  Funding Corporation(5)     |
| 10.220 |   | Power of Attorney  executed by Prospect Medical Holdings, Inc., Prospect Medical Systems, Inc., Sierra Medical  Management, Inc., Pinnacle Health Resources, Prospect Medical  Group, Inc., Sierra Primary Care Medical Group, A Medical  Corporation, Santa Ana/Tustin Physician Group, Inc., Pegasus Medical  Group, Inc., Antelope Valley Medical Associates, Inc., Nuestra  Familia Medical Group, Inc., Prospect Health Source Medical  Group, Inc., Prospect Professional Care Medical Group, Inc.,  Prospect NWOC Medical Group, Inc., APAC Medical Group, Inc., and  StarCare Medical Group, Inc., to Residential Funding Corporation, under  that certain Loan and Security Agreement, dated as of September 27,  2004(5) |
| 10.221 |   | Form of Business  Associate Agreement, effective September 27, 2004, entered into by and  among APAC Medical Group, Inc., and Residential Funding Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.222 |   | Form of Business  Associate Agreement, effective September 27, 2004, entered into by and  among Prospect Health Source Medical Group, Inc., and Residential  Funding Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.223 |   | Form of Business  Associate Agreement, effective September 27, 2004, entered into by and  among Prospect Professional Care Medical Group, Inc., and Residential  Funding Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.224 |   | Form of Business Associate  Agreement, effective September 27, 2004, entered into by and among  Nuestra Familia Medical Group, Inc., and Residential Funding  Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.225 |   | Form of Business  Associate Agreement, effective September 27, 2004, entered into by and  among Prospect NWOC Medical Group, Inc., and Residential Funding  Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.226 |   | Form of Business  Associate Agreement, effective September 27, 2004, entered into by  and among StarCare Medical Group, Inc., and Residential Funding  Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |

97

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| 10.227 |   | Form of  Limited Consent, Omnibus Amendment No. 1 to the Loan Documents and  Joinder Agreement, dated as of July 20, 2005, entered into by and among  Residential Funding Corporation, Prospect Medical Holdings, Inc.,  Prospect Medical Group, Inc., and Prospect Medical  Management, Inc.(6)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.228 |   | Form of stock  option agreement used for incentive stock options granted under the  registrant’s 1998 Stock Option Plan, as amended(7)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.229 |   | Form of stock  option agreement used for non-qualified stock options granted under the  registrant’s 1998 Stock Option Plan, as amended(7)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.230 |   | Limited Consent, Omnibus  Amendment No. 3 and Joinder Agreement to the Loan Documents among  Residential Funding Corporation, Prospect Medical Holdings, Inc.,  Prospect Medical Group, Inc., Prospect Medical Systems, Inc.,  Pinnacle Health Resources, Sierra Medical Management, Inc., Sierra  Primary Care Medical Group, Nuestra Familia Medical Group, Inc., Santa  Ana/Tustin Physicians group, Inc., Pegasus Medical Group, Inc.  Antelope Valley Medical Associates, Inc., Prospect Health Source Medical  Group, Inc., Prospect Professional Care Medical Group, Inc.,  Prospect NWOC Medical Group, Inc. APAC Medical group, Inc.,  Starcare Medical Group, Inc., Prospect Hospital Advisory  Services, Inc., and Genesis Healthcare of Southern  California, Inc.(8) |
| 14.1   |   | Code of Ethics(8)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 21.1   |   | List of Subsidiaries of  Prospect Medical Holdings, Inc.(3)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 23.1   |   | Consent of  Ernst & Young, LLP(8)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 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(8)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 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(8)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 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(8)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 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(8)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |

----

(1)          Previously filed as anexhibit to our Form 10 registration statement (the “Form 10”) onMay 27, 2004, and incorporated herein by reference.

(2)          Previously filed as anexhibit to our registration statement on Form S-1 (File No. 333-63801)on September 18, 1998, and incorporated herein by reference.

(3)          Previously filed as anexhibit to Amendment No. 1 to the Form 10 on May 27, 2004, andincorporated herein by reference.

(4)          Previously filed as anexhibit to Amendment No. 2 to the Form 10 on August 27, 2004,and incorporated herein by reference.

(5)          Previously filed as anexhibit to Amendment No. 3 to the Form 10 on October 21, 2004,and incorporated herein by reference.

(6)          Previously filed as anexhibit to our registration statement on Form S-1 (File No. 333-124915)on July 21, 2005, and incorporated herein by reference.

(7)          Previously filed as anexhibit to our Form 8-K report filed on September 20, 2005.

(8)          Filed herewith.

98

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto dulyauthorized.

|                               | ** ** | PROSPECT MEDICAL  HOLDINGS, INC.                                                                                    |
|-------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------|
|                          | ** ** | (Registrant)                   |
| Date: December 22,  2005 | By:        | /s/  JACOB Y. TERNER, M.D.                                                                                               |
|                          |       |                                                                                                                     |
|                          |       | Jacob Y. Terner,  M.D.*Chairman and Chief Executive Officer*                                                             |

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this report has been signed below by the followingpersons on behalf of the registrant and in the capacities and on the dates indicated.

|                           | **Signature** | ** **                                  | ** ** |                        | **Title** | ** ** | ** ** |  | **Date** | ** ** |
|---------------------------|---------------|---------------------------------------------|------------|------------------------|-----------|------------|------------|--|----------|------------|
| /s/ Jacob Y. Terner, M.D. |          | Chairman, Chief  Executive Officer          |       | December 22, 2005 |
| Jacob  Y. Terner, M.D.    |          | and Director (Principal  Executive Officer) |       |                   |
| /s/ Mike Heather          |          | Chief Financial  Officer (Principal         |       | December 22, 2005 |
| Mike  Heather             |          | Financial and Accounting  Officer)          |       |                   |
| /s/ Catherine Dickson     |          | President, Chief  Operating Officer         |       | December 22, 2005 |
| Catherine  Dickson        |          | and Director                                |       |                   |
| /s/ David A. Levinsohn    |          | Director                                    |       | December 22, 2005 |
| David  A. Levinsohn       |          |                                        |       |                   |
| /s/ Kenneth Schwartz      |          | Director                                    |       | December 22, 2005 |
| Kenneth  Schwartz         |          |                                        |       |                   |
| /s/ Joel S. Kanter        |          | Director                                    |       | December 22, 2005 |
| Joel  S. Kanter           |          |                                        |       |                   |
| /s/ Gene E. Burleson      |          | Director                                    |       | December 22, 2005 |
| Gene E. Burleson          |          |                                        |       |                   |

 

99

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**INDEXTO FINANCIAL STATEMENTS ANDFINANCIAL STATEMENT SCHEDULE**
|                                                                                                                   | ** ** | **Page** |
|-------------------------------------------------------------------------------------------------------------------|------------|----------|
| Report of Independent  Registered Public Accounting Firm                                                          |       | F-2      |   |
| Consolidated Balance Sheets as of  September 30, 2004 and 2005                                               |       | F-3      |   |
| Consolidated Statements of  Income for the Years Ended September 30, 2003, 2004 and 2005                     |       | F-4      |   |
| Consolidated Statements of  Shareholders’ Equity for the Years Ended September 30, 2003,  2004 and 2005 |       | F-5      |   |
| Consolidated Statements of  Cash Flows for the Years Ended September 30, 2003, 2004  and 2005                |       | F-6      |   |
| Notes to Consolidated  Financial Statements                                                                       |       | F-7      |   |
| Report of Independent  Registered Public Accounting Firm                                                          |       | F-31     |   |
| Schedule  II—Valuation and Qualifying Accounts                                                               |       | F-32     |   |

 

F-1

----

**Reportof Independent Registered Public Accounting Firm**

Board of DirectorsProspect Medical Holdings, Inc.

We have audited the consolidated balance sheets ofProspect Medical Holdings, Inc. (the Company), as of September 30,2004 and 2005, and the related consolidated statements of income, shareholders’equity and cash flows for each of the three years in the period ended September 30,2005. These financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. We were not engaged to perform an audit of the Company’s internalcontrol over financial reporting. Our audit included consideration of internalcontrol over financial reporting as a basis for designing audit procedures thatare appropriate in the circumstances, but not for the purpose of expressing anopinion on the effectiveness of the Company’s internal control over financialreporting. Accordingly, we express no such opinion. An audit also includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, and evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

In ouropinion, the consolidated financial statements referred to above presentfairly, in all material respects, the consolidated financial position of ProspectMedical Holdings, Inc., at September 30, 2004 and 2005, and theconsolidated results of its operations and its cash flows for each of the threeyears in the period ended September 30, 2005, in conformity with U.S.generally accepted accounting principles.

|                    | /s/ ERNST &  YOUNG LLP |
|-------------------------|---------------------------------|
| Los Angeles, California |                            |
| December 21, 2005  |                            |

 

F-2

----

**ProspectMedical Holdings, Inc.Consolidated Balance Sheets**

| ** **                                                                                                                                                          | ** ** | **September 30** | ** **       |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------------|
| ** **                                                                                                                                                          | ** ** | **2004**              | ** **       | **2005** | ** ** |
| **Assets**                                                                                                                                                          |       |                  |             |   |   |
| Current assets:                                                                                                                                                     |       |                  |             |   |   |
| Cash and cash equivalents                                                                                                                                           | ** ** | $                     | 20,330,754  |   | **$** | **16,949,304**** ** | ** ** |
| Investments, primarily restricted certificates of  deposit                                                                                                          | ** ** | 512,687               |             | **1,100,000** | ** ** |
| Risk pool receivables                                                                                                                                               | ** ** | 87,979                |             | **57,267** | ** ** |
| Other receivables, net of allowances of $662,000 and  $802,000 at September 30, 2004 and 2005                                                             | ** ** | 1,122,864             |             | **1,940,536** | ** ** |
| Notes receivable, current portion                                                                                                                                   | ** ** | 281,064               |             | **52,160** | ** ** |
| Prepaid expenses and other                                                                                                                                          | ** ** | 607,077               |             | **646,932** | ** ** |
| Deferred income taxes, net                                                                                                                                          | ** ** | 1,605,478             |             | **1,904,137** | ** ** |
| Total current assets                                                                                                                                                | ** ** | 24,547,903            |             | **22,650,336** | ** ** |
| Property, improvements  and equipment:                                                                                                                              | ** ** |                  |             | ** ** | ** ** |
| Land                                                                                                                                                                | ** ** | 40,620                |             | **40,620** | ** ** |
| Leasehold improvements                                                                                                                                              | ** ** | 714,619               |             | **726,973** | ** ** |
| Equipment                                                                                                                                                           | ** ** | 3,291,307             |             | **3,342,385** | ** ** |
| Furniture and fixtures                                                                                                                                              | ** ** | 536,869               |             | **546,523** | ** ** |
|                                                                                                                                                                | ** ** | 4,583,415             |             | **4,656,501** | ** ** |
| Less accumulated depreciation and amortization                                                                                                                      | ** ** | (2,977,411            | )                | **(3,454,282** | **)** |
| Property, improvements and equipment, net                                                                                                                           | ** ** | 1,606,004             |             | **1,202,219** | ** ** |
| Notes receivable, less current portion                                                                                                                              | ** ** | 617,545               |             | **572,979** | ** ** |
| Deposits                                                                                                                                                            | ** ** | 102,958               |             | **583,226** | ** ** |
| Goodwill                                                                                                                                                            | ** ** | 31,461,303            |             | **31,404,328** | ** ** |
| Other intangible assets, net                                                                                                                                        | ** ** | 1,952,291             |             | **1,317,614** | ** ** |
| Total assets                                                                                                                                                        | ** ** | $                     | 60,288,004  |   | **$** | **57,730,702**** ** | ** ** |
| **Liabilities  and shareholders’ equity**                                                                                                                      |       |                  |             | ** ** | ** ** |
| Current liabilities:                                                                                                                                                |       |                  |             | ** ** | ** ** |
| Accrued medical claims and other health care costs  payable                                                                                                         | ** ** | $                     | 13,323,622  |   | **$** | **11,532,328**** ** | ** ** |
| Accounts payable and other accrued liabilities                                                                                                                      | ** ** | 7,523,808             |             | **9,799,968** | ** ** |
| Current maturities of long-term debt and  capital leases                                                                                                            | ** ** | 6,841,887             |             | **2,000,000** | ** ** |
| Total current liabilities                                                                                                                                           | ** ** | 27,689,317            |             | **23,332,296** | ** ** |
| Long-term debt and capital leases, less current  maturities                                                                                                         | ** ** | 8,166,667             |             | **6,166,667** | ** ** |
| Deferred income taxes                                                                                                                                               | ** ** | 796,427               |             | **1,045,696** | ** ** |
| Other long-term liabilities                                                                                                                                         | ** ** | 685,000               |             | **185,000** | ** ** |
| Total liabilities                                                                                                                                                   | ** ** | 37,337,411            |             | **30,729,659** | ** ** |
| Minority interest                                                                                                                                                   | ** ** | 63,653                |             | **65,405** | ** ** |
| Shareholders’  equity:                                                                                                                                         | ** ** |                  |             | ** ** | ** ** |
| Preferred stock, $.01 par value, 5,000,000 shares  authorized, 2,265,237 issued and outstanding at September 30, 2004                                          | ** ** | 22,652                |             | **—** | ** ** |
| Common stock, Class A, $.01 par value,  38,000,000 shares authorized, 4,344,525 and 6,640,362 issued and  outstanding at September 30, 2004 and 2005 | ** ** | 43,445                |             | **66,403** | ** ** |
| Common stock, Class B, $.01 par value, 2,000,000  shares authorized, none issued                                                                               | ** ** | —                |             | **—** | ** ** |
| Additional paid-in capital                                                                                                                                          | ** ** | 18,630,525            |             | **18,373,487** | ** ** |
| Deferred compensation                                                                                                                                               | ** ** | (232,871              | )                | **—** | ** ** |
| Retained earnings                                                                                                                                                   | ** ** | 4,423,189             |             | **8,495,748** | ** ** |
|                                                                                                                                                                | ** ** | 22,886,940            |             | **26,935,638** | ** ** |
| Total liabilities  and shareholders’ equity                                                                                                                    | ** ** | $                     | 60,288,004  |   | **$** | **57,730,702**** ** | ** ** |

 

See accompanying notes.

F-3

----

**Prospect Medical Holdings, Inc.Consolidated Statements ofIncome**

| ** **                                                                | ** ** | **Year ended September 30** | ** **       |
|---------------------------------------------------------------------------|------------|--------------------------------------------|------------------|
| ** **                                                                | ** ** | **2003**                                   | ** **       | **2004** | ** ** | **2005** | ** ** |
| Revenues                                                                  |       | $                                          | 66,541,702  |   | $ | 129,516,437  | ** ** | **$** | **133,518,379**** ** | ** ** |
| Cost of revenues                                                          |       | 46,739,820                                 |             | 95,975,041 | ** ** | **96,371,197** | ** ** |
| Gross margin                                                              |       | 19,801,882                                 |             | 33,541,396 | ** ** | **37,147,182** | ** ** |
| Operating  expenses:                                                      | ** ** | ** **                                 |             |   | ** ** | ** ** | ** ** |
| General and administrative                                                |       | 18,200,250                                 |             | 24,335,510 | ** ** | **27,228,736** | ** ** |
| Depreciation and amortization                                             |       | 539,846                                    |             | 732,806 | ** ** | **948,017** | ** ** |
|                                                                      |       | 18,740,096                                 |             | 25,068,316 | ** ** | **28,176,753** | ** ** |
| Operating income  from unconsolidated joint venture                       |       | 728,549                                    |             | 206,634 | ** ** | **87,516** | ** ** |
| Operating income                                                          |       | 1,790,335                                  |             | 8,679,714 | ** ** | **9,057,945** | ** ** |
| Investment income                                                         |       | 59,038                                     |             | 75,717 | ** ** | **400,356** | ** ** |
| Interest expense                                                          |       | (195,318                                   | )                | (90,803 | ) | **(958,634** | **)** |
| Interest expense,  net                                                    |       | (136,280                                   | )                | (15,086 | ) | **(558,278** | **)** |
| Equity in losses,  and write down, of unconsolidated investment           |       | —                                     |             | — | ** ** | **(1,000,000** | **)** |
| Income before  income taxes                                               |       | 1,654,055                                  |             | 8,664,628 | ** ** | **7,499,667** | ** ** |
| Income tax  provision                                                     |       | 683,056                                    |             | 3,524,704 | ** ** | **3,415,178** | ** ** |
| Net income before  minority interest                                      |       | 970,999                                    |             | 5,139,924 | ** ** | **4,084,489** | ** ** |
| Minority interest                                                         |       | (16,357                                    | )                | (12,681 | ) | **(11,930** | **)** |
| Net income                                                                |       | $                                          | 954,642     |   | $ | 5,127,243  | ** ** | **$** | **4,072,559**** ** | ** ** |
| Net earnings per  common share* *(*Note 1*):                         | ** ** | ** **                                 |             |   |   |   |   |
| Basic:                                                                    | ** ** | ** **                                 |             |   | ** ** | ** ** | ** ** |
| Basic earnings per share                                                  |       | $                                          | 0.23        |   | $ | 1.19  | ** ** | **$** | **0.83**** ** | ** ** |
| Weighted average number of common shares outstanding                      |       | 4,157,341                                  |             | 4,321,799 | ** ** | **4,915,537** | ** ** |
| Diluted:                                                                  | ** ** | ** **                                 |             |   | ** ** | ** ** | ** ** |
| Diluted earnings per share                                                |       | $                                          | 0.22        |   | $ | 0.68  | ** ** | **$** | **0.48**** ** | ** ** |
| Weighted average  number of common and common dilutive shares outstanding |       | 4,297,823                                  |             | 7,547,140 | ** ** | **8,470,411** | ** ** |

 

See accompanying notes.

F-4

----

**Prospect Medical Holdings, Inc.Consolidated Statementsof Shareholders’ Equity**

| ** **                                     | ** ** | **Class A**       | ** ** | ** **        | ** ** | ** **            | ** ** | ** **           | ** ** | ** **                       | ** **  | ** **                 | ** ** | ** **                        | ** ** | ** ** | ** **     |
|------------------------------------------------|------------|------------------------|------------|-------------------|------------|-----------------------|------------|----------------------|------------|----------------------------------|-------------|----------------------------|------------|-----------------------------------|------------|------------|----------------|
| ** **                                     | ** ** | **Number  of  Shares** | ** ** | **Common  Stock** | ** ** | **Preferred  Shares** | ** ** | **Preferred  Stock** | ** ** | **Additional  Paid-in  Capital** | ** **  | **Deferred  Compensation** | ** ** | **Retained  Earnings  (Deficit)** | ** ** | **Total**  | ** **     |
| Balance at September 30, 2002             |       | 4,138,728              |       |              | $          | 41,387                |       |                 | —     |                             |        | —                     |       |                              | $          | 7,954,418  |           |   | $ | (436,154 | ) |   | $ | (1,658,696 | ) | $ | 5,900,955 |   |
| Issuance of Class A common stock          |       | 25,000                 |       |              | 250        |                  |       | —               |       |                             | —      |                       |       | 76,500                            |       |       | —         |   |   | — |   | 76,750 |   |
| Dissolution of fractional shares               |       | (23                    | )          |              | —     |                  |       | —               |       |                             | —      |                       |       | —                            |       |       | —         |   |   | — |   | — |   |
| Change in deferred compensation                |       | —                 |       |              | —     |                  |       | —               |       |                             | —      |                       |       | 123,060                           |       |       | 86,632         |   |   | — |   | 209,692 |   |
| Net income                                     |       | —                 |       |              | —     |                  |       | —               |       |                             | —      |                       |       | —                            |       |       | —         |   |   | 954,642 |   | 954,642 |   |
| Balance at September 30, 2003             |       | 4,163,705              |       |              | 41,637     |                  |       | —               |       |                             | —      |                       |       | 8,153,978                         |       |       | (349,522       | ) |   | (704,054 | ) | 7,142,039 |   |
| Issuance of Class A common stock          |       | 150,820                |       |              | 1,508      |                  |       | —               |       |                             | —      |                       |       | 378,002                           |       |       | —         |   |   | — |   | 379,510 |   |
| Issuance of Preferred Shares                   |       | —                 |       |              | —     |                  |       | 2,265,237            |       |                             | 22,652      |                       |       | 9,997,089                         |       |       | —         |   |   | — |   | 10,019,741 |   |
| Options Exercised                              |       | 30,000                 |       |              | 300        |                  |       | —               |       |                             | —      |                       |       | 64,571                            |       |       | —         |   |   | — |   | 64,871 |   |
| Change in deferred compensation                |       | —                 |       |              | —     |                  |       | —               |       |                             | —      |                       |       | 36,885                            |       |       | 116,651        |   |   | — |   | 153,536 |   |
| Net income                                     |       | —                 |       |              | —     |                  |       | —               |       |                             | —      |                       |       | —                            |       |       | —         |   |   | 5,127,243 |   | 5,127,243 |   |
| Balance at September 30, 2004             |       | 4,344,525              |       |              | 43,445     |                  |       | 2,265,237            |       |                             | 22,652      |                       |       | 18,630,525                        |       |       | (232,871       | ) |   | 4,423,189 |   | 22,886,940 |   |
| Issuance of Class A common stock          |       | **30,622**             | ** ** | ** **        | **306**    | ** **            | ** ** | **—**           | ** ** | ** **                       | **—**  | ** **                 | ** ** | **183,932**                       | ** ** | ** ** | **—**     | ** ** | ** ** | **—** | ** ** | **184,738** | ** ** |
| Conversion of preferred shares to common stock |       | **2,265,215**          | ** ** | ** **        | **22,652** | ** **            | ** ** | **(2,265,215**       | **)**      | ** **                       | **(22,652** | **)**                      | ** ** | **—**                        | ** ** | ** ** | **—**     | ** ** | ** ** | **—** | ** ** | **—** | ** ** |
| Refund of fractional shares                    |       | **—**             | ** ** | ** **        | **—** | ** **            | ** ** | **(22**              | **)**      | ** **                       | **—**  | ** **                 | ** ** | **(50**                           | **)**      | ** ** | **—**     | ** ** | ** ** | **—** | ** ** | **(50** | **)** |
| Additional costs related to private placement  |       | **—**             | ** ** | ** **        | **—** | ** **            | ** ** | **—**           | ** ** | ** **                       | **—**  | ** **                 | ** ** | **(440,920**                      | **)**      | ** ** | **—**     | ** ** | ** ** | **—** | ** ** | **(440,920** | **)** |
| Change in deferred compensation                |       | **—**             | ** ** | ** **        | **—** | ** **            | ** ** | **—**           | ** ** | ** **                       | **—**  | ** **                 | ** ** | **—**                        | ** ** | ** ** | **232,871**    | ** ** | ** ** | **—** | ** ** | **232,871** | ** ** |
| Net income                                     |       | **—**             | ** ** | ** **        | **—** | ** **            | ** ** | **—**           | ** ** | ** **                       | **—**  | ** **                 | ** ** | **—**                        | ** ** | ** ** | **—**     | ** ** | ** ** | **4,072,559** | ** ** | **4,072,559** | ** ** |
| Balance at  September 30, 2005            |       | **6,640,362**          | ** ** | ** **        | **$**      | **66,403**            | ** ** | ** **           | **—** | ** **                       | ** **  | **$**                      | **—** | ** **                        | ** ** | **$**      | **18,373,487** | ** ** | ** ** | **$** | **—** | ** ** | ** ** | **$** | **8,495,748** | ** ** | **$** | **26,935,638** |   |
|                                                |            |                        |            |                   |            |                       |            |                      |            |                                  |             |                            |            |                                   |            |            |                |  |  |  |  |  |  |  |  |  |  |  |  |

 

See accompanying notes.

F-5

 

----

**Prospect Medical Holdings, Inc.Consolidated Statementsof Cash Flows**

| ** **                                                                                   | ** ** | **Year ended September 30** | ** ** |
|----------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                   | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| **Operating activities**                                                                     |       |                                       |       |   |   | ** ** | ** ** |
| Net income                                                                                   |       | $                                          | 954,642    |   | $ | 5,127,243 | ** ** | **$** | **4,072,559** | ** ** |
| Adjustments to  reconcile net income to net cash provided by (used in) operating activities: |       |                                       |       |   | ** ** | ** ** | ** ** |
| Depreciation and  amortization                                                               |       | 539,846                                    |       | 732,806 | ** ** | **948,017** | ** ** |
| Equity in losses,  and write down, of unconsolidated investment                              |       |                                       |       |   | ** ** | **1,000,000** | ** ** |
| Provision for bad  debts                                                                     |       | 18,931                                     |       | 214,757 | ** ** | **141,008** | ** ** |
| Loss on disposal  of assets                                                                  |       | —                                     |       | 13,589 | ** ** | **190,241** | ** ** |
| Deferred income  taxes, net                                                                  |       | (673,559                                   | )          | (385,617 | ) | **(49,390** | **)** |
| Change in deferred  compensation                                                             |       | 86,632                                     |       | 116,651 | ** ** | **232,871** | ** ** |
| Compensatory  common stock issuance                                                     |       | 199,810                                    |       | 316,395 |   | **—** | ** ** |
| Changes in assets  and liabilities:                                                          |       |                                       |       |   | ** ** | ** ** | ** ** |
| Risk pool  receivables                                                                       |       | 117,429                                    |       | 1,098,132 | ** ** | **30,713** | ** ** |
| Other receivables                                                                            |       | 1,576,399                                  |       | (147,498 | ) | **(957,130** | **)** |
| Inventory                                                                                    |       | —                                     |       | 5,399 |   | **—** | ** ** |
| Prepaid expenses  and other                                                                  |       | 42,420                                     |       | (424,240 | ) | **(555,373** | **)** |
| Recoverable income  taxes                                                                    |       | 21,200                                     |       | — |   | **—** | ** ** |
| Deposits                                                                                     |       | (3,522                                     | )          | (12,828 | ) | **35,251** | ** ** |
| Accrued medical  claims and other health care costs payable                                  |       | (1,408,543                                 | )          | (1,579,942 | ) | **(1,791,294** | **)** |
| Accounts payable  and other accrued liabilities                                              |       | 988,658                                    |       | (5,314,932 | ) | **1,776,161** | ** ** |
| Net cash provided  by (used in) operating activities                                         |       | 2,460,343                                  |       | (240,085 | ) | **5,073,634** | ** ** |
| **Investing  activities**                                                                    | ** ** | ** **                                 |       |   | ** ** | ** ** | ** ** |
| Purchase of  property, improvements and equipment                                            |       | (439,853                                   | )          | (767,299 | ) | **(282,945** | **)** |
| Proceeds from note  receivable                                                               |       | —                                     |       | 169,637 | ** ** | **273,469** | ** ** |
| Cash paid for  acquisitions, net of cash received                                            |       | (1,032,869                                 | )          | (3,318,171 | ) | **—** | ** ** |
| Increase in  restricted certificates of deposit                                              |       | (259,871                                   | )          | (252,816 | ) | **(587,313** | **)** |
| Capitalized  expenses related to acquisitions                                                |       | (247,254                                   | )          | (305,685 | ) | **238,573** | ** ** |
| Investment in unconsolidated  entity                                                         | ** ** | **—**                                 | ** ** | **—** | ** ** | **(1,000,000** | **)** |
| Other investing  activities                                                                  | ** ** | **—**                                 | ** ** | **—** | ** ** | **1,753** | ** ** |
| Net cash used in  investing activities                                                       |       | (1,979,847                                 | )          | (4,474,334 | ) | **(1,356,463** | **)** |
| **Financing  activities**                                                                    | ** ** | ** **                                 |       |   | ** ** | ** ** | ** ** |
| Proceeds from sale  of medical clinics                                                       | ** ** | **—**                                 |       | 300,000 | ** ** | **—** | ** ** |
| Repayment of note  payable to shareholder                                                    | ** ** | **—**                                 |       | (500,000 | ) | **—** | ** ** |
| Proceeds from  issuance of note payable                                                      | ** ** | **—**                                 |       | 10,000,000 | ** ** | **—** | ** ** |
| Cash paid for  deferred financing costs                                                      |       | (50,000                                    | )          | (254,424 | ) | **—** | ** ** |
| Net proceeds  (repayments)—lines of credit                                              |       | 2,800,000                                  |       | 1,200,000 | ** ** | **(5,000,000** | **)** |
| Reduction of note  payable to bank and capital leases                                        |       | (1,285,495                                 | )          | (2,401,923 | ) | **(1,841,888** | **)** |
| Proceeds  (expenses) from Issuance of common and preferred stock                             | ** ** | **—**                                 |       | 10,184,613 | ** ** | **(256,733** | **)** |
| Other financing  activities, net                                                             |       | 6,088                                      |       | — | ** ** | **—** | ** ** |
| Net cash provided  by (used in) financing activities                                         |       | 1,470,593                                  |       | 18,528,266 | ** ** | **(7,098,621** | **)** |
| Increase  (decrease) in cash and cash equivalents                                            |       | 1,951,089                                  |       | 13,813,847 | ** ** | **(3,381,450** | **)** |
| Cash and cash  equivalents at beginning of year                                              |       | 4,565,818                                  |       | 6,516,907 | ** ** | **20,330,754** | ** ** |
| Cash and cash  equivalents at end of year                                                    |       | $                                          | 6,516,907  |   | $ | 20,330,754 | ** ** | **$** | **16,949,304** | ** ** |
| **Supplemental  disclosure of cash flow information**                                        |       |                                       |       |   | ** ** | ** ** | ** ** |
| Details of  businesses acquired:                                                             |       |                                       |       |   | ** ** | ** ** | ** ** |
| Fair value of  assets acquired                                                               |       | $                                          | 12,929,583 |   | $ | 19,161,171 | ** ** | **$** | **—** | ** ** |
| Liabilities  assumed or created                                                              |       | (5,879,583                                 | )          | (8,661,171 | ) | **—** | ** ** |
| Less cash acquired                                                                           |       | (6,017,131                                 | )          | (7,181,829 | ) | **—** | ** ** |
| Net cash paid for  acquisition                                                               |       | $                                          | 1,032,869  |   | $ | 3,318,171 | ** ** | **—** | ** ** |
| Common stock issued in  exchange for services rendered                                       |       | $                                          | 76,750     |   | $ | 279,510 | ** ** | **$** | **—** | ** ** |

 

See accompanying notes.

F-6

----

**PROSPECT MEDICAL HOLDINGS, INC.NOTES TO CONSOLIDATEDFINANCIAL STATEMENTSSeptember 30, 2005**

**1.   Operations andSignificant Accounting Policies**

**Business and Basis of Presentation**

Prospect Medical Holdings, Inc. (Prospect or theCompany) is a Delaware corporation. The Company is a health care managementservices organization that develops integrated delivery systems, and providesmedical management systems and services to affiliated medical organizations.The affiliated medical organizations employ and/or contract with physicians andprofessional medical corporations, and contract with managed care payors.

Prospect currentlymanages the provision of prepaid health care services for its affiliatedmedical organizations in Southern California. The Network consists of thefollowing medical organizations as of September 30, 2005 (each, an “Affiliate”):

Prospect Medical Group, Inc. (PMG)Sierra Primary Care Medical Group, a Medical Corporation (SPCMG)Santa Ana-Tustin Physicians Group, Inc. (SATPG)Pegasus Medical Group, Inc. (PEG)Antelope Valley Medical Associates, Inc. (AVM)Prospect Health Source Medical Group, Inc. (PHS)Prospect Professional Care Medical Group, Inc. (PPM)Prospect Northwest Medical Group, Inc. (PNW)Starcare Medical Group, Inc. (PSC)APAC Medical Group, Inc. (APA)Nuestra Famila Medical Group, Inc. (Nuestra)AMVI/Prospect Health Joint Venture (AMVI/Prospect)

All of these entities are wholly-owned by PMG,with the exception of Nuestra, which is 55% owned by PMG and AMVI/Prospectwhich is a 50/50 Joint Venture between AMVI and PMG. PMG is owned by a nomineephysician shareholder who is also an employee, member of management and ashareholder of Prospect. The results of all of these entities, with theexception of AMVI/Prospect, are consolidated in the accompanying financialstatements.

The Joint Venture was formed for the sole purpose ofcombining enrollment in order to meet minimum enrollment levels required forparticipation in the CalOPTIMA Medicaid (“Medi-Cal in California) program inOrange County, California. The joint venture ownership is set at 50/50 toprevent either party from exerting control over the other; however, AMVI andProspect’s businesses are operated autonomously, and enrollees, financialresults and cash flows are each separately tracked and recorded. In accordancewith the joint venture partnership agreement, profits and losses are not splitin accordance with the partnership ownership interest, but rather, are directlytied to the results generated by each separate portion of the business. Separatefrom any earnings we generate from our portion of business within the jointventure, we also earn fees for management services we provide to our partner inthe other joint venture. We account for our interest in the joint venture partnershipusing the equity method of accounting. We include in our financial statementsonly the net results attributable to those Medicaid enrollees specificallyidentified as assigned to us, together with the management fee that we chargefor managing those Medicaid enrollees specifically assigned to the other jointventure partner. Note 11 contains summarized unaudited financial informationfor the joint venture.

F-7

----

Prospect Medical Systems, one of the Company’smanagement company subsidiaries (PMS), has entered into an assignable optionagreement with PMG and the nominee physician shareholder of PMG. Under theassignable option agreement, Prospect acquired an assignable option for anominal amount from PMG and the nominee shareholder to purchase all or part ofPMG’s assets (the Asset Option) and the right to designate the purchaser(successor physician) for all or part of PMG’s issued and outstanding stockheld by the nominee physician shareholder (the Stock Option) in its solediscretion. The Company may also assign the assignable option agreement to anyperson. The assignable option agreement has an initial term of 30 yearsand is automatically extended for additional terms of 10 years each, aslong as the term of the related management services agreement described below(the Management Agreement) is automatically extended. Upon termination of theManagement Agreement with PMG, the related Asset Option and Stock Option areautomatically and immediately exercised. The Asset and Stock Options may beexercised separately or simultaneously for a purchase price of $1,000 each.Under these nominee shareholder agreements, Prospect has the unilateral rightto establish or effect a change of the nominee, at will, and without theconsent of the nominee, on an unlimited basis and at nominal cost throughoutthe term of the Management Agreement. In addition to the Management Agreementwith PMG, Prospect, through one of its management company subsidiaries, has amanagement agreement with each Affiliate. The term of the Management Agreementsis generally 30 years. Prospect has an employment agreement with thecurrent nominee shareholder of PMG in his capacity as the Chief ExecutiveOfficer of the Company. The employment agreement, currently in the process ofrenewal, was for an initial term of three years and could not be terminatedwithout cause, provided for a base compensation and certain customary benefits.Since the agreement is only for the employment of the nominee shareholder asthe President of Prospect and not in his capacity as the nominee shareholder ofPMG, the agreement does not affect Prospect’s ability to change the nomineeshareholder at will. PMG is the nominee shareholder of SPCMG, SATPG, PEG, AVM,PHS, PPM, PNW, PSC, APA and Nuestra (as to a 55% interest).

The Company’sAffiliates have each entered into a Management Agreement whereby the Affiliatehas agreed to pay a management fee to PMS or Sierra Medical Management, Inc.(SMM), as applicable (each of which is a wholly owned subsidiary of Prospect).The fee is based in part on the costs to the management company and on apercentage of revenues the Affiliate receives (i) for the performance ofmedical services by the Affiliate’s employees and independent contractorphysicians and physician extenders, (ii) for all other services performedby the Affiliates, and (iii) as proceeds from the sale of assets or themerger or other business combination of the Affiliate. The management fee alsoincludes a fixed fee for marketing and public relations services. The revenuefrom which this fee is determined includes medical capitation, all sums earnedfrom participation in any risk pools and all fee-for-service revenue earned.Except in the case of Nuestra and AMVI/Prospect, the Management Agreements haveinitial terms of 30 years, renewable for successive 10-year periodsthereafter, unless terminated by either party for cause. In the case ofNuestra, its Management Agreement has an initial 10 year term renewablefor successive 1 year terms. In the case of AMVI/Prospect, its ManagementAgreement has a 1 year term with successive 1 year renewal terms. Inreturn for payment of the management fee, Prospect has agreed to providefinancial management, information systems, marketing, advertising, publicrelations, risk management, and administrative support for utilization reviewand quality of care. The Company has exclusive decision-making authoritywith respect to the establishment and preparation of operating and capitalbudgets, and the establishment of policies and procedures for the Affiliates,and makes recommendations for the development of guidelines for selection andhiring of health care professionals, compensation payable to such personnel,scope of services to be provided, patient acceptance policies, pricing of services,and contract negotiation and execution. At its cost, Prospect has assumed theobligations for all facilities, medical and non-medical supplies, andemployment of non-physician personnel of its affiliated medical clinics. Allremaining funds are remitted to the Affiliate, from which the Affiliate paysfor the cost of all medical services. The management fee earned by Prospectfluctuates based on the profitability of each wholly-owned Affiliate.With the exception of PHS, Prospect is allocated a 50% residual interest in the

F-8

----

profits above 8% of theprofits or a 50% residual interest in the losses of the Affiliate, afterdeduction for costs to the management company and physician compensation.Prospect is allocated a 40% residual interest in the profits or losses of PHS.The remaining balance is retained by the Affiliate.

The Management Agreements are not terminable by theAffiliates except in the case of gross negligence, fraud or other illegal actsof Prospect, or bankruptcy of the Company. Through the Management Agreementsand the Company’s relationship with the nominee shareholder of each Affiliate,Prospect has exclusive authority over all decision-making related to theongoing major or central operations of the physician practices. The Company,however, does not engage in the practice of medicine.

Further, Prospect’s rights under the ManagementAgreements are unilaterally salable or transferable. Based on the provisions ofthe Management Agreements and the assignable option agreement with PMG,Prospect has determined that it has a controlling financial interest in theAffiliates. Consequently, under applicable accounting principles, Prospectconsolidates the revenues and expenses of all the Affiliates exceptAMVI/Prospect from the respective dates of execution of the ManagementAgreements. All significant inter-entity balances have been eliminated inconsolidation. In the case of AMVI/Prospect, only that portion of the resultswhich are contractually identified as Prospect’s are recognized in the financialstatements, together with the management fee that the Company charges AMVI formanaging AMVI’s share of the Joint Venture operations.

The Company consolidates all controlled subsidiaries,which control is effectuated through ownership of voting common stock or byother means. The subsidiaries which have been consolidated using EITF 97-2would also be consolidated under the provisions of FIN 46. The underlyingentities (subsidiaries) have been determined to be variable interest entitiesdue to the existence of a call option under which the Company has the abilityto require the holders of all of the voting common stock of the underlyingsubsidiaries to sell their shares at a fixed nominal price ($1,000) to anotherdesignated physician chosen by the Company. This call option agreementrepresents rights provided through a variable interest other than the equityinterest itself that caps the returns that could be earned by the equityholders. In addition, the Company has a management agreement with the subsidiariesand the holders of the voting common stock of the subsidiaries which allows theCompany to direct all of the activities of the subsidiaries, retain all of theeconomic benefits and assume all of the risks associated with ownership of thesubsidiaries. In this manner, the Company has all of the economic benefits andrisks associated with the subsidiaries, but has disproportionately few votingrights (based on the terms of the equity). Substantially all of the activitiesof the subsidiaries are conducted on behalf of the Company and as such, thesubsidiaries are variable interest entities due to the fact that they violatethe anti-abuse clause provisions in FIN 46. As the Company retains all of theeconomic benefits and assumes all of the risks associated with ownership of thesubsidiaries, the Company is considered to be the primary beneficiary of theactivities of the subsidiaries. As a result, the Company must consolidate theunderlying subsidiaries under FIN 46. All significant intercompany transactionshave been eliminated in consolidation.

As of September 30,Prospect managed health care services to the following number of enrolleesunder contracts with various health plans:

| ** ** | ** ** | **Commercial** | ** **  | **Senior** | ** ** | **MediCal** | ** ** |
|------------|------------|----------------|-------------|------------|------------|-------------|------------|
| 2003       |       |           | 136,200     |       |       | 11,200      |       |   | 13,700 |   |   |
| 2004       |       |           | 168,500     |       |       | 15,500      |       |   | 14,400 |   |   |
| **2005**   | ** ** | ** **     | **144,900** | ** ** | ** ** | **12,500**  | ** ** | ** ** | **14,500** | ** ** | ** ** |

 

**Related Party Transactions**

The Company has an employment agreement with our ChiefExecutive Officer, Jacob Y. Terner, which was for an initial three-year termending on August 1, 2005. The agreement, currently in the process ofrenewal, provides for a specified annual compensation and in the event that theCompany terminates 

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Dr. Terner’semployment without cause, the Company will be required to pay him $12,500 foreach month of past service as the Chief Executive Officer, commencing as of July 31,1996. The contingent termination obligation was capped at $1,237,500, effectiveSeptember 30, 2004. Since the Company has not indicated any intention toterminate Dr. Terner, no such potential liability is accrued as of September 30,2005.

Prospect Medical Group, Inc. (PMG), which iswholly owned by Dr. Terner, and whose accounts are consolidated in thesefinancial statements under EITF 97-2, maintains an intercompany accountreceivable due from Prospect Medical Holdings, Inc. The intercompanyreceivable was created in connection with previous acquisitions. In the eventthat PMG is required by the HMO’s or regulatory agencies to maintain a positivetangible net equity and positive working capital, Dr. Terner hadpreviously agreed to personally guarantee the intercompany account receivabledue from Prospect Medical Holdings, Inc. up to a level sufficient toenable PMG to attain positive tangible net equity and working capital.

On June 1, 2003, in consideration for Dr. Terner’spersonal guarantee and pledge, the Compensation Committee of the Board ofDirectors granted to Dr. Terner a six-year, non-qualified stock option topurchase 800,000 shares of common stock at $3.00 per share. During it’s term, Dr. Terner’spersonal guarantee was supported through the pledge of certain of his personalassets. Dr. Terner agreed to maintain his personal guarantee andcollateral in effect until PMG had positive tangible net equity. This personalguarantee arrangement was terminated by the Board of directors effective January 19,2005.

See Notes 3 and 7regarding stock transactions.

**MedicalRevenues and Cost Recognition**

Revenuesare comprised of the following amounts:

| ** **      | ** ** | **Year Ended September 30** | ** **       |
|-----------------|------------|--------------------------------------------|------------------|
| ** **      | ** ** | **2003**                                   | ** **       | **2004** | ** ** | **2005** | ** ** |
| Capitation      |       | $                                          | 63,512,597  |   | $ | 125,860,567  |   | **$** | **129,143,656**** ** |   |
| Fee for service |       | 2,084,132                                  |             | 2,546,444 |   | **2,232,059** |   |
| Management fees |       | 793,667                                    |             | 841,152 |   | **806,788** |   |
| Other           |       | 151,306                                    |             | 268,274 |   | **1,335,876** |   |
| Total revenues  |       | $                                          | 66,541,702  |   | $ | 129,516,437  |   | **$** | **133,518,379**** ** |   |

 

Operatingrevenue of the Company consists primarily of fees for medical services providedby the Affiliates under capitated contracts with various managed care providersincluding health maintenance organizations (HMOs) or under fee-for-servicearrangements. Capitation revenue under HMO contracts is prepaid monthly to theAffiliates based on the number of enrollees electing any one of the Affiliatesas their health care provider. HMO contracts also include provisions to sharein the risk for hospitalization whereby the Affiliate can earn additionalincentive revenue or incur penalties based upon the utilization of hospitalservices. Except for two contracts, representing a small percentage of theCompany’s enrollees, where the Company is contractually obligated for downsiderisk, any shared risk deficits are not payable until and unless the Companygenerates future risk sharing surpluses, or if the HMO withholds a portion ofthe capitation revenue to fund any risk share deficits. At the termination ofthe HMO contract, any accumulated risk share deficit is extinguished. Estimatedshared-risk amounts receivable from the HMOs are recorded based upon estimatedhospital utilization and estimated associated costs incurred by assigned HMOenrollees, compared to budgeted costs. Differences between actual contractsettlements and estimated receivables relating to HMO risk-sharing arrangementsare recorded in the year of final settlement.

See****“Concentrationsof Credit Risks” below for details of significant portion of revenue receivedfrom four HMOs.

F-10

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Fiscal 2003, 2004 and 2005, net patient servicerevenues include approximately, $76,000, $555,000 and $1,007,000 respectively,of additional revenues due to favorable settlements on prior year risk-sharingarrangements.

Capitation revenue under HMO contracts is recognizedin the month in which the Affiliates are obligated to provide services. Minorongoing adjustments to prior months’ capitation, primarily arising fromcontracted HMOs’ finalizing of monthly patient eligibility data for additionsor subtractions of enrollees, are recognized in the month they are communicatedto the Company. Additionally, in 2005, Medicare is at the mid-point of a fouryear phase-in to a new “Risk Adjusted” methodology of paying capitation relatedto eligible senior enrollees. Under Risk Adjustment, additional capitation ispaid for seniors with conditions requiring more healthcare services. Periodicchanges in capitation amounts earned as a result of Risk Adjustment arerecognized in the year to which they relate, once those changes have beencommunicated to the Company. We received and recorded as revenue approximately$4 million in the fourth quarter of fiscal 2005 from HMOs for riskadjustment factors. Since this revenue could not previously be estimated by us,we recorded it upon receipt from the HMOs.

Fee-for-service revenues are recognized when theservices have been performed. Management fee revenue is earned in the month theservices have been delivered. Fee for service revenues are recorded net ofallowances to reduce billed amounts to estimated contractually entitledamounts. All receivables are recorded net of an allowance for bad debts.Uncollectible amounts are written off when collection efforts have ceased, oramounts have been turned over to an outside collection agency.

Management fee arrangements provide for compensationranging from 8.5% of revenues to 15% of revenues. The Company also providesmanagement services to affiliated providers whose results are consolidated inthe Company’s financial statements under management fee arrangements based oncost, a fixed marketing fee, a percentage of revenues and a percentage of netincome or loss. Revenues and expenses relating to these inter-entityagreements have been eliminated in consolidation.

We present segment information externally the same waymanagement uses financial data internally to make operating decisions andassess performance. Because we manage health care services that are contractedfor as part of bundled managed care products to members of all ages, we haveone reportable operating segment.

In connection with providing services to HMOenrollees, the Affiliates are responsible for the medical services theiraffiliated physicians provide to assigned HMO enrollees. The cost of healthservices is recognized in the period in which it is provided and includes anestimate of the cost of services which have been incurred but not yet reported.The estimate for accrued medical costs is based on projections of costs usinghistorical studies of claims paid and adjusted for seasonality, and utilizationtrends. These estimates are subject to trends in loss severity and frequency.Although considerable variability is inherent in such estimates, managementrecords its best estimate of the amount of medical claims incurred at eachreporting period. Estimates are continually monitored and reviewed and, assettlements are made or estimates adjusted, differences are reflected incurrent operations.

We also regularly evaluatethe need to establish premium deficiency reserves for the probability thatanticipated future health care costs could exceed future capitation paymentsfrom HMOs. To date, we have determined that no premium deficiency reserves havebeen necessary.

**Property,Improvements and Equipment**

Property, improvements andequipment are stated on the basis of cost. Depreciation of equipment isprovided using the straight-line method over the estimated useful lives of theassets, and amortization of leasehold improvements is provided using thestraight-line basis over the shorter of the lease period or the estimateduseful lives of the leasehold improvements. Leasehold improvements aredepreciated over 

F-11

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five years,equipment is depreciated over three to five years and furniture and fixtures isdepreciated over five to seven years. Capitalized lease obligations areamortized over the life of the lease. Amortization for capitalized assets underlease agreements is included in depreciation expense.

**Goodwilland Other Intangible Assets**

Goodwill and related intangible assets totaling$37,278,016 and $37,039,444 at September 30, 2004 and 2005, respectively(see tables below under this heading), arose primarily as the result of theacquisitions of Santa Ana-Tustin Physicians Group, Inc., Sierra Primary CareMedical Group, Inc, AV Western Medical Group, Inc., Antelope ValleyMedical Group, Inc., Prospect Health Source Medical Group, Inc.,Prospect Professional Care Medical Group, Inc, Prospect NWOC Medical Group, Inc.,Pinnacle Health Resources, Starcare Medical Group, Inc. and APAC MedicalGroup (collectively called Gateway). Related intangible assets consist of thefair value of acquired HMO contracts, covenants not-to-compete and enrolleemembership.

Goodwill represents the excess of the consideration paidand liabilities assumed over the fair value of the assets acquired, includingidentifiable intangible assets. In conjunction with these acquisitions,management of the Company has reviewed the allocation of the excess of costs(including costs incurred related to the acquisitions) over net assetsacquired, and has determined, to date, that these costs (goodwill) areallocable primarily to the operating platforms acquired which allowed theCompany to expand its geographical territory through the addition of theexisting renewable HMO contracts included in the acquisitions. These HMOcontracts have historically been renewed each year with the acquired physicianorganizations and the HMOs are currently not offering additional contracts tosimilarly situated physician organizations in the same territories. Suchacquisitions are discussed further in Note 2 below.

Goodwill and related intangible assets have beenrecorded at cost and were, through September 30, 2001, being amortized onthe straight-line method over an average life of 20 years. Relatedidentifiable intangible assets, consisting of $2,120,000 ascribed to enrolledmember accounts that were being amortized over 48 months, had been fullyamortized as of September 30, 2001.

Effective October 1, 2001, the Company adoptedStatement of Financial Accounting Standards (SFAS) No. 142, “Goodwill andOther Intangible Assets.” Upon adoption, goodwill and other intangible assetswith indefinite useful lives are no longer amortized; rather they are reviewedannually for impairment or more frequently if impairment indicators arise.Impairment is the condition that exists when the carrying amount of goodwillexceeds its implied fair value. A two-step impairment test is used to identifypotential goodwill impairment and to measure the amount of goodwill impairmentloss to be recognized (if any).

In accordance with SFAS No. 142, the Company hasdetermined that the affiliated physician organizations comprise a singleoperating segment, with each affiliated physician organization a component ofthe operating segment. While each affiliated physician organization earnsrevenues, incurs expenses and produces discrete financial information(including balance sheets and statements of operations), the affiliatedphysician organizations are similarly organized and operated to provide managedhealth care services. They share similar characteristics in the enrollees theyserve, the nature of services provided and the method by which medical care isrendered. The affiliated physician organizations are centrally managed, sharingassets and resources, including executive management, payor and providercontracting, claims and utilization management, information technology, legal,financial accounting, risk management and human resource support. Theaffiliated physician organizations are also subject to similar regulatoryenvironments and long-term economic prospects. They form an integrated medicalnetwork that support and benefit from each other in delivering care to theCompany’s patient base. Since goodwill is recoverable from these affiliatedphysician organizations working in concert, the groups have been aggregatedinto a single reporting unit for the purpose of goodwill impairment testing inaccordance with 

F-12

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SFAS No. 142.Similarly, the Company has also determined that the affiliated physicianorganizations represent a single operating segment for financial reportingunder SFAS No. 131, “Disclosures about Segments of an Enterprise andRelated Information,” since the Company presents segment information externallythe same way management uses financial data internally to make operatingdecisions, allocate resources and assess performance.

The Company tests for goodwill impairment in thefourth quarter of each year, or sooner if events or changes in circumstancesindicate that the carrying amount may exceed the fair value. In evaluatingwhether indicators of impairment exist, we consider adverse changes in marketvalue and/or stock price, laws and regulations, profitability, cash flows, ourability to maintain enrollment and renew payor contracts at favorable terms.The goodwill impairment test is a two-step process. The first step consists ofestimating the fair value of the reporting unit based on a weighted combinationof (i) the guideline company method that utilizes revenue multiples forcomparable publicly-traded companies, and (ii) a discounted cash flowmodel that utilizes future cash flows, the timing of these cash flows, and adiscount rate (or weighted average cost of capital which considers the cost ofequity and cost of debt financing expected by a typical market participant)representing the time value of money and the inherent risk and uncertainty ofthe future cash flows. If the estimated fair value of the reporting unit is lessthan its carrying value, a second step is performed to compute the amount ofthe impairment by determining the “implied fair value” of the goodwill, whichis compared to its corresponding carrying value.

The annual impairment test, performed at September 30,2004 and 2005, indicated that the fair value of the Company’s net assetsexceeded the carrying value; thus goodwill was not impaired.

Asummary schedule of the Company’s acquisition costs and accumulatedamortization of goodwill related to the acquisitions at September 30, 2004and 2005 is as follows:

| ** **                                | ** ** | **Purchase  Price** | ** **       | **(Net Assets)  Liabilities  Assumed** | ** ** | **Total Purchase  Consideration in  Excess of Net  Tangible Assets  Acquired** | ** ** | **Professional  Fees and  Other  Related Costs** | ** ** | **Total**        | ** ** |
|-------------------------------------------|------------|---------------------|------------------|---------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|------------------|------------|
| **2004**                                  |       |                |             |                                        |       |                                                                                                    |       |                                                       |       |             |       |   |   |   |   |
| Santa Ana/Tustin  Physicians Group        | ** ** | $                   | 5,000,000   |                                        | $          | (116,473                                                                                           | )          |                                                       | $          | 4,883,527   |       |   |   | $ | 197,816  |   | ** ** | $ | 5,081,343  |   |
| Sierra Medical  Group                     | ** ** | 10,200,000          |             | 717,544                                     |       |                                                                                                    | 10,917,544 |                                                       |       |             | 216,584    |   | ** ** | 11,134,128 |   |
| AV Western  Medical Group                 | ** ** | 700,000             |             | —                                      |       |                                                                                                    | 700,000    |                                                       |       |             | 53,310     |   | ** ** | 753,310 |   |
| Antelope Valley  Medical Group            | ** ** | 2,000,000           |             | —                                      |       |                                                                                                    | 2,000,000  |                                                       |       |             | 104,425    |   | ** ** | 2,104,425 |   |
| Premier                                   | ** ** | 630,000             |             | —                                      |       |                                                                                                    | 630,000    |                                                       |       |             | 68,153     |   | ** ** | 698,153 |   |
| Sherman Oaks                              | ** ** | 28,000              |             | 151,800                                     |       |                                                                                                    | 179,800    |                                                       |       |             | —     |   | ** ** | 179,800 |   |
| Prospect Health  Source Medical Group     | ** ** | 1,000,000           |             | —                                      |       |                                                                                                    | 1,000,000  |                                                       |       |             | 184,055    |   | ** ** | 1,184,055 |   |
| Prospect  Professional Care Medical Group | ** ** | 7,050,000           |             | 119,009                                     |       |                                                                                                    | 7,169,009  |                                                       |       |             | 200,419    |   | ** ** | 7,369,428 |   |
| Prospect NWOC                             | ** ** | 2,000,000           |             | (1,770,882                                  | )          |                                                                                                    | 229,118    |                                                       |       |             | 40,795     |   | ** ** | 269,913 |   |
| Gateway                                   | ** ** | 8,500,000           |             | (488,682                                    | )          |                                                                                                    | 8,011,318  |                                                       |       |             | 351,324    |   | ** ** | 8,362,642 |   |
| Other                                     | ** ** | —              |             | —                                      |       |                                                                                                    | —     |                                                       |       |             | 140,819    |   | ** ** | 140,819 |   |
|                                      | ** ** | $                   | 37,108,000  |                                        | $          | (1,387,684                                                                                         | )          |                                                       | $          | 35,720,316  |       |   |   | $ | 1,557,700  |   | ** ** | 37,278,016 |   |
| Accumulated  amortization                 | ** ** | ** **          | ** **       | ** **                                  | ** ** | ** **                                                                                              | ** ** |                                                       | ** ** | ** **       | ** ** |   | ** ** | (4,168,846 | ) |
|                                      | ** ** | ** **          | ** **       | ** **                                  | ** ** | ** **                                                                                              | ** ** |                                                       | ** ** | ** **       | ** ** |   | ** ** | $ | 33,109,170  |   |

 

F-13

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| ** **                                | ** ** | **Purchase  Price** | ** **     | **(Net Assets)  Liabilities  Assumed** | ** **      | **Total Purchase  Consideration in  Excess of Net  Tangible Assets  Acquired** | ** **     | **Professional  Fees and  Other  Related Costs** | ** ** | **Total**     | ** **  |
|-------------------------------------------|------------|---------------------|----------------|---------------------------------------------|-----------------|---------------------------------------------------------------------------------------------------------|----------------|------------------------------------------------------------|------------|---------------|-------------|
| **2005**                                  |       |                |           |                                        |            |                                                                                                    |           |                                                       |       |          |        |   |   |   |   |
| Santa Ana/Tustin  Physicians Group        | ** ** | **$**               | **5,000,000**  |                                        | **$**           | **(116,473**                                                                                            | **)**          | ** **                                                 | **$**      | **4,883,527** | ** **  | ** ** | ** ** | **$** | **197,816** | ** ** | ** ** | **$** | **5,081,343** | ** ** |
| Sierra Medical  Group                     | ** ** | **10,200,000**      |           | **717,544**                                 | ** **      | ** **                                                                                              | **10,917,544** | ** **                                                 | ** ** | ** **    | **216,584** | ** ** | ** ** | **11,134,128** | ** ** |
| AV Western  Medical Group                 | ** ** | **700,000**         |           | **—**                                  | ** **      | ** **                                                                                              | **700,000**    | ** **                                                 | ** ** | ** **    | **53,310**  | ** ** | ** ** | **753,310** | ** ** |
| Antelope Valley  Medical Group            | ** ** | **2,000,000**       |           | **—**                                  | ** **      | ** **                                                                                              | **2,000,000**  | ** **                                                 | ** ** | ** **    | **104,425** | ** ** | ** ** | **2,104,425** | ** ** |
| Premier                                   | ** ** | **630,000**         |           | **—**                                  | ** **      | ** **                                                                                              | **630,000**    | ** **                                                 | ** ** | ** **    | **68,153**  | ** ** | ** ** | **698,153** | ** ** |
| Sherman Oaks                              | ** ** | **28,000**          |           | **151,800**                                 | ** **      | ** **                                                                                              | **179,800**    | ** **                                                 | ** ** | ** **    | **—**  | ** ** | ** ** | **179,800** | ** ** |
| Prospect Health  Source Medical  Group    | ** ** | **1,000,000**       |           | **—**                                  | ** **      | ** **                                                                                              | **1,000,000**  | ** **                                                 | ** ** | ** **    | **184,055** | ** ** | ** ** | **1,184,055** | ** ** |
| Prospect  Professional Care Medical Group | ** ** | **7,050,000**       |           | **119,009**                                 | ** **      | ** **                                                                                              | **7,169,009**  | ** **                                                 | ** ** | ** **    | **200,419** | ** ** | ** ** | **7,369,428** | ** ** |
| Prospect NWOC                             | ** ** | **2,000,000**       |           | **(2,022,393**                              | **)**           | ** **                                                                                              | **(22,393**    | **)**                                                      | ** ** | ** **    | **40,795**  | ** ** | ** ** | **18,402** | ** ** |
| Gateway                                   | ** ** | **8,500,000**       |           | **(488,682**                                | **)**           | ** **                                                                                              | **8,011,318**  | ** **                                                 | ** ** | ** **    | **353,398** | ** ** | ** ** | **8,364,716** | ** ** |
| Other                                     | ** ** | **—**          |           | **—**                                  | ** **      | ** **                                                                                              | **—**     | ** **                                                 | ** ** | ** **    | **151,684** | ** ** | ** ** | **151,684** | ** ** |
|                                      | ** ** | **$**               | **37,108,000** |                                        | **$(1,639,195** | **)**                                                                                                   | ** **     | **$35,468,805**                                            | ** ** | ** **    | ** **  | **$1,570,639** | ** ** | ** ** | **37,039,444** | ** ** |
| Accumulated  amortization                 | ** ** | ** **          |           | ** **                                  | ** **      | ** **                                                                                              | ** **     | ** **                                                 | ** ** | ** **    | ** **  | ** ** | ** ** | **(4,520,451** | **)** |
|                                      | ** ** | ** **          | ** **     | ** **                                  | ** **      | ** **                                                                                              | ** **     | ** **                                                 | ** ** | ** **    | ** **  | ** ** | ** ** | **$** | **32,518,993** | ** ** |
|                                           |            |                     |                |                                             |                 |                                                                                                         |                |                                                            |            |               |             |  |  |  |  |  |  |  |  |  |

 

As part of the acquisition of Prospect ProfessionalCare Medical Group and Gateway, the Company purchased $950,000 and $710,000,respectively, of identifiable intangible assets which are included in the abovetable, which are being amortized on a straight-line basis over 24 to 54 months,or approximately $451,000 per year. As part of the acquisition of Prospect NWOCMedical Group, the Company purchased $200,000 of identifiable intangible assets(included in the above table), which has been fully amortized. Identifiableintangibles are being amortized on a straight line basis, with 30 months ofamortization remaining as of September 30, 2005.

As part of the acquisition of Gateway, the Companypaid $50,000 for a covenant not to compete (included in the above table), whichare being amortized on a straight-line basis over 2 years, or approximately$25,000 per year.

Additional intangibleassets unrelated to the acquisitions consisted of net deferred financing costswere $304,424 and $202,950 as of September 30, 2004 and 2005,respectively.

**MedicalMalpractice Liability Insurance**

Certain of the Affiliates maintain claims-made basismedical malpractice insurance coverage on employed physicians of up to$1,000,000 per incident and $3,000,000 in the aggregate on an annual basis.Claims-made coverage covers only those claims reported during the policyperiod. An estimate of losses, if any, for incurred but unreported claims isrecorded based upon historical experience.

The individual physicianswho contract with the Affiliates carry their own medical malpractice insurance.

**Earnings Per Share**

Basic earnings per share is computed by dividing netincome by the weighted average number of common shares outstanding. Dilutedearnings per share is computed by dividing net income by the weighted averagenumber of common shares outstanding, after giving effect to potentiallydilutive shares 

F-14

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computed using thetreasury stock method. Such shares are excluded if determined to beanti-dilutive. Common stock issued at below estimated fair value on theissuance date is included in weighted average number of common shares as if suchshares have been outstanding for all periods presented.

Thefollowing is a reconciliation of the numerators and denominators used in thecalculation of basic and diluted earnings per share for each period presentedin the financial statements.

| ** **                                                   | ** ** | **Year ended September 30** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                   | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Basic earnings per  common share:                            |       |                                       |       |   |   |   |   |
| Numerator—net income                                    |       | $                                          | 954,642    |   | $ | 5,127,243 | ** ** | **$** | **4,072,559** | ** ** |
| Denominator—                                            |       |                                       |       |   | ** ** | ** ** | ** ** |
| Weighted average number of common shares outstanding         |       | 4,157,341                                  |       | 4,321,799 | ** ** | **4,915,537** | ** ** |
| Basic earnings per common share                              |       | $                                          | 0.23       |   | $ | 1.19 | ** ** | **$** | **0.83** | ** ** |
| Diluted earnings per  common share:                          |       |                                       |       |   | ** ** | ** ** | ** ** |
| Numerator—net income                                    |       | $                                          | 954,642    |   | $ | 5,127,243 | ** ** | **$** | **4,072,559** | ** ** |
| Denominator—                                            |       |                                       |       |   | ** ** | ** ** | ** ** |
| Weighted average number of common shares outstanding         |       | 4,157,341                                  |       | 4,321,799 | ** ** | **4,915,537** | ** ** |
| Dilutive stock options, warrants and preferred  shares  |       | 140,482                                    |       | 3,225,341 | ** ** | **3,554,874** | ** ** |
|                                                         |       | 4,297,823                                  |       | 7,547,140 | ** ** | **8,470,411** | ** ** |
| Diluted earnings  per common share                           |       | $                                          | 0.22       |   | $ | 0.68 | ** ** | **$** | **0.48** | ** ** |

 

As more fully discussed inNote 3, effective July 27, 2005, all shares of the Company’s Series AConvertible Preferred Stock outstanding automatically converted to a likenumber of shares of Common Stock.

**Stock Options**

SFAS No. 123, “Accounting for Stock-BasedCompensation,” provides an alternative to Accounting Principles Board (APB)Opinion 25, “Accounting for Stock Issued to Employees.” SFAS No. 123encourages, but does not require, that compensation expense for grants ofstock, stock options and other equity instruments to employees be based on thefair value of such instruments. The statement also allows companies to continueto measure compensation expense using the intrinsic value method prescribed byAPB Opinion No. 25.

The Company has elected to follow APB Opinion No. 25and related interpretations in accounting for its stock options because, asdiscussed below, the alternative fair value accounting provided for under SFAS No. 123requires use of option valuation models that were not developed for use invaluing stock options. Under APB No. 25, because the exercise price of theCompany’s stock options equals or exceeds the market price of the underlyingstock on the date of grant, no compensation expense is recognized.

On December 16, 2004, the Financial AccountingStandards Board issued SFAS 123(R), “*Share-BasedPayment*”. SFAS 123(R) revises SFAS 123 and supersedes APBOpinion No. 25, “*Accounting for StockIssued to Employees*”. SFAS 123(R) requires all companies tomeasure compensation cost for all share-based payments (includingemployee stock options) at fair value. SFAS 123(R) is effective for publiccompanies for interim or annual periods beginning after December 15, 2005.SFAS No. 123(R) will eliminate the Company’s ability to account forshare-based compensation using the intrinsic value method permitted under APBOpinion No. 25. The Company will utilize the modified prospective method,recognizing compensation cost for share-based awards to employees based ontheir grant-date fair values 

F-15

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from the beginning of theyear in which the recognition provisions are first applied as if the fairvalue-based method had been used to account for all employee awards. Under thisapproach, compensation cost will be recognized for all awards granted, modifiedor settled subsequent to the date of adoption, or where the requisite serviceperiod has not been completed prior to the date of adoption. The Companyintends to apply the new rules beginning January 1, 2006. The impactof adopting SFAS No. 123(R) has not yet been determined.

In December 2002,SFAS No. 148 “Accounting for Stock-Based Compensation—Transition andDisclosure,” was issued. SFAS No. 148 amends SFAS No. 123 to providealternative methods of transition to SFAS No. 123’s fair value method ofaccounting for stock-based employee compensation. It also amends andexpands the disclosure provisions of SFAS No. 123 and APB Opinion No. 28,“Interim Financial Reporting,” to require disclosure in the summary ofsignificant accounting policies of the effect of an entity’s accounting policywith respect to stock-based employee compensation on reported net incomeand earnings per share in annual and interim financial statements. While SFAS No. 148does not require companies to account for employee stock options using thefair-value method, the disclosure provisions of SFAS No. 148 areapplicable to all companies with stock-based employee compensation,regardless of whether they account for that compensation using the fair-valuemethod of SFAS No. 123 or the intrinsic-value method of APB Opinion No. 25.SFAS No. 148’s amendment of the transition and annual disclosurerequirements of SFAS No. 123 is effective for fiscal years ending after December 15,2002. The Company has adopted the disclosure requirement under SFAS No. 148.The following table illustrates the effect on net income if the Company hadapplied the fair value recognition provisions for the years ended September 30,2003, 2004 and 2005.

| ** **                                                                                          | ** ** | **2003** | ** ** | **2004** | ** ** | **2005**       | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------------|------------|
| Net income, as  reported                                                                            |       | $        | 954,642    |     | $          | 5,127,243      |       | **$** | **4,072,559** | ** ** |
| Add stock-based  compensation under the intrinsic value method, included in net income as  reported |       | 123,718  |       | 96,662   |       | **139,723**    | ** ** |
| Less stock-based  compensation under the fair-value method                                          |       | (446,257 | )          | (259,585 | )          | **(1,420,555** | **)**      |
| Pro forma net  income                                                                               |       | $        | 632,103    |     | $          | 4,964,320      |       | **$** | **2,791,727** | ** ** |
| Basic earnings per  share:                                                                          |       |     |       |     |       | ** **     | ** ** |
| As reported                                                                                         |       | $        | 0.23       |     | $          | 1.19           |       | **$** | **0.83** | ** ** |
| Pro forma                                                                                           |       | $        | 0.15       |     | $          | 1.15           |       | **$** | **0.57** | ** ** |
| Diluted earnings per  share:                                                                        |       |     |       |     |       | ** **     | ** ** |
| As reported                                                                                         |       | $        | 0.22       |     | $          | 0.68           |       | **$** | **0.48** | ** ** |
| Pro forma                                                                                           |       | $        | 0.15       |     | $          | 0.66           |       | **$** | **0.33** | ** ** |

 

The fair value for the options granted in 2003, 2004and first quarter 2005 were estimated at the date of grant using a MinimumValue option pricing model with the following weighted average assumptions:expected market price of the Company’s common stock of $3.07, $5.05 and $6.45,respectively, on the date of grant, a weighted average expected life of theoptions of four years, risk-free interest rate of 3 %, 3%, and 3.5%,respectively, and dividend yield of 0%. With respect to stock options grantedat an exercise price that is less than the fair market value on the date ofgrant, the difference between the option exercise price and market value atdate of grant is charged to operations on a straight line basis over the periodthe options vest. Income tax benefits attributable to stock options arecredited to additional paid-in capital when exercised.

The Minimum Value optionvaluation model was developed for use in estimating the fair value of tradedoptions that have no vesting restrictions and are fully transferable. Inaddition, option valuation models require the input of highly subjectiveassumptions including the expected stock price volatility. Options granted in September 2005were estimated at the date of the grant using the Black-Scholes option 

F-16

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pricingmodel, based on the following factors: expected life 4 years; risk-freeinterest rate of 3.96% and 4.18%, volatility of 71.4%, and dividend yield of 0%.

**Cash and Cash Equivalents**

Cash equivalents areconsidered to be all liquid investments with maturities of three months or lesswhen purchased.

**RestrictedInvestments**

The Company is required tokeep restricted deposits by certain HMOs for the payment of claims. Suchrestricted deposits are classified as current as they are restricted forpayment of current liabilities.

**Fair Value of Financial Instruments**

The financial instruments reported in the accompanyingconsolidated balance sheets consist primarily of cash and cash equivalents,accounts receivable, notes payable and capital lease obligations and all otherliabilities. The carrying amounts of current assets and liabilities approximatetheir fair value due to the relatively short period of time between theorigination of the instruments and their expected realization.

The carrying amounts ofnotes payable and capital lease obligations approximate fair value since theoutstanding debt relates primarily to a revolving bank loan and a bank term loanthat bear interest at the prime rate plus applicable margin.

**Concentrations of Credit Risk**

Financial instruments which potentially subject theCompany to concentrations of credit risk consist of shared-risk receivables.The Company’s credit risk with respect to shared-risk receivables is limitedsince amounts are generally due from large HMOs.

Forthe fiscal years ended September 30, 2003, 2004 and 2005, our affiliatedphysician organizations recognized capitation revenue of $63,512,597,$125,860,567, and $129,143,656 respectively. The four largest customers of ouraffiliated physician organizations, PacifiCare of California, Health Net ofCalifornia, Blue Cross of California and Blue Shield of California accountedfor approximately 84%, 80%, 80% of total capitation revenue for the fiscalyears ended September 30, 2003, 2004 and 2005, respectively:

| ** **  | ** ** | **Capitation  Revenue  Year Ended  September 30,  2003** | ** ** | **% of Total  Capitation  Revenue** | ** ** | **Capitation  Revenue  Year Ended  September 30,  2004** | ** ** | **% of Total  Capitation  Revenue** | ** ** | **Capitation  Revenue  Year Ended  September 30,  2005** | ** ** | **% of Total  Capitation  Revenue** | ** ** |
|-------------|------------|--------------------------------------------------------------------|------------|-----------------------------------------------|------------|--------------------------------------------------------------------|------------|-----------------------------------------------|------------|--------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| PacifiCare  |       | $                                                                  | 19,238,866 |                                          |       | 30                                                                 | %          |                                          | $          | 40,903,464                                                         |       |                                          | 32         | % |   | **$** | **40,155,679** | ** ** | ** ** | **31** | **%** |   |
| Health Net  |       | 15,318,402                                                         |       |                                          | 24         | %                                                                  |       | 25,933,742                                    |       |                                                               | 21         | %                                             |       | **25,224,324** | ** ** | ** ** | **20** | **%** |   |
| Blue Cross  |       | 11,850,966                                                         |       |                                          | 19         | %                                                                  |       | 19,899,135                                    |       |                                                               | 16         | %                                             |       | **21,365,598** | ** ** | ** ** | **17** | **%** |   |
| Blue Shield |       | 7,399,387                                                          |       |                                          | 11         | %                                                                  |       | 13,467,152                                    |       |                                                               | 11         | %                                             |       | **14,802,756** | ** ** | ** ** | **12** | **%** |   |
| Totals      | ** ** | $                                                                  | 53,807,621 |                                          |       | 84                                                                 | %          |                                          | $          | 100,203,493                                                        |       |                                          | 80         | % | ** ** | **$** | **101,548,357** | ** ** | ** ** | **80** | **%** | ** ** |

 

**Use of Estimates**

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions that affect the reported amounts of assets, liabilities, revenuesand expenses at the date and for the periods that the financial statements areprepared. Actual results could differ from those estimates.

F-17

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**Recent Pronouncements**

In March 2005, the Securities and ExchangeCommission issued Staff Accounting Bulletin No. 107 (SAB 107) whichprovides guidance regarding the interaction of FAS123(R) and certain SEC rules andregulations. The new guidance includes the SEC’s view on the valuation ofshare-based payment arrangements for public companies and may simplify some ofFAS 123(R)’s implementation challenges for registrants and enhance theinformation that investors receive.

In August 2005, theFASB issued Statement No. 154, Accounting Changes and Error Corrections (“SFASNo. 154”). This statement applies to all voluntary changes in accountingprinciple and to changes required by an accounting pronouncement if thepronouncement does not include specific transition provisions, and it changesthe requirements for accounting for and reporting them. Unless it isimpractical, the statement requires retrospective application of the changes toprior periods’ financial statements. This statement is effective for accountingchanges and correction of errors made in fiscal years beginning after December 15,2005.

**Reclassifications**

Certain prior year amountshave been reclassified to conform to the current year presentation.

**2.**   Acquisitions

**ProspectProfessional Care Medical Group**

On September 30, 2003, PMG acquired the assets,and assumed the liabilities of Professional Care Medical Group, Inc. for$7,050,000 through a merger with Prospect LA Medical Group, Inc., a whollyowned subsidiary of PMG. The name of the surviving corporation was immediatelychanged to Prospect Professional Care Medical Group, Inc. (PPM) and is awholly owned subsidiary of Prospect Medical Group, Inc. $950,000 of thepurchase consideration was allocated to Identifiable Intangibles, specificallyenrolled member accounts. Related acquisition costs totaled $200,419.Simultaneous with this purchase transaction, PPM entered into a managementservice agreement with PMS with an initial 30-year term, renewable foradditional 10-year terms thereafter.

Revenues and expenses for this acquisition have beenincluded in our consolidated results starting October 1, 2003.

In connection with thisacquisition, the sellers were required to place a total of $2,000,000 into anescrow account. Of this amount, $1,000,000 was used to secure a letter ofcredit to PacifiCare on behalf of PMG. This letter of credit expired on March 31,2005, at which time the $1,000,000 was returned to the sellers. The second$1,000,000 placed in escrow was to secure certain seller indemnifications madepursuant to the purchase agreement, and, subject to any purchaser demands madeon the sellers, these funds are expected to be released from escrow in early2006. None of these escrow amounts are included in the accompanying financialstatements, as they do not belong to the Company.

**Prospect NWOC Medical Group**

On February 1, 2004,PMG acquired the assets and assumed the liabilities of Northwest Orange CountyMedical Group, Inc. for $2,000,000. The name was simultaneously changed toProspect NWOC Medical Group, Inc. (PNW), a wholly owned subsidiary of PMG.Related acquisition costs totaled $40,795. $200,000 of the purchaseconsideration was allocated to identifiable intangibles, specifically enrolledmember accounts. Effective February 28, 2004, PNW then entered into a newmanagement services agreement with PMS with an initial 30-year term,renewable for additional 10-year terms thereafter. Revenues and expensesfor this acquisition have been included in our consolidated results starting February 1,2004.

F-18

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**StarcareMedical Group, Inc., APAC Medical Group, Inc. and Pinnacle HealthResources (the “Gateway” entities)**

On February 1, 2004,Prospect Medical Group, Inc., acquired the assets and assumed the liabilitiesof Starcare Medical Group, Inc. (StarCare) and APAC Medical Group for atotal of $4,000,000. Both entities became wholly owned subsidiaries of PMG.Also on that date, Prospect Medical Systems, Inc. acquired the managementcompany for these medical groups, Pinnacle Heath Resources, for $4,450,000.$660,000 of the purchase consideration was allocated to identifiableintangibles, specifically enrolled member accounts, which is being amortizedover 54 months. An additional $50,000 was paid for a covenant not to compete.Related acquisition costs totaled $353,398. Revenues and expenses for thisacquisition have been included in our consolidated results starting February 1,2004.

StarCare Medical Groupowned three clinics at the time of the acquisition. On April 1, 2004, wesold the three clinics for cash consideration of $300,000, promissory notes inthe aggregate amount of $1,068,247 and the assumption of all operatingcommitments pertaining to the medical clinics. A nominal gain of $12,009 wasrecorded on the sale. We retained StarCare Medical Group in its capacity as anindependent practice association (IPA). As a condition of StarCare MedicalGroup’s sale of the medical clinics, the acquiring buyer executed a provideragreement with StarCare Medical Group in StarCare’s capacity as an IPA.

**NuestraFamilia Medical Group**

During fiscal 2004 theCompany increased its stake in Nuestra Familia Medical Group (Nuestra) from50.2% to 55.02%. The purchase was in the form of a cash payment of $99,855 tocertain of minority shareholders of Nuestra. The results of Nuestra have beenincluded in the accompanying consolidated financial statements at the higherownership percentage effective the date of the share purchase. The impact ofthis was not significant.

The followingtable summarizes the estimated fair values of the assets acquired andliabilities assumed, as of the date of acquisition, for Professional CareMedical Group, Inc. (PPM), the Gateway entities (Gateway) and NorthwestOrange County Medical Group, Inc. (PNW):

| ** **                            | ** ** | **PPM**    | ** ** | **Gateway** | ** ** | **PNW**   | ** ** |
|---------------------------------------|------------|------------|------------|-------------|------------|-----------|------------|
| Current assets                        |       | $          | 6,030,162  |        | $          | 6,318,057 |       | $ | 3,514,923 |   |
| Property, improvements  and equipment |       | —     |       | 1,029,317   |       | —    |       |
| Goodwill                              |       | 6,219,009  |       | 7,301,318   |       | 29,118    |       |
| Identifiable intangibles              |       | 950,000    |       | 710,000     |       | 200,000   |       |
| Other assets acquired                 |       | —     |       | 58,437      |       | —    |       |
| Total assets                          |       | 13,199,171 |       | 15,417,129  |       | 3,744,041 |       |
| Current liabilities                   |       | 6,149,171  |       | 6,368,562   |       | 1,744,041 |       |
| Long-term liabilities                 |       | —     |       | 548,567     |       | —    |       |
| Total liabilities  assumed            |       | 6,149,171  |       | 6,917,129   |       | 1,744,041 |       |
| Net assets acquired                   |       | $          | 7,050,000  |        | $          | 8,500,000 |       | $ | 2,000,000 |   |

 

F-19

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Thefollowing unaudited pro forma information for the year ended September 30,2004 gives effect to the PNW and Gateway acquisitions as if they had occurredon October 1, 2003. The unaudited pro forma information for the year endedSeptember 30, 2003 gives effect to the acquisitions of ProCare, PNW andGateway as if each had occurred on October 1, 2002. Such unaudited proforma information is based on historical financial information with respect tothe acquisition and does not include operational or other changes that mighthave been effected by the Company.

| ** **                  | ** ** | **Year ended September 30 **                                                                                             | ** ** |
|-----------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                  | ** ** | **           2003           ** | ** ** | **           2004           ** | ** ** |
| ** **                  | ** ** | **(unaudited)**                                                                                                                              | ** ** |
| Net revenue                 | ** ** |                                                                                                                                         | $          | 160,300,955 |   |   |   | $ | 144,861,104 |   |   |
| Net income                  | ** ** |                                                                                                                                         | 2,044,929  |   |   |   | 5,402,438 |   |   |
| Basic earnings  per share   | ** ** |                                                                                                                                         | $          | 0.48 |   |   |   | $ | 1.25 |   |   |
| Diluted earnings per  share | ** ** |                                                                                                                                         | $          | 0.29 |   |   |   | $ | 0.64 |   |   |

 

See Note 12 for discussionof acquisition of Genesis HealthCare, effective November 1, 2005.

**Investmentin Brotman Medical Center, Inc (Hospital)**

Effective August 31, 2005, the Company acquiredan approximately 38% stake in Brotman Medical Center, Inc. for $1,000,000.The Company made the investment with the intention that it, with the Hospital,would be able to offer joint contracting to HMOs operating in the areasurrounding the Hospital. The Hospital, previously owned by Tenet HealthCare,had been incurring significant operating deficits. The new investors in the Hospital,including Prospect, hoped to help turn around the Hospital operations andrestore profitability.

During September 2005, the first month ofoperation under new ownership, the Hospital experienced a net loss ofapproximately $1,000,000, of which Prospect’s portion totaled approximately$400,000. The Hospital has continued to incur significant losses after September 30,2005, and, with its limited capital, may not ultimately be able to survive.

Prospect is not obligated, nor does it have anycurrent intention, to invest any additional monies in the Hospital.

Based on the Hospital’scurrent significant operating deficits, uncertain ability to increase revenuesand cut costs, and limited capital, management of Prospect believes that theremaining investment in Brotman Medical Center at September 30, 2005 was impairedand has written off its entire investment in the Hospital as of September 30,2005.

**3.   Private Placement**

The Company entered into a Private Placement Agency Agreementeffective November 1, 2003. Per the terms of the agreement, the Companyoffered for sale through Spencer Trask Ventures, Inc., and its selecteddealers, as exclusive agent for the Company, shares at $5.50 per share of theCompany’s Series A Convertible Preferred Stock, $0.01 par value per share.Effective July 27, 2005, these shares were converted into common stock ona 1 to 1 basis.

In conjunction with the Private Placement, the Companyissued warrants to purchase 659,409 shares of the Company’s common stock at$1.00 per share to Spencer Trask Ventures Investment Partners, LLC as apromotional fee. These warrants are exercisable at any time and expire on September 19,2010. On November 3, 2003, 100,000 warrants were exercised and 100,000shares of common stock were issued. The original warrant certificate wascancelled and reissued for 559,409 warrants at the same terms and conditions.

F-20

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In addition to commissions and expenses, and the $1.00warrants discussed above, Prospect also agreed to issue warrants to purchase453,047 shares of the company’s Series A Convertible Preferred Stock at anexercise price of $5.50 per share. These warrants are exercisable at any timeand expire 10 years from the date of issuance. Because, effective July 27,2005, the Company’s Series A Convertible Stock was, by its terms,automatically converted to shares of common stock, these 453,047 warrants tobuy Series A Convertible Preferred Stock now effectively represent theright to buy a like number of shares of common stock.

This offering was finalized on March 31, 2004,whereby a total of 2,265,237 shares of preferred stock were sold for grossproceeds of $12,458,802, related expenses of $2,439,061, and net cash proceedsof $10,019,741. The proceeds were used to complete the acquisitions of StarcareMedical Group, Inc., APAC Medical Group, Inc. and Pinnacle HealthResources, Inc. for $8,500,000 and to repay $1,750,000 borrowed throughour bank line of credit to finance a portion of the cost to acquire NorthwestOrange County Medical Group, Inc.

F-21

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**4.   NotesReceivable**

In connection with the April 1,2004 sale of three clinics previously owned by StarCare Medical Group wereceived promissory notes in the aggregate amount of $1,068,247. There arethree separate notes, each bearing interest at 5% per annum. The first note, inthe original principal amount of $400,000, required monthly principal andinterest payments of $34,243 through April 1, 2005. The second note, inthe original principal amount of $424,994, requires monthly principal andinterest payments of $5,448 through March 1, 2009 and a balloon payment of$181,155 on April 1, 2009. The third note, in the original principalamount of $243,253, is due in two payments of $121,626 on May 1, 2007 and$177,790 on April 1, 2009. The notes receivable are secured by all of theclinic assets and are personally guaranteed by each of the purchasers.

Currentand non-current portions of the notes receivable as of September 30, 2005were as follows:

| Total principal  outstanding | ** ** | **$**       | **625,139** | ** ** |
|------------------------------|------------|-------------|-------------|------------|
| Less current  maturities     | ** ** | **(52,160** | **)**       |
| Non-current portion          | ** ** | **$**       | **572,979** | ** ** |

 

Futureminimum payments required under the notes receivable as of September 30,2005 are as follows:

| 2006                          | ** ** | **$**       | **69,078**  | ** ** |
|-------------------------------|------------|-------------|-------------|------------|
| 2007                          | ** ** | **186,996** | ** **  |
| 2008                          | ** ** | **65,370**  | ** **  |
| 2009                          | ** ** | **391,630** | ** **  |
| 2010                          | ** ** | **—**  | ** **  |
| Gross payments                | ** ** | **713,074** | ** **  |
| Amount  representing interest | ** ** | **(87,935** | **)**       |
| Total principal  outstanding  | ** ** | **$**       | **625,139** | ** ** |

 

**5.   IncomeTaxes**

The Company accounts forincome taxes under Statement of Financial Accounting Standards No. 109, “Accountingfor Income Taxes” (SFAS No. 109), under which deferred income tax assetsand liabilities are recognized for the differences between financial and incometax reporting bases of assets and liabilities based on enacted tax rates andlaws.

The components of theprovision for income tax for the year ended September 30 are as follows:

| ** ** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005**    | ** ** |
|------------|------------|----------|------------|----------|------------|-------------|------------|
| Current:   |       |     |       |     |       |        |       |
| Federal    |       | $        | 1,054,374  |     | $          | 3,112,220   | ** ** | **$** | **2,746,453** | ** ** |
| State      |       | 302,241  |       | 913,266  | ** ** | **738,031** | ** ** |
|       |       | $        | 1,356,615  |     | $          | 4,025,486   | ** ** | **3,484,484** | ** ** |
| Deferred:  |       |     |       |     | ** ** | ** **  | ** ** |
| Federal    |       | $        | (514,174   | )        | $          | (358,650    | )          | **$** | **(89,167** | **)** |
| State      |       | (159,385 | )          | (142,132 | )          | **19,861**  | ** ** |
|       |       | $        | (673,559   | )        | $          | (500,782    | )          | **$** | **(69,306** | **)** |
| Total:     |       |     |       |     | ** ** | ** **  | ** ** |
| Federal    |       | $        | 540,200    |     | $          | 2,753,570   | ** ** | **$** | **2,657,286** | ** ** |
| State      |       | 142,856  |       | 771,134  | ** ** | **757,892** | ** ** |
|       |       | $        | 683,056    |     | $          | 3,524,704   | ** ** | **$** | **3,415,178** | ** ** |

 

F-22

----

Temporarydifferences and carryforward items that result in deferred income tax balancesas of September 30 are as follows:

| ** **                                          | ** ** | **2004** | ** ** | **2005**       | ** ** |
|-----------------------------------------------------|------------|----------|------------|----------------|------------|
| State tax benefit                                   |       | $        | 257,108    | ** **     | **$**      | **202,992** | ** ** |
| Amortization                                        |       | (827,635 | )          | **(1,095,905** | **)**      |
| Depreciation                                        |       | (13,873  | )          | **27,264**     | ** ** |
| Risk pool  settlement                               |       | 299,880  | ** ** | **—**     | ** ** |
| Net operating  loss                                 |       | 44,608   | ** ** | **—**     | ** ** |
| Allowances for  bad debts                           |       | 283,432  | ** ** | **342,906**    | ** ** |
| Deferred  compensation                              |       | 149,058  | ** ** | **248,820**    | ** ** |
| Vacation accrual  and other                         |       | 177,569  | ** ** | **224,766**    | ** ** |
| Accrued physician  bonuses                          |       | 352,750  | ** ** | **798,972**    | ** ** |
| Creditor reserve                                    |       | 85,680   | ** ** | **85,680**     | ** ** |
| Deferred rent                                       |       | —   | ** ** | **22,946**     | ** ** |
| Charitable  contributions                           |       | 474      | ** ** | **—**     | ** ** |
| Write off of  investment in Hospital (capital loss) |       | —   | ** ** | **400,000**    | ** ** |
| Deferred income  tax asset                          |       | 809,051  | ** ** | **1,258,441**  | ** ** |
| Valuation  allowance (on capital loss)              |       | —   | ** ** | **(400,000**   | **)**      |
| Net deferred income tax  asset                      |       | $        | 809,051    | ** **     | **$**      | **858,441** | ** ** |

 

Given uncertainty regarding the likelihood of theCompany generating sufficient future capital gains to offset the unrealizedcapital loss associated with writing down its investment in the Hospital, therelated deferred tax asset was fully reserved, effective September 30,2005.

Thedifferences between the provision for income tax expense at the federalstatutory rate of 34% and that reflected in the consolidated statements ofoperations are summarized as follows for the years ended September 30:

| ** **                           | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Tax provision at  statutory rate     |       |     | 34         | %        |       |     | 34         | % |   |   | **34** | **%** |   |
| State taxes, net  of federal benefit |       |     | 6          |     |       |     | 6          |   |   |   | **6** | ** ** |   |
| Goodwill                             |       |     | 1          |     |       |     | 1          |   |   |   | **—** | ** ** |   |
| Change in  valuation allowance       |       |     | —     |     |       |     | —     |   |   |   | **6** | ** ** |   |
|                                 |       |     | 41         | %        |       |     | 41         | % |   |   | **46** | **%** |   |

 

Taxes paid totaledapproximately $1,148,000, $3,932,000 and $3,586,000 for the years ended September 30,2003, 2004 and 2005, respectively.

F-23

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**6.   Long-Term Debt**

Long-termdebt consists of the following:

| ** **                                                                | ** ** | **September 30** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                | ** ** | **2004**              | ** ** | **2005** | ** ** |
| Term loan                                                                 |       | $                     | 10,000,000 |   | **$** | **8,166,667** | ** ** |
| Revolving credit  facility, interest at prime rate plus applicable margin |       | 5,000,000             |       | **—** | ** ** |
| Equipment loan  (net of amount representing interest)                     |       | 8,554                 |       | **—** | ** ** |
|                                                                      |       | 15,008,554            |       | **8,166,667** | ** ** |
| Less current  maturities                                                  |       | (6,841,887            | )          | **(2,000,000** | **)** |
|                                                                      |       | $                     | 8,166,667  |   | **$** | **6,166,667** | ** ** |

 

Until repaid on September 28, 2004, the Companyhad a term loan and revolving credit facility with Comerica Bank-California.The term loan was originally for $5 million and the revolving credit facilitywas originally for $11.5 million. On September 28, 2004, the Companyrepaid all amounts due to Comerica Bank in connection with entering into thenew term loan and revolving credit facility discussed below.

On September 27, 2004, the Company entered into asenior secured credit facility with Residential Funding Corporation (RFC, asubsidiary of General Motors Acceptance Corporation) that consists of a$10,000,000 term loan and a $5,000,000 revolving credit facility. The term loanrequires repayment of principal installments of $166,667 per month until September 27,2007, at which time the entire remaining unpaid balance is due. Amountsoutstanding under the term loan bear interest at a rate of prime plus 2% perannum. The Company may borrow, make repayments and re-borrow under therevolving credit facility until September 27, 2007. Amounts outstandingunder the revolving credit facility bear interest at a rate of prime plus 0.5%per annum. The Company is charged an unused line fee of 0.25% per annum payablemonthly, calculated on the difference between the average daily usage of therevolving credit facility during each month and $5,000,000, the maximum amountof the revolving credit commitment. Both the term loan and the revolving creditfacility are secured by substantially all of the Company’s assets, includingthe rights to receive capitation payments under HMO contracts. The Company issubject to certain financial covenants under the loan agreement, including amaximum senior debt/EBITA ratio, maximum fixed charge coverage ratio, minimumconsolidated net worth, minimum liquidity and a limit on capital expenditures.The Company is also restricted, without the lender’s consent, from using netproceeds of any sale of equity securities except to pay down indebtedness underthe loan agreement.

On September 28, 2004, the Company borrowed$10,000,000 on the RFC term loan and paid off the Comerica Bank term loan andrevolving credit facility. The Company borrowed $5,000,000 on the RFC revolvingcredit facility on September 29, 2004, which was repaid in full on October 4,2004.

The Company exceeded the 1.50 maximum seniordebt/EBITDA ratio as of September 30, 2004 and December 31, 2004. Theactual senior debt/EBITDA ratio on those two dates was 1.57and 1.51respectively. Effective April 7, 2005, RFC has waived these covenantviolations. RFC has, in addition, agreed to exclude certain items from thecovenant computations for a twelve month period, which enabled the company tomeet the minimum fixed charge coverage ratio at December 31, 2004. Thecompany was in compliance with all of its loan covenants as of September 30,2005.

Interest paid totaled $195,318, $90,802 and $958,634in fiscal 2003, 2004, and 2005, respectively.

F-24

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Scheduledpayments under long-term debt, as of September 30, 2005, are as follows:

| 2006                   | ** ** | **$2,000,000** | ** **    |
|------------------------|------------|----------------|---------------|
| 2007                   | ** ** | **6,166,667**  | ** **    |
| Total minimum payments | ** ** | **$**          | **8,166,667** | ** ** |
|                        |            |                |               |  |

 

**7.   StockTransactions and Option Plans**

**Stock Options**

TheCompany has stock option agreements with certain directors, officers andemployees. A summary of the option agreements at September 30 is asfollows:

| ** **                      | ** ** | **2003**    | ** ** | **2004**                               | ** ** | **2005**    | ** ** |
|---------------------------------|------------|-------------|------------|----------------------------------------|------------|-------------|------------|
| ** **                      | ** ** | **Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Outstanding,  beginning of year |       | 327,119     |       |                                   | $          | 1.25        |       |   | 1,998,000 |   |   | $ | 2.82 |   |   | **2,681,500** | ** ** |   | **$** | **3.43** | ** ** |   |
| Granted                         |       | 1,880,500   |       |                                   | 3.00       |        |       | 739,700 |   |   | 5.00 |   |   | **705,313** | ** ** |   | **5.65** | ** ** |   |
| Exercised                       |       | —      |       |                                   |       |        |       | (30,000 | ) |   | 1.25 |   |   | **—** | ** ** |   | ** ** | ** ** |   |
| Forfeited                       |       | (92,500     | )          |                                   | 3.00       |        |       | (26,200 | ) |   | 3.17 |   |   | **(10,950** | **)** |   | **5.93** | ** ** |   |
| Expired                         |       | (117,119    | )          |                                   | 1.25       |        |       | — |   |   | — |   |   | **—** | ** ** |   | ** ** | ** ** |   |
| Outstanding, end  of year       |       | 1,998,000   |       |                                   | $          | 2.82        |       |   | 2,681,500 |   |   | $ | 3.43 |   |   | **3,375,863** | ** ** |   | **$** | **3.89** | ** ** |   |
| Exercisable, end  of year       |       | 1,648,667   |       |                                   | $          | 2.78        |       |   | 2,353,502 |   |   | $ | 3.23 |   |   | **3,375,863** | ** ** |   | **$3.89** | ** ** |   |
| Price                           |       | $           | 1.25-$3.00 |                                   |       |        |       |   | $ | 1.25-$5.00 |   |   |   |   |   | **$** | **1.25-$7.15** | ** ** |   | ** ** | ** ** |   |
|                                 |            |             |            |                                        |            |             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The weighted average remaining contractual life ofstock options outstanding at September 30, 2004 and 2005 was 44 and37 months, respectively.

In May 2002, the Company extended the contractualterms on 210,000 options for four years beyond their original expiration dateto the end of fiscal 2006. This represented a material modification of theaward and the recognition of a new measurement date. The intrinsic value of theoptions as of the new measurement date was determined (defined as thedifference between the fair value at the modification date as determined byindependent appraisers and the exercise price). Total deferred compensation wasamortized over the remaining future service period. Expense recognized duringfiscal 2003, 2004 and 2005 was $108,762, $108,762, and $232,871 respectively.

In April, May and June 2004, the Companyissued options totaling 300,000, 409,700 and 30,000, respectively, at anexercise price of $5.00 per share. In November 2004, March 2005 and September 2005(two grant dates) the Company issued options totaling 291,500, 25,000, 120,000and 261,813, respectively, at exercise prices of $6.45, $7.15, $4.86 and $4.97,respectively. Total deferred compensation was amortized over the vestingperiod. Expense recognized during fiscal 2004 and 2005 was $44,773 and $0,respectively.

During September 2005,the Company fully vested all remaining unvested portions of previously issuedstock options. Because the Company follows the intrinsic method of accountingfor stock option grants, and none of the stock options whose vesting wasaccelerated had exercise prices below the market price of the Company’s stock,no expense was recognized upon the acceleration of vesting.

**Warrants**

In 1997, a warrant to purchase 132,375 shares of theCompany’s common stock at $5.00 per share was issued to the Company’s lender inconnection with obtaining a revolving credit facility. The warrant 

F-25

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expired in July 2004.In 1998, another warrant to purchase 60,350 shares of the Company’s commonstock at $5.00 per share was issued to the Company’s lender upon the amendmentof the Company’s credit facility. This warrant was exercised in February 2005.An additional warrant to purchase 40,000 shares of the Company’s common stockat $3.00 per share was issued to the lender on July 3, 1999 in conjunctionwith a further amendment to the credit facility. This warrant expires in July 2006.All warrants issued to the bank were immediately exercisable.

In 2000, the Company also issued warrants to purchase480,461 shares of the Company’s common stock at $5.00 per share to certainshareholders. The shareholders paid cash or converted outstanding loans inorder to receive the warrants. The warrants were exercisable on January 31,2002 and expire on January 31, 2007.

No value was assigned to the issuance of thesewarrants as the exercise price exceeded the fair value of the underlying stock,estimated at $1.25 to $2.00 per share during this period, and there was eitherno or only nominal trading activity in the stock. Consequently, the Companydetermined that the fair value of the warrants was *de minimis*.

In conjunction with the Private Placement (Note 3),the Company issued warrants to purchase 659,409 shares of the Company’s commonstock at $1.00 per share to Spencer Trask Investment Partners, LLC., as apromotional fee. These warrants are exercisable at any time and expire on September 19,2010. On November 3, 2003, 100,000 warrants were exercised and 100,000shares of common stock were issued. The original warrant certificate wascancelled and reissued for 559,409 warrants at the same terms and conditions.

In addition to the $1.00 warrants discussed above,Prospect also agreed to issue warrants to purchase, at an exercise price of$5.50, a number of shares equal to twenty percent of the shares of Series AConvertible Preferred Stock sold in the Private Placement offering. Warrants topurchase 453,047 shares were issued. These warrants are exercisable at any timeand expire 10 years from the date of issuance. Because Series AConvertible Stock in now, by its terms, automatically convertible upon issuanceinto shares of common stock, these warrants now effectively represent the rightto buy a like number of shares of common stock.

On June 15, 2004, theCompany issued warrants to purchase a total of 22,727 shares of common stock ata price of $5.50 per share to New Capital Advisors. These warrants were issuedfor services provided in connection with the Private Placement, are exercisableat any time, and expire on June 15, 2011.

**8.   Commitments and Contingencies**

**Leases**

The Company leases certain buildings and equipmentunder operating leases. Certain building leases contain renewal options for twoconsecutive five-year periods at the then market rent.

F-26

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Futureminimum rental payments required under operating leases that have initial orremaining non-cancelable lease terms in excess of one year as of September 30,2005 are as follows:

| ** ** | ** ** | **Operating  Leases** | ** **    |
|------------|------------|-----------------------|---------------|
| 2006       | ** ** | **$**                 | **1,100,792** | ** ** |
| 2007       | ** ** | **1,032,441**         | ** **    |
| 2008       | ** ** | **881,479**           | ** **    |
| 2009       | ** ** | **804,835**           | ** **    |
| 2010       | ** ** | **586,858**           | ** **    |
| Thereafter | ** ** | **49,031**            | ** **    |
|       | ** ** | **$**                 | **4,455,435** | ** ** |

 

Consolidated rent expensefor 2003, 2004, and 2005 was $1,172,936, $1,614,268 and $1,664,374respectively.

**Regulatory Matters**

Laws and regulationsgoverning the Medicare program and health care generally are complex andsubject to interpretation. Prospect and its affiliates believe that they are incompliance with all applicable laws and regulations and are not aware of anypending or threatened investigations involving allegations of potentialwrongdoing. While no such regulatory inquiries have been made, compliance withsuch laws and regulations can be subject to future government review andinterpretation as well as significant regulatory action including fines,penalties, and exclusion from the Medicare and Medicaid programs.

**NASD Inquiry**

On February 3, 2004,the Company received a notice of inquiry from the National Association ofSecurities Dealers, Inc., concerning trading in its common stock that tookplace around the time that it announced the first closing of a privateplacement of its Series A Preferred Stock. The Company responded to anNASD request for documents on February 12, 2004, and has received nofurther contacts from the NASD since that date. However, it is possible thatthe NASD could continue its inquiry or open a formal investigation and that theNASD or other government agencies could imitate enforcement proceedings if theNASD concluded that improprieties occurred in connection with the trading.

**Litigation**

*St.Jude Medical Center*—In 1998, Prospect initiatedarbitration proceedings against St. Jude Medical Center (“St. Jude”) andPacifiCare of California (“PacifiCare”) for failure by St. Jude to provide anaccurate accounting of hospital incentive pools for the years 1997, 1998 and1999.

In November 2001, the Arbitrator awarded Prospect$1,200,000, plus interest, plus legal fees of approximately $1,000,000.PacifiCare was dismissed from the Prospect claim, and Prospect was ordered topay PacifiCare’s legal fees of approximately $125,000. Approximately $1,200,000was included in fiscal 2001 net patient service revenue, related to thismatter.

In a counter-claim, the Arbitrator awarded St.Jude $275,000, plus interest. These amounts are also included in the fiscal2001 financial statements.

In November 2001, Prospect received a partialpayment of $925,000 related to the above amounts, St. Jude filed apetition to vacate the award, and Prospect filed a cross-petition toconfirm the award. In December 2002, the Orange County Superior Courtgranted Prospect’s petition and entered judgment in favor of Prospect. St. Judefiled an appeal of this judgment.

F-27

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On January 31, 2003, St. Jude paid Prospectapproximately $1,492,000, reflecting the remaining amount due under thearbitration award, including interest and attorneys’ fees. The payment was madesubject to Prospect’s agreement to repay this amount in the event thearbitration award was ultimately vacated as a result of further judicialproceedings.

Various appeals and other court actions ensued,related to portions of the arbitration award, interest thereon, and legal fees.Pending the final outcome of this matter, at September 30, 2003, wereserved approximately $700,000 primarily related to those amounts alreadyreceived from St. Jude, but which remained subject to appeal.

During Prospect’s fourth quarter of Fiscal 2005, followingrulings by the California Court of Appeals which upheld the Arbitrator awardsin favor of Prospect, but ruled that Prospect was responsible to St. Judefor approximately $71,000 of arbitration costs, the parties concluded asettlement agreement as to all disputed matters. That settlement agreement,dated July 7, 2005, stated that, upon Prospect paying the $71,000 to St.Jude (which we did), all portions of the prior litigation would have beensatisfied, the parties would refrain from any further proceedings, and theparties would file the required stipulation with Superior Court, stipulating tothe satisfaction of all prior judgments and the end of proceedings on thematter. On September 13, 2005, the Superior Court entered its orderconfirming these stipulations; following which, Prospect reversed the remaininglegal reserve, effective in the fourth quarter ended September 30, 2005.

*Other Matters*—Weand our affiliated physician organizations are parties to other legal actionsarising in the ordinary course of business. We believe that liability, if any,under these claims will not have a material adverse effect on our consolidatedfinancial position or results of operations.

**9.   Defined Contribution Plan**

The Company sponsors adefined contribution plan covering substantially all employees who meet certaineligibility requirements. Under the plan, employees can contribute up to 15% oftheir annual compensation. The Company matches 25% of the first 4% contributed.The total expense under the plan was $48,438 in 2003, $49,099 in 2004, and$102,498 in 2005.

**10.   IncurredBut Not Reported Claims Reserves**

Thefollowing table presents the roll-forward of incurred but not reported, or IBNR,claims reserves as of the periods indicated:

| ** **                                            | ** ** | **Year ended September 30** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                            | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| IBNR as of  beginning of year                         |       | $                                          | 6,965,969  |   | $ | 10,557,426 | ** ** | **$** | **13,323,622** | ** ** |
| Health care claim  expenses incurred during the year: |       |                                       |       |   | ** ** | ** ** | ** ** |
| Related to current year                               |       | 22,240,501                                 |       | 44,699,711 | ** ** | **46,030,847** | ** ** |
| Related to prior year                                 |       | (983,140                                   | )          | (2,327,044 | ) | **(855,164** | **)** |
| Total incurred                                        |       | 21,257,361                                 |       | 42,372,667 | ** ** | **45,175,683** | ** ** |
| Health care claims paid  during the year:             |       |                                       |       |   | ** ** | ** ** | ** ** |
| Related to current year                               |       | (18,630,639                                | )          | (33,295,082 | ) | **(35,266,828** | **)** |
| Related to prior year                                 |       | (4,535,265                                 | )          | (7,268,752 | ) | **(11,700,149** | **)** |
| Total paid                                            |       | (23,165,904                                | )          | (40,563,834 | ) | **(46,966,977** | **)** |
| IBNR acquired  during the year                        |       | 5,500,000                                  |       | 957,363 | ** ** | **—** | ** ** |
| IBNR as of end of year                                |       | $                                          | 10,557,426 |   | $ | 13,323,622 | ** ** | **$** | **11,532,328** | ** ** |

 

F-28

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Followingis a reconciliation of cost of medical services per our statement of income tohealthcare claims expense reflected in the preceding table:

| ** **                      | ** ** | **Year ended September 30** | ** ** |
|---------------------------------|------------|--------------------------------------------|------------|
| ** **                      | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Capitation expense              |       | $                                          | 22,350,492 |   | $ | 48,053,154 | ** ** | **$** | **45,967,875** | ** ** |
| Fee-for-service  claims expense |       | 21,257,361                                 |       | 42,372,667 | ** ** | **45,175,683** | ** ** |
| Other physician compensation    |       | 2,606,124                                  |       | 4,495,641 | ** ** | **4,524,284** | ** ** |
| Other cost of revenues          |       | 525,843                                    |       | 1,053,579 | ** ** | **703,355** | ** ** |
| Total cost of revenues          |       | $                                          | 46,739,820 |   | $ | 95,975,041 | ** ** | **$** | **96,371,197** | ** ** |

 

**11.   Joint Venture**

As discussed at Note 1, the Company and an unrelatedthird party, AMVI/IMC Health Network, Inc. (“AMVI”) formed a joint ventureto participate in the CalOPTIMA Medicaid (“Medi-Cal in California) program inOrange County, California. The Company does not consolidate the joint venture.The Company includes in its financial statements only the net resultsattributable to those Medicaid enrollees specifically identified as assigned toit, together with the management fee that it charges for managing thoseMedicaid enrollees specifically assigned to AMVI. Costs incurred by the Companyin managing the joint venture are included in general and administrativeexpenses in the accompanying consolidated financial statements.

Summarizedunaudited financial information for the unconsolidated joint venture at September 30,2004 and 2005 and for the years then ended is as follows:

| ** **                                   | ** ** | **2003**  | ** ** | **2004**  | ** ** | **2005**    | ** ** |
|----------------------------------------------|------------|-----------|------------|-----------|------------|-------------|------------|
| Cash                                         |       | $         | 1,068,910  |      | $          | 1,308,587   |       | **$** | **823,306** | ** ** |
| Receivables                                  |       | 758,845   |       | 514,524   |       | **914,113** | ** ** |
| Total assets                                 |       | $         | 1,827,755  |      | $          | 1,823,111   |       | **$** | **1,737,419** | ** ** |
| Accrued medical claims                       |       | $         | 536,941    |      | $          | 659,807     |       | **$** | **575,671** | ** ** |
| Other payables                               |       | 1,200,000 |       | 1,200,000 |       | **900,000** | ** ** |
| Other partner’s  capital                |       | 274,637   |       | 424,170   |       | **260,748** | ** ** |
| Prospect’s  capital                     |       | (183,823  | )          | (460,866  | )          | **1,000**   | ** ** |
| Total liabilities and partners’ capital |       | $         | 1,827,755  |      | $          | 1,823,111   |       | **$** | **1,737,419** | ** ** |
| Revenues                                     |       | $         | 7,733,381  |      | $          | 8,801,565   |       | **$** | **8,836,729** | ** ** |
| Income (loss) before income taxes            |       | $         | (440,988   | )         | $          | 344,972     |       | **$** | **(101,403** | **)** |
| Prospect’s equity income                |       | $         | 728,549    |      | $          | 206,634     |       | **$** | **87,516** | ** ** |
| Management fees  earned by Prospect          |       | $         | 793,667    |      | $          | 841,153     |       | **$** | **806,788** | ** ** |

 

F-29

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**12.   Quarterly Results of Operations (Unaudited)**

Thefollowing is a summary of the quarterly results of operations for the yearsended September 30, 2004 and 2005 in thousands, except per share data:

| ** **                          | ** ** | **For the quarter ended** | ** ** |
|-------------------------------------|------------|------------------------------------------|------------|
| ** **                          | ** ** | **December 31,  2003**              | ** ** | **March 31,  2004** | ** ** | **June 30,  2004** | ** ** | **September 30,  2004** | ** ** |
| Total revenues                      |       |                                     | $          | 25,857 |   |   |   | $ | 32,987 |   |   | $ | 35,657 |   |   | $ | 35,014 |   |   |
| Gross margin                        |       |                                     | 6,973      |   |   |   | 9,632 |   |   | 9,203 |   |   | 7,733 |   |   |
| Income before income taxes          |       |                                     | 1,814      |   |   |   | 2,572 |   |   | 2,565 |   |   | 1,714 |   |   |
| Net income before minority interest |       |                                     | 1,127      |   |   |   | 1,521 |   |   | 1,588 |   |   | 904 |   |   |
| Net income                          |       |                                     | $          | 1,122 |   |   |   | $ | 1,514 |   |   | $ | 1,583 |   |   | $ | 908 |   |   |
| Net earnings per common share:      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                               |       |                                     | $          | 0.26 |   |   |   | $ | 0.35 |   |   | $ | 0.36 |   |   | $ | 0.21 |   |   |
| Diluted                             |       |                                     | $          | 0.21 |   |   |   | $ | 0.21 |   |   | $ | 0.20 |   |   | $ | 0.11 |   |   |

 

| ** **                                                         | ** ** | **For the quarter ended** | ** ** |
|--------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                         | ** ** | **December 31,  2004**              | ** ** | **March 31,  2005** | ** ** | **June 30,  2005** | ** ** | **September 30,  2005** | ** ** |
| Total revenues                                                     |       |                                     | $          | 33,280 |   |   |   | $ | 32,331 |   |   | $ | 32,393 |   |   | $ | 35,514 |   |   |
| Gross margin                                                       |       |                                     | 8,480      |   |   |   | 8,674 |   |   | 9,548 |   |   | 10,444 |   |   |
| Income before income taxes                                         |       |                                     | 1,815      |   |   |   | 1,545 |   |   | 1,699 |   |   | 3,440 |   |   |
| Net income before loss in equity investment and minority  interest |       |                                     | 1,087      |   |   |   | 926 |   |   | 1,025 |   |   | 2,046 |   |   |
| Net income                                                         |       |                                     | $          | 1,087 |   |   |   | $ | 922 |   |   | $ | 1,015 |   |   | $ | 1,049 |   |   |
| Net earnings per common share:                                     |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                              |       |                                     | $          | 0.25 |   |   |   | $ | 0.20 |   |   | $ | 0.22 |   |   | $ | 0.17 |   |   |
| Diluted                                                            |       |                                     | $          | 0.13 |   |   |   | $ | 0.11 |   |   | $ | 0.12 |   |   | $ | 0.13 |   |   |

 

As more fully discussed inNote 1, during the fourth quarter of fiscal 2005, the Company recordedapproximately $4 million of revenue related to services rendered betweenJanuary 1, 2005 and September 30, 2005. Additionally, the Company recordedphysician and employee bonuses totaling approximately $2.8 million, recoupedapproximately $0.5 million of previously expensed transaction expenses upon theclosing of its investment in Brotman Medical Center, and recorded approximately$0.6 million resulting from the favorable conclusion of a longstandinglegal matter.

**13.   SubsequentEvents**

Effective November 1, 2005 the company acquiredGenesis HealthCare of Southern California for $8,000,000 in cash. The purchaseprice was funded using $4,000,000 of the company’s existing cash and a $4,000,000term loan from RFC. The terms of the RFC loan are similar to those of thecompany’s existing term loan with RFC, and require an additional monthly principalpayment of $66,667.

F-30

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**Report of Independent Registered Public AccountingFirm**

Wehave audited the consolidated financial statements of Prospect Medical Holdings, Inc.as of September 30, 2004 and 2005, and for each of the three years in theperiod ended September 30, 2005, and have issued our report thereon dated December 21,2005 (included elsewhere in this Form 10-K). This schedule is theresponsibility of the Company’s management. Our responsibility is to express anopinion based on our audits. In our opinion, the financial statement schedulereferred to above, when considered in relation to the basic financialstatements taken as a whole, presents fairly in all material respects theinformation set forth therein.
|                         | /s/ ERNST &  YOUNG LLP |
|-------------------------|---------------------------------|
| Los Angeles, California |                            |
| December 21, 2005  |                            |

 

F-31

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**Prospect Medical Holdings, Inc.Schedule II—Valuationand Qualifying Accounts**

| ** **                       | ** ** | **Balance at the  Beginning of the  Period** | ** ** | **Charges to  Operations** | ** ** | **Deductions** | ** ** | **Balance at the  End of the  Period** | ** ** |
|----------------------------------|------------|------------------------------------------------------------------|------------|---------------------------------|------------|----------------|------------|------------------------------------------------------------|------------|
| 2003                             |       |                                                             |       |                            |       |           |       |                                                       |       |   |   |   |   |   |   |   |   |
| Allowance for  Doubtful Accounts |       |                                                             | $          | 429,000                         |       |           |       | $                                                          | 116,000    |   |   |   | $ | 97,000 |   |   |   | $ | 448,000 |   |   |
| 2004                             |       |                                                             |       |                            |       |           |       |                                                       |       |   |   |   |   |   |   |   |   |
| Allowance for  Doubtful Accounts |       |                                                             | $          | 448,000                         |       |           |       | $                                                          | 215,000    |   |   |   | $ | 1,000 |   |   |   | $ | 662,000 |   |   |
| 2005                             |       |                                                             |       |                            |       |           |       |                                                       |       |   |   |   |   |   |   |   |   |
| Allowance for Doubtful  Accounts |       |                                                             | $          | 662,000                         |       |           |       | $                                                          | 141,000    |   |   |   | $ | 1,000 |   |   |   | $ | 802,000 |   |   |

 

F-32

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**EXHIBIT INDEX**

| 2.1    |   | Agreement for the Purchase and Sale of Assets of  Health Source Medical Group, Inc. dated as of November 7, 2000  between Prospect Medical Group, Inc. and Health Source Medical Group, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   | Pursuant to Regulation S-K,  Item 601(b)(2), the following schedules to the Agreement for the Purchase and  Sale of Assets will be provided supplementally to the Commission upon  request: Exhibit 1.1 Assets, Exhibit 1.1(a)(i) Prospect Health  Source Medical Group, Inc. Exclusive Primary Care Physician Services  Agreement, Exhibit 1.1(a)(ii) Prospect Health Source Medical Group, Inc.  Nonexclusive Specialist Physician Services Agreement, Exhibit 1.1 (g) Management  Services Agreement, Exhibit 1.3 Assumed Liabilities, Exhibit 2.2  Purchase Price Allocation, Exhibit 5.1 Noncompetition Agreement, Exhibit 7.2(a) Bill  of Sale/Assignment and Assumption Agreement, Exhibit 7.5(i) Guaranty  of Purchaser’s Obligations by Prospect Medical Holdings, Inc., Exhibit 7.5(j) Prospect  Health Source Medical Group, Inc. Organizational Documents, Schedule 3.3  Consents, Schedule 3.5 Accounts Receivable, Schedule 3.6 Title to Assets,  Schedule 3.7(a) Inventory and Furniture, Fixtures, and Equipment at the  Robertson Clinic, Schedule 3.7(b) Furniture, Fixtures, and Equipment  used at Seller’s Former Administrative Office, Schedule 3.8 Contracts,  Schedule 3.9 Litigation, Schedule 3.10 Violation of Law, Schedule 3.12  Employees and Employee Benefits, Schedule 3.15 Intellectual Property |
| 2.2    |   | Agreement of Purchase  and Sale of Assets of Health Source Medical Group, Inc. dated as of May 1,  2001 among David M. Frisch, M.D., Prospect Medical Group, Inc., Prospect  Health Source Medical Group, Inc. and Prospect Medical Systems, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   |   | Pursuant to Regulation S-K,  Item 601(b)(2), the following schedules to the Agreement for the Purchase and  Sale of Assets will be provided supplementally to the Commission upon  request: Exhibit 1.1 Assets, Exhibit 1.1(a) Exclusive Primary  Care Physician Services Agreement, Exhibit 1.3 Assumed Liabilities,  Schedule 3.3 Consents, Schedule 3.5 Inventory and Furniture, Fixtures and  Equipment, Schedule 3.7 Litigation, Schedule 3.8 Violation of Law, Schedule  3.10 Employees and Employee Benefits                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 2.3    |   | Agreement of Purchase  and Sale of Assets of Health Source Medical Group, Inc. dated as of July 1,  2001 among James Daniel, M.D. & Dana Eisenman, M.D. Medical  Corporation, Prospect Medical Group, Inc., Prospect Health Source  Medical Group, Inc. and Prospect Medical Systems, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   |   | Pursuant to Regulation S-K,  Item 601(b)(2), the following schedules to the Agreement for the Purchase and  Sale of Assets will be provided supplementally to the Commission upon  request: Exhibit 1.1 Assets, Exhibit 1.1(a) Exclusive Primary  Care Physician Services Agreement, Exhibit 1.3 Assumed Liabilities, Exhibit 7.2(a) Bill  of Sale/Assignment and Assumption Agreement, Exhibit 7.2 Sublease,  Schedule 3.3 Consents, Schedule 3.5 Inventory and Furniture, Fixtures and  Equipment, Schedule 3.5(a) Additional Furniture, Fixtures and Equipment  used in the Sunset Practice, Schedule 3.7 Litigation, Schedule 3.8 Violation  of Law, Schedule 3.10 Prospect Employees Through the Effective Date, Schedule  4.8 Employees Purchaser will Retain from the Effective Date Through the  Closing Date                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 2.4    |   | Agreement and  Plan of Reorganization for Professional Care Medical Group, Inc. dated  as of June 30, 2003 among Prospect Medical Group, Inc., Prospect LA  Medical Group, Inc., Professional Care Medical Group, Inc. and the  Shareholders of Professional Care Medical Group, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |

 

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|   |   | Pursuant to  Regulation S-K, Item 601(b)(2), the following schedules to the  Agreement and Plan of Reorganization will be provided supplementally to the  Commission upon request:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   | Schedule 2.4,  ProCare Consent Requirements, Schedule 2.6, List of Holders of Record and  Number Held of ProCare Shares, Schedule 2.7, List of ProCare Financial  Statements Delivered to Prospect, Schedule 2.12, Intellectual Property,  Schedule 2.13, Contracts, Schedule 2.18, Insurance, Schedule 2.20, Bank  Accounts, Schedule 3.3, Prospect/Sub Consent Requirements, Schedule 11.7,  Notices, Exhibit ”A,” Shareholders of ProCare, Exhibit ”B,”  Agreement of Merger, Exhibit ”C,” Acknowledgement by Escrow Agent                                                                                                                                                     |
| 2.5    |   | Amendment to Agreement  and Plan of Reorganization for Professional Care Medical Group, Inc.  dated as of September 30, 2003 among Prospect Medical Group, Inc.,  Prospect LA Medical Group, Inc., Professional Care Medical Group, Inc.  and the Shareholders of Professional Care Medical Group, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                       |
| 2.6    |   | Agreement of Merger for  Northwest Orange County Medical Group, Inc. dated as of November 19,  2003 among Prospect Medical Group, Inc., Prospect NWOC Medical Group, Inc.,  Northwest Orange County Medical Group, Inc., the Shareholders of Northwest  Orange County Medical Group, Inc., and Harriman-Jones Medical  Group, Inc.(1)                                                                                                                                                                                                                                                                                                                                                       |
|   |   | Pursuant to Regulation S-K,  Item 601(b)(2), the following schedules to the Agreement of Merger will be  provided supplementally to the Commission upon request:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   |   | Schedule 2.4, Northwest  Consent Requirements, Schedule 2.6, List of Holders of Record and Number Held  of Northwest Shares, Schedule 2.9, Tax Matters, Schedule 2.12, Intangible  Property, Schedule 2.13, Contracts, Schedule 2.14, Legal Proceedings,  Schedule 2.16, Officers and Directors, Schedule 2.17, Insurance, Schedule  2.18, Powers of Attorney, Schedule 2.24, Inspections, Schedule 2.28, Permits,  Schedule 2.29, Fraud and Abuse, Schedule 2.33, Bank Accounts, Schedule 3.3,  Consent Requirements—Prospect Parties, Schedule 4.7, North West Enrollees—August 2003  Enrollment, Exhibit ”A,” Agreement of Merger, Exhibit ”B,” Form of  Escrow Agreement |
| 2.7    |   | Amendment to Agreement  of Merger dated as of January 30, 2004 for Northwest Orange County  Medical Group, Inc. among Prospect Medical Group, Inc., Prospect  NWOC Medical Group, Inc., Northwest Orange County Medical Group, Inc.,  the Shareholders of Northwest Orange County Medical Group, Inc., and  Harriman-Jones Medical Group, Inc.(1)                                                                                                                                                                                                                                                                                                                                           |
| 2.8    |   | Stock Purchase Agreement  dated as of January 31, 2004 among Prospect Medical Group, Inc.,  Prospect Medical Systems, Inc., StarCare Medical Group, Inc. dba  Gateway Medical Group, Inc, APAC Medical Group, Inc. dba Gateway  Physicians Medical Associates, Inc., Pinnacle Health Resources and David  Tsoong, M.D.(1)                                                                                                                                                                                                                                                                                                                                                                        |
|   |   | Pursuant to Regulation S-K,  Item 601(b)(2), the following schedules to the Stock Purchase Agreement will  be provided supplementally to the Commission upon request:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   |   | Schedule 1.2, StarCare  Shares, Schedule 1.3, APAC Shares, Schedule 1.4, Pinnacle Shares, Schedule  1.6, Purchase Price Allocation, Schedule 2.4, StarCare, APAC and Pinnacle  Consent Requirements, Schedule 2.5, Conflicts and/or Breaches as a Result of  the Transaction, Schedule 2.8,Contingent Liabilities, Schedule 2.9, Actions  and Proceedings for Taxes, Schedule 2.11(b), Leases and Subleases,  Schedule 2.12(b), Aggregate Tangible Personal Property, Schedule 2.12(c),  Excluded Tangible Personal Property, Schedule 2.12(d), Items Currently in  Storage                                                                                                                                               |

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|   |   | or Supply Rooms  at 710 N. Euclid or Subleased Storage Space at La Mirada Clinic, Schedule  2.13, Intellectual Property, Schedule 2.13(b), Website Internet Portal Modem  Fee, Schedule 2.14, Contracts, Schedule 2.15, Legal Proceedings: Existing and  Threatened Claims, Schedule 2.17, Employee Information, Schedule 2.17(b),  Employee Information, Schedule 2.17(c), Employee Information, Schedule 2.18,  Insurance, Schedule 2.19, Management; Powers of Attorney, Schedule 2.24,  Confidentiality and Non-Compete Agreements, Schedule 2.25, Inspections,  Schedule 2.28, Permits, Schedule 2.29(a), Fraud and Abuse, Schedule 2.29(b),  Fraud and Abuse, Schedule 2.35(a), Bank Accounts, Schedule 2.35(b),  Letters of Credit or Other Security Pledged for StarCare Shared Risk  Contracts, APAC Shared Risk Contracts or APAC Full Risk Contracts, Schedule  3.3, Group/Systems Consent Requirements, Schedule 5.2, Employees to Be Hired  By Prospect Parties, Exhibit ”A,” October Interim Financial  Statements, Exhibit ”B,” Form of Non-Competition Agreement, Exhibit ”C,”  Legal Opinion Matters                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.9    |   | Asset Purchase Agreement  dated as of March 31, 2004 among StarCare Medical Group, Inc. dba  Gateway Medical Group, Inc., Pinnacle Health Resources, Primary and  Multi-Specialty Medical Clinics of Anaheim, Inc., and the  shareholders of Primary and Multi-Specialty Medical Clinics of Anaheim, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   |   | Pursuant to Regulation S-K,  Item 601(b)(2), the following schedules to the Asset Purchase Agreement will  be provided supplementally to the Commission upon request:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   |   | Schedule 1.2(a), Clinic  Assets, Attachment A to Schedule 1.2(a), Schedule 1.2(b), Excluded Clinic  Assets, Schedule 1.3, Assumed Liabilities, Schedule 1.5, Wells Fargo Loans,  Schedule 1.6, Accumulated PTO as of the Closing Date, Schedule 1.7,  Purchase Price Allocation, Schedule 2.2, Group Consent Requirements, Schedule  2.3, Conflicts and Breaches, Schedule 2.4, Liens, Schedule 2.5(a), February Financial  Statements, Schedule 2.5(b), March Estimated Partial Financial  Statements, Schedule 2.7, Tangible Personal Property, Schedule 2.7(b), Assets  in Storage, Schedule 2.8, Intellectual Property, Schedule 2.9, Contracts,  Schedule 2.10 Legal Proceedings: Existing and Threatened Claims, Schedule  2.12, Employee Information, Schedule 2.16, Confidentiality, Non-Solicitation  and Non-Compete Arrangements, Exhibit E, Covenant Not To Compete, Exhibit F-1,  Industrial Medicine Client List, Schedule 2.19, Permits, Schedule 2.22,  Insurance, Schedule 2.24, Tax Matters, Schedule 2.25, Inspection,  Schedule 3.3, Buyer Consent Requirements, Schedule 4.1, Gateway Representations  and Warranties, Schedule 4.6(b), Non-Physician Acknowledgement,  Schedule 4.6(c), StarCare Updated Patient Diversion Provisions, Schedule  4.6(d), Full Time Primary Care Physicians, Schedule 4.13, Prepaid  Obligations, Schedule 4.17, Initial Trust Deposits with Cap-MPT, Exhibit ”A,”  Secured Promissory Note (Purchase Price Note), Exhibit ”B,” Security  Agreement, Exhibit ”C,” Guaranty, Exhibit ”D,” Secured Promissory  Note (Additional Consideration Note), Exhibit ”E,” Guaranty, Exhibit ”F,”  Secured Promissory Note (PTO Note), Exhibit ”G,” Guaranty, Exhibit ”H,”  Form of Buyer/StarCare Provider Agreement, Exhibit ”I,” Form of  Buyer/Prospect Provider Agreement, Exhibit ”J,” Form of Specialty  Provider Agreement, Exhibit ”K,” Sublease for Anaheim Clinic, Exhibit ”L,”  Sublease for Anaheim Hills Clinic, Exhibit ”M,” Sublease for Euclid  Clinic and Clinic Corporate Office, Exhibit ”N,” Sublease for Clinic  Storage Space, Exhibit ”O,” Guaranty, Exhibit ”P,” Bill of  Sale/Assignment and Assumption Agreement |
| 2.10   |   | Omnibus Amendment  to Asset Purchase Agreement and Other Documents Delivered in Connection with  The Transactions Described Therein dated as of April 15, 2004 among  StarCare Medical Group, Inc. d/b/a Gateway Medical Group, Inc.,  Pinnacle Health Resources, APAC Medical Group, Inc., Prospect Medical  Group, Inc., Prospect Professional Medical Group, Inc., Prospect  NWOC Medical Group, Inc., Primary and Multi-Specialty Clinics of  Anaheim, Inc., and the Shareholders of Primary and Multi-Specialty  Clinics of Anaheim, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 2.11   |   | Stock Purchase Agreement  dated November 1, 2005 among Prospect Medical Group, Inc., Genesis  Healthcare of Southern California, Inc. and Mitchell W. Lew, M.D.(8)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   |   | Pursuant to Regulation  S-K, Item 601(b)(2), the following schedules to the Stock Purchase  Agreement will be provided supplementally to the Commission upon request:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |

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|   |   | Schedule 1.2,  Stock; Schedule 1.6, Allocation of Purchase Price; Schedule 2.9,  Tax Matters; Schedule 2.11(b), List and Summary of all Leases, Subleases  and other Agreements under which Company uses or has the right to occupy any  Real Property; Schedule 2.12(b), Tangible Personal Property;  Schedule 2.13, Intellectual Property; Schedule 2.14, Contracts;  Attachment to Schedule 2.14, List of PCP Physicians; Attachment to Schedule 2.14,  List of Specialist Physicians; Attachment to Schedule 2.14, Form of  PCP (Individual)—Capitated; Attachment to Schedule 2.14, Form of  PCP (Group)—Capitated; Attachment to Schedule 2.14, Form of  Specialist Physician Agreement—Fee for Service; Attachment to  Schedule 2.14, Form of Specialist Agreement—Capitated; Attachment  to Schedule 2.14, List of Ancillary Service Providers; Attachment to  Schedule 2.14, Form of Ancillary Services Agreement—Fee for  Service; Schedule 2.15, Existing/Threatened Claims; Schedule 2.18,  Insurance; Schedule 2.19, Officers and Directors; Schedule 2.17,  Employee Matters; Schedule 2.24, Confidentiality/Non-Compete;  Schedule 2.25, Inspections, Section 2.28, Permits;  Schedule 2.30(a), Bank Accounts; Schedule 2.30(b), Cash securing  Letters of Credit or Certificates of Deposits pledged as Security for the  Company Health Plans; Schedule 3.3, Consents of Purchaser;  Schedule 5.2, Employees to be offered Employment; Schedule 5.6,  IBNR Formula; Exhibit A, Form of Non-Competition Agreement; Exhibit B,  Management Agreement; Exhibit C, Employment Agreement; Exhibit D,  Legal Opinion Matters |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 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)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.1   |   | Warrant to Acquire  Common Stock between Prospect Medical Holdings, Inc. and Spencer Trask  Venture Investment Partners, LLC(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.2   |   | Warrant Agreement for Series A  Preferred Stock dated as of January 15, 2004 between Prospect Medical  Holdings, Inc. and Spencer Trask Ventures, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.3   |   | Form of  Registration Rights Agreement between Prospect Medical Holdings, Inc.  and each Investor of Series A Convertible Preferred Stock(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.4   |   | Agreement For The  Purchase And Sale of Stock, dated as of January 13, 2000, between  Jacob Y. Terner, M.D., and Gregg DeNicola, M.D.(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.5   |   | Amended and Restated  Assignable Option Agreement, made as of January 13, 2000, among Prospect  Medical Systems, Inc., Prospect Medical Group, Inc. and Jacob Y.  Terner, M.D.(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.6   |   | Form of Amended and  Restated Management Services Agreement, made as of September 15, 1998  and deemed to have been effective as of June 4, 1996, between Prospect  Medical Systems, Inc. and Prospect Medical Group, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.7   |   | Form of Amendment  to Management Services Agreement, made as of October 1, 1998, between  Prospect Medical Systems, Inc. and Prospect Medical Group, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.8   |   | Management Agreement  dated as of January 1, 2003 between Pinnacle Health Resources Inc. and  StarCare Medical Group, Inc. dba Gateway Medical Group, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.9   |   | Management Agreement  dated as of January 1, 2003 between Pinnacle Health Resources Inc. and  APAC Medical Group, Inc. dba Gateway Physicians Medical Associates, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.10  |   | Form of Management  Services Agreement, made as of August 1, 1999, between Prospect Medical  Systems, Inc. and Nuestra Familia Medical Group(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.11  |   | Management Services  Agreement, made as of July 1, 1999, between Prospect Medical Systems, Inc.  and AMVI/Prospect Medical Group(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.12  |   | Employment  Agreement, dated as of August 1, 1999 between Prospect Medical Holdings, Inc.  and Jacob Y. Terner, M.D.(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |

 

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| 10.13 |   | Amendment to Employment  Agreement, dated as of August 1, 2002 between Prospect Medical Holdings, Inc.  and Jacob Y. Terner, M.D.(1)                                                                                                                                     |
|-------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.14 |   | Investment  Agreement dated as of July 31, 1996 between Jacob Y. Terner and Med-Search, Inc.(2)                                                                                                                                                                          |
| 10.15 |   | Agreement dated as of July 31,  1996 among Jacob Y. Terner and Barbara Noble, both individually and as  representative of Joseph W. Noble, M.D., deceased, and the Noble 1992 Family  Trust(2)                                                                                |
| 10.16 |   | Amended and Restated  Revolving Credit Agreement, dated as of July 3, 1999, between Prospect  Medical Holdings, Inc. and Imperial Bank(1)                                                                                                                                |
| 10.17 |   | First Amendment to  Amended and Restated Revolving Credit Agreement dated as of October 25,  2002 between Imperial Bank and Prospect Medical Holdings, Inc.(1)                                                                                                           |
| 10.18 |   | Third Amendment to  Amended and Restated Revolving Credit Agreement dated as of November 3,  2001 between Comerica Bank-California, successor-by-merger  to Imperial Bank and Prospect Medical Holdings, Inc.(1)                                                         |
| 10.19 |   | Fourth Amendment to  Amended and Restated Revolving Credit Agreement dated as of February 1,  2002 between Comerica Bank-California, successor-by-merger  to Imperial Bank and Prospect Medical Holdings, Inc.(1)                                                        |
| 10.20 |   | Fifth Amendment to  Amended and Restated Revolving Credit Agreement dated as of July 31,  2002 between Comerica Bank-California, successor-by-merger  to Imperial Bank and Prospect Medical Holdings, Inc.(1)                                                            |
| 10.21 |   | Sixth Amendment to  Amended and Restated Revolving Credit Agreement dated as of September 24,  2003, between Comerica Bank, successor-by-merger to Comerica Bank-California,  successor-by-merger to Imperial Bank, and Prospect Medical  Holdings, Inc.(1)              |
| 10.22 |   | Amended and Restated  Security Agreement dated as of September 24, 2003, between Prospect  Medical Holdings, Inc. and Comerica Bank, successor-by-merger  to Comerica Bank-California, successor-by-merger to  Imperial Bank(1)                                          |
| 10.23 |   | Continuing Guaranty,  dated as of July 3, 1997, executed by Prospect Medical Systems, Inc.  in favor of Imperial Bank(2)                                                                                                                                                 |
| 10.24 |   | Amended and Restated  Security Agreement (Prospect Medical Systems, Inc.) dated as of September 24,  2003, between Prospect Medical Systems, Inc. and Comerica Bank,  successor-by-merger to Comerica Bank-California, successor-by-merger  to Imperial Bank(1)     |
| 10.25 |   | Security Agreement—Stock  Pledge, dated as of July 3, 1997, between Prospect Medical Holdings, Inc.  and Imperial Bank(2)                                                                                                                                           |
| 10.26 |   | Security Agreement  (Physician Group), dated as of July 3, 1997, between Prospect Medical  Systems, Inc. and Prospect Medical Group, Inc.(2)                                                                                                                        |
| 10.27 |   | Amendment Number One to  Security Agreement dated as of July 6, 1999 between Prospect Medical  Systems, Inc. and Prospect Medical Group, Inc.(2)                                                                                                                    |
| 10.28 |   | Amended and Restated Warrant,  dated as of July 3, 1997, issued by Prospect Medical Holdings, Inc.  to Imperial Bank(2)                                                                                                                                                  |
| 10.29 |   | Warrant, dated as of July 3,  1999, issued by Prospect Medical Holdings, Inc. to Imperial Bancorp(2)                                                                                                                                                                     |
| 10.30 |   | Amended and Restated  Assignable Option Agreement made as of September 2, 1998 and deemed to  have been effective as of July 14, 1997, among Prospect Medical Systems, Inc.,  Prospect Medical Group, Inc. and Santa Ana/Tustin Physicians Group, Inc.(2) |
| 10.31 |   | Form of  Management Services Agreement dated as of January 1, 2001 between  Prospect Medical Systems, Inc. and Prospect Health Source Medical Group, Inc.(1)                                                                                                   |
| 10.32 |   | Form of Amendment  to Management Services Agreement dated as of November 1, 2002 between  Prospect Medical Systems, Inc. and Prospect Health Source Medical Group, Inc.(1)                                                                                     |

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| 10.33 |   | Form of Management  Services Agreement dated as of October 1, 2003, by and between Prospect  Medical Systems, Inc. and Prospect Professional Care Medical Group, Inc.(1)                                                                                                                                                                                           |
|-------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.34 |   | Form of Management  Services Agreement dated as of March 1, 2004 by and between Prospect  Medical Systems, Inc. and Prospect NWOC Medical Group, Inc.(1)                                                                                                                                                                                                           |
| 10.35 |   | Amendment Number One to  Security Agreement, dated as of July 14, 1997, between Prospect Medical  Systems, Inc. and Imperial Bank(2)                                                                                                                                                                                                                                         |
| 10.36 |   | Collateral Assignment of  Transaction Documents dated as of October 1, 2003, by and between  Prospect Medical Systems, Inc. and Comerica Bank(1)                                                                                                                                                                                                                             |
| 10.37 |   | Collateral Assignment of  Transaction Documents, dated as of July 14, 1997, between Prospect  Medical Systems, Inc. and Imperial Bank(2)                                                                                                                                                                                                                                     |
| 10.38 |   | Amendment Number One To  Collateral Assignment of Transaction Documents, dated as of January 26,  2000, between Prospect Medical Systems, Inc. and Imperial Bank(1)                                                                                                                                                                                                          |
| 10.39 |   | Security Agreement  (Physician Group), dated as of July 14, 1997, between Prospect Medical  Systems, Inc. and Santa Ana/Tustin Physicians Group, Inc.(2)                                                                                                                                                                                                                |
| 10.40 |   | Amendment Number One to  Security Agreement dated as of July 1, 1999 between Santa Ana/Tustin  Physicians Group, Inc. and Prospect Medical Systems, Inc.(1)                                                                                                                                                                                                             |
| 10.41 |   | Security Agreement dated  as of October 1, 2003, between Prospect Professional Care Medical Group, Inc.  and Prospect Medical Systems, Inc.(1)                                                                                                                                                                                                                          |
| 10.42 |   | Amended and Restated  Credit Succession Agreement, dated as of July 14, 1997, among Prospect  Medical Holdings, Inc., Gregg DeNicola, M.D., Santa Ana/Tustin  Physicians Group, Inc., Prospect Medical Systems, Inc., Prospect  Medical Group, Inc. and Imperial Bank(2)                                                                                      |
| 10.43 |   | Form of Amendment  Number One to Amended and Restated Credit Succession Agreement, dated as of April 6,  2000, among Jacob Y. Terner, M.D., Prospect Medical Holdings, Inc.,  Santa Ana/Tustin Physicians Group, Inc., Sierra Primary Care Medical  Group, Inc., Prospect Medical Systems, Inc., Prospect Medical Group, Inc.  and Imperial Bank(1) |
| 10.44 |   | Joinder Agreement, dated  as of January 26, 2000, among Sierra Medical Management, Inc.,  Jacob Y. Terner, M.D., Sierra Primary Care Medical Group, Inc., Gregg  DeNicola, M.D., Prospect Medical Systems, Inc., Prospect Medical Group,  Santa Ana/Tustin Physicians Group, Inc.(1)                                                                          |
| 10.45 |   | Amended and Restated  Assignable Option Agreement, made as of September 2, 1998 and deemed to  have been effective as of September 25, 1997, by and among Sierra  Primary Care Medical Group, Inc., Sierra Medical Management, Inc.  and Prospect Medical Group, Inc.(2)                                                                                      |
| 10.46 |   | Assignable Option  Agreement dated as of October 1, 2003, by and among Prospect Medical  Holdings, Inc., Prospect Professional Care Medical Group, Inc., and  Prospect Medical Group, Inc.(1)                                                                                                                                                                      |
| 10.47 |   | Intentionally Omitted.                                                                                                                                                                                                                                                                                                                                                                 |
| 10.48 |   | Form of Second  Amended and Restated Management Services Agreement, made as of September 15,  1998 and deemed to have been effective as of September 25, 1997, between  Sierra Medical Management, Inc. and Sierra Primary Care Medical Group, Inc.(1)                                                                                                        |
| 10.49 |   | Amendment to Management  Services Agreement, made as of October 1, 1998, between Sierra Medical  Management, Inc. and Sierra Primary Care Medical Group, Inc.(1)                                                                                                                                                                                                        |
| 10.50 |   | Continuing Guaranty,  dated as of September 25, 1997, delivered by Sierra Medical Management, Inc.  to Imperial Bank(2)                                                                                                                                                                                                                                                      |
| 10.51 |   | Amended and Restated  Security Agreement (Sierra Medical Management, Inc.), dated as of September 24,  2003, between Sierra Medical Management, Inc., and Comerica Bank,  successor-by-merger to Comerica Bank-California, successor-by-merger  to Imperial Bank(1)                                                                                                     |

 

----

| 10.52 |   | Security Agreement—Stock  Pledge, dated as of September 25, 1997, between Prospect Medical  Holdings, Inc. and Imperial Bank(2)                                                                                                                               |   |
|-------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| 10.53 |   | Collateral Assignment of  Transaction Documents, dated as of September 25, 1997, between Sierra  Medical Management, Inc. and Imperial Bank(2)                                                                                                                     |   |
| 10.54 |   | Security Agreement,  dated as of September 25, 1997, between Sierra Primary Care Medical  Group, Inc. and Sierra Medical Management, Inc.(2)                                                                                                                  |   |
| 10.55 |   | Amendment Number  One to Security Agreement dated as of September 6, 1999 between Sierra  Primary Care Medical Group, Inc. and Sierra Medical  Management, Inc.(1)                                                                                            |   |
| 10.56 |   | Intentionally Omitted.                                                                                                                                                                                                                                                       |   |
| 10.57 |   | Form of Amended and  Restated Management Services Agreement, made as of September 15, 1998  and deemed to have been effective as of October 31, 1997, by and between  Sierra Medical Management, Inc. and Pegasus Medical Group, Inc.(1)            |   |
| 10.58 |   | Amendment to Management  Services Agreement made as of October 1, 1998, by and between Sierra  Medical Management, Inc. and Pegasus Medical Group, Inc.(1)                                                                                                    |   |
| 10.59 |   | Amended and Restated  Assignable Option Agreement, made as of September 2, 1998 and deemed to  have been effective as of October 31, 1997, among Sierra Medical  Management, Inc., Pegasus Medical Group, Inc. and Prospect Medical  Group, Inc.(2) |   |
| 10.60 |   | Assignment and  Assumption Agreement, by Marvin L. Ginsburg, M.D. Medical Corporation d/b/a  A.V. Western Medical Group, Inc. to Pegasus Medical Group, Inc.(2)                                                                                                    |   |
| 10.61 |   | Collateral Assignment of  Transaction Documents, dated as of October 31, 1997, between Sierra  Medical Management, Inc. and Imperial Bank(2)                                                                                                                       |   |
| 10.62 |   | Security Agreement  (Physician Group), dated as of October 31, 1997, between Pegasus Medical  Group, Inc. and Sierra Medical Management, Inc.(2)                                                                                                              |   |
| 10.63 |   | Amendment Number One to  Security Agreement dated as of July 6, 1999 between Pegasus Medical  Group, Inc. and Sierra Medical Management, Inc.(1)                                                                                                              |   |
| 10.64 |   | Intentionally Omitted.                                                                                                                                                                                                                                                       |   |
| 10.65 |   | Form of $11,500,000  Amended and Restated Secured Revolving Note, dated July 3, 1999,  executed by Prospect Medical Holdings, Inc. and made payable to Imperial  Bank(1)                                                                                      |   |
| 10.66 |   | First Amendment to  Amended and Restated Secured Revolving Note dated as of October 25, 2000  between Imperial Bank and Prospect Medical Holdings, Inc.(1)                                                                                                         |   |
| 10.67 |   | Third Amendment to  Amended and Restated Secured Revolving Note dated as of October 25, 2000  between Comerica Bank-California, successor by merger to Imperial Bank  and Prospect Medical Holdings, Inc.(1)                                                       |   |
| 10.68 |   | Fifth Amendment  to Amended and Restated Secured Revolving Note dated as of September 24,  2003, between Comerica Bank, successor-by-merger to Comerica Bank-California,  successor-by-merger to Imperial Bank, and Prospect Medical  Holdings, Inc.(1)            |
| 10.69 |   | Term Loan Note dated October 25,  2000 in the original principal amount of $5,000,000 by Prospect Medical  Holdings, Inc. in favor of Imperial Bank(1)                                                                                                             |
| 10.70 |   | First Amendment to Term  Loan Note entered into as of November 3, 2001 between Comerica Bank-California,  successor-by-merger to Imperial Bank and Prospect Medical  Holdings, Inc.(1)                                                                             |
| 10.71 |   | Second Amendment to Term  Loan Note entered into as of February 1, 2002 between Comerica Bank-California,  successor by merger to Imperial Bank and Prospect Medical Holdings, Inc.(1)                                                                             |
| 10.72 |   | Third Amendment to Term  Loan Note dated as of July 12, 2002 between Comerica Bank-California,  successor by merger to Imperial Bank and Prospect Medical Holdings, Inc.(1)                                                                                        |
| 10.73 |   | Fourth Amendment to Term  Loan Note dated as of September 24, 2003, between Comerica Bank,  successor-by-merger to Comerica Bank-California, successor-by-merger  to Imperial Bank, and Prospect Medical Holdings, Inc.(1)                                         |
|       |        |                                                                                                                                                                                                                                                                              |        |  |  |

----

 

| 10.74 |   | Amended and Restated  Warrant, issued as of February 6, 1998, by Prospect Medical Holdings, Inc.  to Imperial Bank.(2)                                                                                                                                                                                                                                                                                                                                                                                                 |
|-------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.75 |   | Consulting Agreement,  dated as of March 1, 1998, between Sierra Primary Care Medical Group, Inc.  and Sinnadurai E. Moorthy, M.D.(2)                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.76 |   | Employment Agreement  made as of April 8, 2004, but effective on April 19, 2004, between  Prospect Medical Holdings, Inc. and Mike Heather(1)                                                                                                                                                                                                                                                                                                                                                                     |
| 10.77 |   | Form of Partnership  Agreement dated July 1, 1999 between AMVI/MC Health Network, Inc.  and Santa Ana/Tustin Physicians Group(1)                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.78 |   | Intentionally Omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.79 |   | Forbearance Agreement,  dated as of January 25, 2002, between Prospect Medical Group, Inc.  and Prospect Medical Holdings, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                |
| 10.80 |   | Amendment to Forbearance  Agreement, effective May 30, 2003, between Prospect Medical Group, Inc.  and Prospect Medical Holdings, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                         |
| 10.81 |   | Collateral Substitution  Agreement, dated as of January 25, 2002, between Prospect Medical Group, Inc.,  Prospect Medical Holdings, Inc., Foothill City, Ltd.(1)                                                                                                                                                                                                                                                                                                                                                  |
| 10.82 |   | Continuing Guaranty,  effective May 30, 2003, by Jacob Y. Terner, M.D., in favor of Prospect  Medical Group, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.83 |   | Amendment to Collateral  Substitution Agreement, effective May 30, 2003, among Prospect Medical  Group, Inc., Prospect Medical Holdings, Inc., and Jacob Y. Terner,  M.D.(1)                                                                                                                                                                                                                                                                                                                                      |
| 10.84 |   | Pledge Agreement,  effective May 30, 2003, between Prospect Medical Group, Inc. and  Jacob Y. Terner, M.D.(1)                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.85 |   | Form of Placement  Agency Agreement, dated November 1, 2003, between Prospect Medical  Holdings, Inc. and Spencer Trask Ventures, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                    |
| 10.86 |   | Form of Amendment No. 1  to Placement Agency Agreement, dated December 30, 2003, between Prospect  Medical Holdings, Inc. and Spencer Trask Ventures, Inc.(1)                                                                                                                                                                                                                                                                                                                                           |
| 10.87 |   | Form of Finder’s  Fee Agreement, dated January 15, 2004, between Prospect Medical Holdings, Inc.  and Spencer Trask Ventures, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                   |
| 10.88 |   | Intentionally Omitted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.89 |   | Form of  Stockholders’ Agreement, dated January 15, 2004, by and among Prospect  Medical Holdings, Inc., Spencer Trask Ventures, Inc., private  placement purchasers of Series A Preferred Stock, “management  stockholders” including Jacob Y. Terner, M.D., Catherine Dickson, Donna  Vigil, R. Stewart Kahn and Linda Hodges, and “principal stockholders”  including Spencer Trask Venture Investment Partners LLC, Paul Amir and the  Herta and Paul Amir Family Trust(1) |
| 10.90 |   | Prospect Medical  Holdings, Inc. 1998 Stock Option Plan(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.91 |   | First Amendment to  Prospect Medical Holdings, Inc. 1998 Stock Option Plan(1)                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.92 |   | Participating Physician  Group Provider Services Agreement, effective March 1, 1999, between the  Foundation Health Systems Affiliate(s) identified in Addendum A to the  Agreement and Professional Care Medical Group IPA, a Participating Physician  Group (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(1)                                      |
| 10.93 |   | Health Net  Medicare+Choice (M+C) Addendum to the March 1, 1999 Participating  Physician Group Provider Agreement between Health Net and Professional Care  Medical Group IPA, effective October 1, 1999 (Certain portions of this Exhibit have  been omitted subject to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities  Exchange Act of 1934)(1)                                                                                          |

 

----

 

| 10.94  |   | Amendment to the March 1,  1999 Participating Physician Group Provider Services Agreement between Professional  Care Medical Group IPA and Foundation Health Systems, Inc., effective July 1,  2000 (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(1)                                                                                  |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.95  |   | Amendment to the March 1,  1999 Participating Physician Group Provider Services Agreement and all  subsequent Amendments between Professional Care Medical Group IPA and Health  Net Inc. Affiliates, formerly known as Foundation Health Systems Affiliates,  effective October 1, 2002 (Certain portions of this Exhibit have  been omitted subject to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities  Exchange Act of 1934)(1) |
| 10.96  |   | Amendment to the March 1,  1999 Participating Physician Group Provider Services Agreement, between  Professional Care Medical Group, IPA, and Health Net, Inc. Affiliates,  effective April 14, 2003(1)                                                                                                                                                                                                                                                                                                  |
| 10.97  |   | Assignment and  Delegation of Participating Physician Group Provider Services Agreement and  Consent to Assignment, effective as of October 1, 2003, between  Professional Care Medical Group, IPA, Prospect Medical Group, and Health Net, Inc.  Affiliates(1)                                                                                                                                                                                                                                               |
| 10.98  |   | Amendment to the March 1,  1999 Participating Physician Group Provider Services Agreement between  Professional Care Medical Group, IPA and Health Net, Inc. Affiliates, as  subsequently amended, effective January 1, 2004 (Certain portions of  this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(1)                                                        |
| 10.99  |   | CaliforniaCare Medical  Services Agreement, effective November 1, 1999, between Blue Cross of  California and Affiliates and Professional Care IPA Medical Group, Inc.  (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(4)                                                                                                                   |
| 10.100 |   | Amendment to the November 1, 1999 Blue Cross  Medical Services Agreement between Blue Cross of California and its  Affiliates and Professional Care IPA Medical Group executed November 29,  1999 and November 19, 1999, respectively(1)                                                                                                                                                                                                                                                                 |
| 10.101 |   | Amendment to the November 1,  1999 CaliforniaCare Medical Services Agreement between Blue Cross of  California and its Affiliates and Professional Care IPA Medical Group, Inc.  executed December 13, 1999 and November 30, 1999, respectively  (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(1)                                |
| 10.102 |   | Amendment to the November 1,  1999 CaliforniaCare Medical Services Agreement between Blue Cross of  California and its Affiliates and Professional Care IPA, effective as of January 1,  2002 (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(1)                                                                                             |
| 10.103 |   | Business Associate  Amendment supplementing November 1, 1999 CaliforniaCare Medical Services  Agreement between Blue Cross of California and Professional Care IPA,  effective April 14, 2003(1)                                                                                                                                                                                                                                                                                                              |
| 10.104 |   | Assignment and Consent  to Assignment between Professional Care IPA Medical Group, Inc.,  Prospect Medical Group, Inc. and Blue Cross of California and its  Affiliates, effective October 1, 2003(1)                                                                                                                                                                                                                                                                                                    |
| 10.105 |   | Blue Cross Senior Secure  Medicare+Choice Medical Services Agreement, effective November 1, 1999,  between Blue Cross of California and Affiliates and Professional Care IPA  Medical Group, Inc. (Certain portions of this Exhibit have been  omitted subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(1)                                                                                        |

----

 

| 10.106 |   | Amendment to November 1,  1999 Blue Cross Senior Secure Medicare Risk Professional Services executed December 3,  1999 and November 19, 1999, respectively(1)                                                                                                                                                                                                                                                                                                                 |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.107 |   | Assignment and Consent  to Assignment, effective October 1, 2003, between Professional Care IPA  Medical Group, Inc., Prospect Medical Group, Inc. and Blue Cross of  California and its Affiliates(1)                                                                                                                                                                                                                                                                        |
| 10.108 |   | AIM Medical Services  Agreement, effective May 1, 2001, between Blue Cross of California and  Affiliates and Professional Care IPA Medical Group (Certain portions of this Exhibit have  been omitted subject to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities  Exchange Act of 1934)(4)                                                                                                                   |
| 10.109 |   | PacifiCare of California  Medical Group/IPA Services Agreement (Professional Capitation), effective June 1,  1999, between PacifiCare of California, Inc. and Professional Care IPA  Medical Group (Certain portions of this Exhibit have been omitted  subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(3)                                                            |
| 10.110 |   | Amendment Number One to  the June 1, 1999 PacifiCare of California Medical Group/IPA Services  Agreement (Professional Capitation) between PacifiCare of California, Inc.  and Professional Care IPA Medical Group, effective June 1, 1999 (Certain  portions of this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)               |
| 10.111 |   | Amendment Number 1 to the June 1, 1999  PacifiCare of California Medical Group/IPA Services Agreement (Professional  Capitation) between PacifiCare of California and Professional Care IPA  Medical Group, effective January 1, 2002 (Certain portions of this Exhibit have  been omitted subject to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities  Exchange Act of 1934)(3)                         |
| 10.112 |   | Amendment to the June 1,  1999 PacifiCare of California Medical Group/IPA Services Agreement  (Professional Capitation) between PacifiCare of California and Professional  Care IPA Medical Group, effective January 1, 2003 (Certain portions of  this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                                  |
| 10.113 |   | Claims Management Agreement, among Prospect Medical  Group, Professional Care IPA Medical Group and PacifiCare of California,  effective October 1, 2003(3)                                                                                                                                                                                                                                                                                                                             |
| 10.114 |   | Notice Amendment to the June 1,  1999 PacifiCare of California Medical Group/IPA Services (Professional  Capitation) Agreement, effective January 1, 2004(3)                                                                                                                                                                                                                                                                                                                       |
| 10.115 |   | HMO IPA Agreement,  effective January 1, 2003, between Professional Care IPA Medical Group  and California Physicians’ Service dba Blue Shield of California (Certain  portions of this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                                                                                                  |
| 10.116 |   | Amendment No. 1 to  HMO IPA/Medical Group Shared Provider Agreement between California Physicians’  Service dba Blue Shield of California and Professional Care IPA Medical  Group, effective January 1, 2003 (Certain portions of this Exhibit have  been omitted subject to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities  Exchange Act of 1934)(3)                                            |
| 10.117 |   | Participating Physician  Group Provider Services Agreement, effective January 1, 1998, between  the Foundation Health Systems Affiliate(s) identified in Addendum A to  the Agreement and Prospect Medical Group, Inc., a Participating  Physician Group (Certain portions of this Exhibit have been omitted  subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(4) |

 

----

 

| 10.118 |   | Amendment to the January 1,  1998 Participating Physician Group Provider Services Agreement between  Prospect Medical Group and Foundation Health Systems Affiliate(s), effective January 1,  1998(3)                                                                                                                                                                                                                  |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.119 |   | Amendment to the January 1,  1998 Participating Physician Group Provider Services Agreement between  Prospect Medical Group and Foundation Health Systems Affiliates, effective July 1,  2000 (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)      |
| 10.120 |   | Amendment to the January 1,  1998 Participating Physician Group Provider Services Agreement, between  Prospect Medical Group and Health Net, Inc. Affiliates, effective February 19,  2001(3)                                                                                                                                                                                                                     |
| 10.121 |   | Amendment to the January 1,  1998 Participating Physician Group Provider Services Agreement between  Prospect Medical Group and Foundation Health Systems Affiliate(s), effective October 1,  2001 (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3) |
| 10.122 |   | Amendment to the January 1, 1998 Participating  Physician Group Provider Services Agreement between Prospect Medical Group  and Health Net, Inc. Affiliates, effective April 1, 2003 (Certain  portions of this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)         |
| 10.123 |   | CaliforniaCare Medical  Services Agreement, effective on January 1, 1997, between Blue Cross of  California and Affiliates and Prospect Medical Group (Certain portions of  this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(4)                                                  |
| 10.124 |   | Letter of Agreement  Serving as Addendum to the January 1, 1997 CaliforniaCare Medical  Services Agreement between Blue Cross of California and Prospect Medical  Group, effective January 1, 1997(3)                                                                                                                                                                                                                  |
| 10.125 |   | Letter of Agreement Serving as Addendum to the January 1,  1997 CaliforniaCare Medical Services Agreement between Blue Cross of  California and Prospect Medical Group, effective January 1, 1997  (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3) |
| 10.126 |   | Amendment to the January 1,  1997 CaliforniaCare Medical Services Agreement between Blue Cross of  California and Affiliates and Prospect Medical Group, effective May 1,  1997(3)                                                                                                                                                                                                                                     |
| 10.127 |   | Amendment to the January 1,  1997 CaliforniaCare Medical Services Agreement between Blue Cross of California  and Affiliates and Prospect Medical Group, effective May 1, 1997(3)                                                                                                                                                                                                                                      |
| 10.128 |   | Amendment to the January 1,  1997 CaliforniaCare Medical Services Agreement between Blue Cross of  California and its Affiliates and Prospect Medical Group, effective August 1,  1997 (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)             |
| 10.129 |   | Amendment to the January 1,  1997 CaliforniaCare Medical Services Agreement by and between Blue Cross of  California and its Affiliates and Prospect Medical Group, effective July 1,  1999(3)                                                                                                                                                                                                                         |
| 10.130 |   | Amendment to the January 1,  1997 CaliforniaCare Medical Services Agreement by and between Blue Cross of  California and its Affiliates and Prospect Medical Group, effective January 1,  1999(3)                                                                                                                                                                                                                      |

----

 

| 10.131 |   | Amendment to the January 1,  1997 CaliforniaCare Medical Services Agreement between Blue Cross of  California and its Affiliates and Prospect Medical Group, effective January 1,  2001 (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                                                                     |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.132 |   | PacifiCare of California  Medical Group/IPA Services Agreement (Professional Capitation), effective January 1,  2001, between PacifiCare of California, Inc. and Prospect Medical Group  (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                                                                    |
| 10.133 |   | First Amendment to January 1, 2001 PacifiCare  of California Medical Group/IPA Services Agreement (Professional Capitation)  between PacifiCare of California, Inc. and Prospect Medical Group,  effective January 1, 2002 (Certain portions of this Exhibit have  been omitted subject to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities  Exchange Act of 1934)(3)                            |
| 10.134 |   | Second Amendment to January 1,  2001 PacifiCare of California Medical Group/IPA Services Agreement  (Professional Capitation) between PacifiCare of California, Inc. and  Prospect Medical Group, effective January 1, 2003 (Certain portions of  this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                           |
| 10.135 |   | Notice Amendment to the January 1,  2001 PacifiCare of California Medical Group/IPA Services Agreement  (Professional Capitation)(3)                                                                                                                                                                                                                                                                                                                                                 |
| 10.136 |   | HMO IPA/Medical Group Shared Savings Provider  Agreement between Prospect Medical Group Inc. and California Physicians’  Service, Inc. dba Blue Shield of California dated November 12, 2003  (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                                                          |
| 10.137 |   | HMO IPA Agreement,  effective November 1, 1995, between California Physicians’ Service dba  Blue Shield of California and Prospect Medical Group, Inc. (Certain  portions of this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                                                                                                |
| 10.138 |   | Participating Physician  Group Provider Services Agreement, effective January 1, 1998, between  the Foundation Health Systems Affiliate(s) identified in Addendum A to  the Agreement and Sierra Medical Group, Inc., a Participating Physician  Group (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3) |
| 10.139 |   | Amendment to the January 1,  1998 Participating Physician Group Provider Services Agreement between  Prospect Medical Group, Inc. on behalf of Sierra Medical Group and  Foundation Health Systems Affiliate(s), effective November 1, 2000  (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)           |
| 10.140 |   | Amendment to the January 1,  1998 Participating Physician Group Provider Services Agreement between Sierra  Medical Group and Health Net, Inc. Affiliates, effective January 1,  2003 (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                                                                  |
| 10.141 |   | PacifiCare of California  Medical Group/IPA Services Agreement (Professional Capitation) effective July 1,  1999, between PacifiCare of California, Inc. and Sierra Medical Group  (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                                                                          |

----

 

| 10.142 |   | 2001 Amendment to the July 1,  1999 PacifiCare of California Medical Group/IPA Services Agreement  (Professional Capitation) between PacifiCare of California, Inc. and  Sierra Medical Group, effective January 1, 2001 (Certain portions of  this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                              |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.143 |   | Express Referrals  Amendment to the July 1, 1999 PacifiCare of California Medical Group/IPA  Services Agreement (Professional Capitation) between PacifiCare of California, Inc.  and Sierra Medical Group, effective October 1, 2002(3)                                                                                                                                                                                                                                   |
| 10.144 |   | Third Amendment to the July 1,  1999 PacifiCare of California Medical Group/IPA Services Agreement  (Professional Capitation) between PacifiCare of California, Inc. and  Sierra Medical Group, effective January 1, 2003 (Certain portions of  this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                             |
| 10.145 |   | Participating Physician Group Provider Services  Agreement, effective June 1, 1998, between the Foundation Health Systems  Affiliate(s) identified in Addendum A to the Agreement and A.V. Medical  Group, a Participating Physician Group (Certain portions of this Exhibit have  been omitted subject to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities  Exchange Act of 1934)(3)                 |
| 10.146 |   | Amendment to the June 1,  1998 Participating Physician Group Provider Services Agreement between A.V.  Medical Group and Foundation Health Systems Affiliate(s), effective July 1,  1999(3)                                                                                                                                                                                                                                                                                     |
| 10.147 |   | Amendment to the June 1,  1998 Participating Physician Group Provider Services Agreement between A.V.  Medical Group and Foundation Health Systems, effective November 1, 2000  (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                                                                             |
| 10.148 |   | Amendment to the June 1,  1998 Participating Physician Group Provider Services Agreement between A.V.  Medical Group and Health Net, Inc. Affiliates, effective March 1,  2003 (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                                                                         |
| 10.149 |   | Participating Physician  Group Provider Services Agreement, effective June 1, 2001, between the  Health Net, Inc. Affiliate(s) identified in Addendum A to the  Agreement and Northwest Orange County Medical Group, a Participating  Physician Group (Certain portions of this Exhibit have been omitted  subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(3) |
| 10.150 |   | CaliforniaCare Medical  Services Agreement, effective January 1, 1997, between Blue Cross of  California and Affiliates and Northwest Orange County Medical Group (Certain  portions of this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                                                                                               |
| 10.151 |   | Amendment to the January 1,  1997 CaliforniaCare Medical Services Agreement between Blue Cross of  California and Affiliates and Northwest Orange County Medical Group, Inc.,  effective January 1, 1998(3)                                                                                                                                                                                                                                                           |
| 10.152 |   | Amendment to the January 1,  1997 CaliforniaCare Medical Services Agreement between Blue Cross of  California and its Affiliates and Northwest Orange County Medical Group,  effective January 1, 1999(3)                                                                                                                                                                                                                                                                  |

 

----

 

| 10.153 |   | Amendment to the January 1,  1997 CaliforniaCare Medical Services Agreement between Blue Cross of  California and its Affiliates and Northwest Orange County Medical Group, Inc.,  effective January 1, 2003 (Certain portions of this Exhibit have  been omitted subject to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities  Exchange Act of 1934)(3)                              |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.154 |   | PacifiCare of California  Medical Group/IPA Services Agreement (Split Capitation), effective January 1,  2001, between PacifiCare of California, Inc. and Northwest Orange County  Medical Group (Certain portions of this Exhibit have been omitted  subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(3)                                               |
| 10.155 |   | Amendment Number 1 to January 1, 2001  PacifiCare of California Medical Group/IPA Services Agreement (Split  Capitation) between PacifiCare of California and Northwest Orange County  Medical Group, effective January 1, 2003 (Certain portions of this Exhibit have  been omitted subject to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities  Exchange Act of 1934)(3)                |
| 10.156 |   | Amendment Number 4 to  PacifiCare of California Medical Group/IPA Services Agreement (Split  Capitation) between PacifiCare of California and Northwest Orange County  Medical Group, effective January 1, 2004 (Certain portions of this Exhibit have  been omitted subject to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities  Exchange Act of 1934)(3)                                     |
| 10.157 |   | Health Plan and  Physician Group Service Agreement, effective September 1, 1990, between  CareAmerica Southern California, Inc. and Northwest Orange County  Medical Group (Certain portions of this Exhibit have been omitted  subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(3)                                                                     |
| 10.158 |   | Amendment to September 1,  1990 Medicare+Choice Physician Group Service Agreement between California  Physicians’ Service, Inc. dba Blue Shield of California and Northwest  Orange County Medical Group, effective September 1, 1999(3)                                                                                                                                                                                                                  |
| 10.159 |   | Amendment to September 1,  1990 Medicare+Choice Physician Group Service Agreement between California  Physicians’ Service, Inc. dba Blue Shield of California and Northwest  Orange County Medical Group, effective December 1, 1999(3)                                                                                                                                                                                                                   |
| 10.160 |   | Amendment to September 1,  1990 Medicare+Choice Physician Group Service Agreement between California  Physicians’ Service, Inc. dba Blue Shield of California and Northwest  Orange County Medical Group, effective December 1, 2000 (Certain  portions of this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3) |
| 10.161 |   | Amendment to September 1,  1990 Medicare+Choice Physician Group Service Agreement between California  Physicians’ Service, Inc. dba Blue Shield of California and Northwest  Orange County Medical Group, effective January 1, 2002 (Certain portions  of this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)  |
| 10.162 |   | Amendment to September 1, 1990 Medicare+Choice  Physician Group Service Agreement between California Physicians’ Service, Inc.  dba Blue Shield of California and Northwest Orange County Medical Group,  effective May 1, 2002 (Certain portions of this Exhibit have been  omitted subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(3)      |

 

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| 10.163 |   | HMO IPA/Medical Group Shared Savings Provider  Agreement, effective February 1, 2003, between Northwest Orange County  Medical Group and California Physicians’ Service, Inc., dba Blue Shield  of California (Certain portions of this Exhibit have been omitted  subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(3)                             |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.164 |   | Amendment to HMO  IPA/Medical Group Shared Savings Provider Agreement between California Physicians’  Service dba Blue Shield of California and Northwest Orange County Medical  Group, effective February 1, 2003 (Certain portions of this Exhibit have  been omitted subject to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities  Exchange Act of 1934)(3)                             |
| 10.165 |   | CaliforniaCare Medical  Services Agreement, effective January 1, 2001, between Blue Cross of  California and Affiliates and Prospect Health Source Medical Group (Certain  portions of this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                                                                                    |
| 10.166 |   | Letter of Agreement  Serving as Addendum to the January 1, 2001 California Care Medical  Services Agreement between Blue Cross of California and Prospect Health  Source Medical Group, effective January 1, 2001 (Certain portions of  this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                              |
| 10.167 |   | Amendment to the January 1,  2001 CaliforniaCare Medical Services Agreement between Blue Cross of  California and its Affiliates and Prospect Health Source Medical Group, effective  January 1, 2001 (Certain portions of this Exhibit have been omitted  subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(3)                                          |
| 10.168 |   | PacifiCare of California  Medical Group/IPA Services Agreement (Professional Capitation), effective January 1,  2001, between PacifiCare of California, Inc. and Prospect Health Source  Medical Group (Certain portions of this Exhibit have been omitted  subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(3)                                         |
| 10.169 |   | First Amendment to January 1,  2001 PacifiCare of California Medical Group/IPA Services Agreement  (Professional Capitation) between PacifiCare of California, Inc. and  Prospect Health Source Medical Group, effective January 1, 2002 (Certain  portions of this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)  |
| 10.170 |   | Second Amendment to January 1,  2001 PacifiCare of California Medical Group/IPA Services Agreement  (Professional Capitation) between PacifiCare of California, Inc. and  Prospect Health Source Medical Group, effective January 1, 2003 (Certain  portions of this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3) |
| 10.171 |   | HMO IPA/Medical Group  Shared Savings Provider Agreement, effective July 1, 2003, between  Prospect Health Source Medical Group and California Physicians’ Service, Inc.  dba Blue Shield of California (Certain portions of this Exhibit have  been omitted subject to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities  Exchange Act of 1934)(3)                                   |
| 10.172 |   | Amendment No. 1 to July 1,  2003 HMO IPA/Medical Group Shared Savings Provider Agreement between Prospect  Health Source Medical Group and California Physicians’ Service, Inc. dba  Blue Shield of California, effective July 1, 2003(3)                                                                                                                                                                                                            |
|        |        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |  |  |

----

 

| 10.173 |   | Participating Physician Group Provider Services  Agreement, effective March 1, 1999, between the Foundation Health  Systems Affiliate(s) identified in Addendum A to the Agreement and  StarCare Medical Group dba Gateway Medical Group, a Participating Physician  Group (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3) |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.174 |   | Health Net  Medicare+Choice (M+C) Addendum to the March 1, 1999 Participating  Physician Group Provider Services Agreement between Health Net and StarCare  Medical Group dba Gateway Medical Group, effective October 1, 1999(3)                                                                                                                                                                                                                                                              |
| 10.175 |   | Amendment to the  Participating Physician Group Provider Services Agreement between Foundation  Health Systems Affiliates and StarCare Medical Group dba Gateway Medical  Group, effective July 1, 2000 (Certain portions of this Exhibit have  been omitted subject to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities  Exchange Act of 1934)(3)                                                                        |
| 10.176 |   | Amendment to the  Participating Physician Group Provider Services Agreement between Foundation  Health Systems Affiliates and StarCare Medical Group dba Gateway Medical  Group, effective October 10, 2000 (Certain portions of this Exhibit have  been omitted subject to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities  Exchange Act of 1934)(3)                                                                    |
| 10.177 |   | Amendment to the  Participating Physician Group Provider Services Agreement between Health Net  Inc., Affiliates and StarCare Medical Group dba Gateway Medical Group,  effective February 1, 2002 (Certain portions of this Exhibit have  been omitted subject to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities  Exchange Act of 1934)(3)                                                                             |
| 10.178 |   | CaliforniaCare Medical  Services Agreement, effective January 1, 1997, between Blue Cross of  California and Affiliates and Gateway Medical Group (Certain portions of this  Exhibit have been omitted subject to an application for confidential  treatment filed with the Commission pursuant to Rule 24b-2 under  the Securities Exchange Act of 1934)(4)                                                                                                                              |
| 10.179 |   | Letter of Agreement  Serving as Addendum to the January 1, 1997 CaliforniaCare Medical  Services Agreement between Blue Cross of California and Gateway Medical  Group, effective January 1, 1997 (Certain portions of this Exhibit have  been omitted subject to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities  Exchange Act of 1934)(3)                                                                         |
| 10.180 |   | Letter of Agreement  Serving as Addendum to the January 1, 1997 CaliforniaCare Medical  Services Agreement between Blue Cross of California and Gateway Medical Group  (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                                                                                                          |
| 10.181 |   | Amendment to the January 1,  2000 CaliforniaCare Medical Services Agreement between Blue Cross of  California and StarCare Medical Group dba Gateway Medical Group, Inc.,  effective January 1, 2000 (Certain portions of this Exhibit have  been omitted subject to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities  Exchange Act of 1934)(3)                                                                 |
| 10.182 |   | Amendment to the January 1, 2000 CaliforniaCare  Medical Services Agreement between Blue Cross of California and Gateway  Medical Group, effective July 1, 2000 (Certain portions of this Exhibit have  been omitted subject to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities  Exchange Act of 1934)(3)                                                                                                           |

----

 

| 10.183 |   | Amendment to the January 1,  2000 CaliforniaCare Medical Services Agreement between Blue Cross of  California and StarCare Medical Group dba Gateway Medical Group, Inc.,  effective January 1, 2002 (Certain portions of this Exhibit have  been omitted subject to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities  Exchange Act of 1934)(3)                                          |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.184 |   | Californiakids Medical  Services Agreement, effective February 1, 2000, between Blue Cross of  California and Affiliates and Gateway Medical Group, Inc. (Certain  portions of this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)                                                                                           |
| 10.185 |   | Amendment to the January 1,  2000 Blue Cross Senior Secure Medicare+Choice Medical Services Agreement  between Blue Cross of California and Affiliates and StarCare Medical Group  dba Gateway Medical Group, Inc., effective January 1, 2002 (Certain  portions of this Exhibit have been omitted subject to an application for  confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3) |
| 10.186 |   | HMO IPA/Medical  Group Shared Savings Provider Agreement, effective January 1, 2002,  between Starcare Medical Group Inc., dba Gateway Medical Group, Inc. and  California Physicians’ Service, Inc., dba Blue Shield of California  (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)      |
| 10.187 |   | First Amendment to January 1,  2002 HMO IPA/Medical Group Shared Savings Provider Agreement between Starcare  Medical Group Inc., dba Gateway Medical Group, Inc. and California  Physicians’ Service, Inc., dba Blue Shield of California effective February 1,  2002(3)                                                                                                                                                                                |
| 10.188 |   | PacifiCare of California  Medical Group/IPA Services Agreement (Professional Capitation), effective January 1,  2001, between PacifiCare of California, Inc. and Gateway Physicians  Medical Associates, Inc. (Certain portions of this Exhibit have  been omitted subject to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities  Exchange Act of 1934(3)                                  |
| 10.189 |   | Amendment Number 1 to January 1,  2001 PacifiCare of California Medical Group/IPA Services Agreement  (Professional Capitation) between PacifiCare of California and Gateway  Physicians Medical Associates, Inc., effective January 1, 2002  (Certain portions of this Exhibit have been omitted subject to an  application for confidential treatment filed with the Commission pursuant to Rule 24b-2  under the Securities Exchange Act of 1934)(3)  |
| 10.190 |   | Business Associate  Amendment to the January 1, 2001 PacifiCare of California Medical  Group/IPA Services Agreement between PacifiCare of California, Inc. and  Gateway Physicians Medical Associates, Inc.(3)                                                                                                                                                                                                                                                     |
| 10.191 |   | Letter Amendment to the January 1,  2001 PacifiCare of California Medical Group/IPA Services Agreement between  PacifiCare of California, Inc. and Gateway Physicians Medical Associates, Inc.,  dated November 15, 2002 (Certain portions of this Exhibit have been  omitted subject to an application for confidential treatment filed with the  Commission pursuant to Rule 24b-2 under the Securities Exchange  Act of 1934)(3)                 |
| 10.192 |   | Amendment Number 2 to the January 1, 2001  PacifiCare of California Medical Group/IPA (Professional Capitation) Services  Agreement, between PacifiCare of California and Gateway Physicians Medical  Associates, effective January 1, 2003 (Certain portions of this Exhibit have  been omitted subject to an application for confidential treatment filed with  the Commission pursuant to Rule 24b-2 under the Securities  Exchange Act of 1934)(3)        |
| 10.193 |   | Form of  Subscription Agreement dated as of January 15, 2004 between Prospect  Medical Holdings and each purchaser of preferred stock(4)                                                                                                                                                                                                                                                                                                                                |
| 10.194 |   | Form of Cash Management  Agreement among Prospect Medical Systems, Inc., Prospect Medical  Holdings, Inc., and Prospect Medical Group, Inc., effective as of June 6,  1996(4)                                                                                                                                                                                                                                                                            |
| 10.195 |   | Second Amendment to  Prospect Medical Holdings, Inc. 1998 Stock Option Plan(5)                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.196 |   | Amended and Restated Assignable Option Agreement dated September 27,  2004, by and among Prospect Medical Systems, Inc., Prospect  Medical Group, Inc.,and Jacob Y. Terner, M.D.(5)                                                                                                                                                                                                                                                                           |

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| 10.197 |       | Management  Services Agreement effective as of May 19, 2003, by and between Sierra  Medical Management, Inc. and Antelope Valley Medical Associates, Inc.(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.198 |       | Amendment to Management  Agreement, effective as of February 1, 2004 to that certain Management  Agreement made and entered into as of January 1, 2003, entered into by  and between Pinnacle Health Resources and StarCare Medical Group, Inc.  dba Gateway Medical Group, Inc.(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.199 |       | Amendment to Management  Agreement, effective as of February 1, 2004 to that certain Management  Agreement made and entered into as of January 1, 2003, entered into by  and between Pinnacle Health Resources and APAC Medical Group, Inc. dba  Gateway Physicians Medical Associates, Inc.(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.200 | ** ** | Security Agreement,  effective as of March 1, 2004, entered into between Prospect NWOC  Medical Group, Inc. dba Prospect Northwest Orange County Medical Group, Inc.,  and Prospect Medical Systems, Inc.(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.201 | ** ** | Security Agreement,  effective as of January 1, 2001, entered into between Prospect Health  Source Medical Group, Inc. and Prospect Medical Systems, Inc.(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.202 | ** ** | Security Agreement,  effective as of February 1, 2004, entered into between StarCare Medical  Group, Inc. dba Gateway Medical Group, Inc. and Pinnacle Health  Resources(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.203 | ** ** | Security Agreement  effective as of February 1, 2004, entered into between APAC Medical  Group, Inc. dba Gateway Physicians Medical Associates, Inc. and  Pinnacle Health Resources(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.204 | ** ** | Security Agreement,  effective as of August 1, 1999, entered into between Nuestra Familia  Medical Group and Prospect Medical Systems, Inc.(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.205 |       | Omnibus Amendment to  Security Agreements dated as of September 27, 2004, entered into by and  among Prospect Medical Systems, Inc., Sierra Medical Management, Inc.,  Pinnacle Health Resources, Prospect Medical Group, Inc., Santa/Ana Tustin  Physicians Group, Inc., Sierra Primary Care Medical Group, A Medical  Corporation, Pegasus Medical Group, Inc., Antelope Valley Medical  Associates, Inc., Prospect Health Source Medical Group, Inc.,  Prospect Professional Care Medical Group, Inc., Prospect NWOC Medical  Group, Inc., APAC Medical Group, Inc., StarCare Medical Group, Inc.,  and Nuestra Familia Medical Group(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.206 |       | Loan and Security  Agreement entered into and effective as of September 27, 2004 among  Residential Funding Corporation, Prospect Medical Holdings, Inc.,  Prospect Medical Group, Inc., Prospect Medical Group, Inc., and  each of the other Credit Parties(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   |       | Pursuant to  Regulation S-K, Item 601(b)(2), the following schedules to the Loan and  Security Agreement will be provided supplementally to the Commission upon  request:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   |       | Exhibit A  Supplemental Terms and Conditions, Exhibit B Advance Request &  Receivables Information Borrowing Certificate, Exhibit C Revolving  Credit Borrowing Base Certificate, Exhibit D Closing Checklist, Exhibit E  Interest Statement, Exhibit F Form of Secretary’s/Clerk  Certificate, Exhibit G Form of Compliance Certificate, Exhibit H  Financial Covenants Calculation Worksheet, Exhibit I-1 Form of  Revolving Credit Note, Exhibit I-2 Form of Term Note, Exhibit I-3  Form of Intercompany Note, Exhibit J Form of Assignable Option  Agreement, Exhibit K Form of Credit Succession Agreement, Schedule  3.2.2(b) Existing Convertible Stock, Schedule 8.5 Litigation Matters,  Schedule 8.7 Credit Party Information, Capitated Contracts and Transaction  Documents, Schedule 8.9 Tax Matters, Schedule 8.10 Government And Other  Offsets, Schedule 8.12 ERISA Matters, Schedule 8.13 Authorized  Capital/Outstanding Capital, Schedule 8.15 Deposit Accounts, Schedule 8.16  Environmental Matters, Schedule 8.17 Insurance Policies, Schedule 8.18  Commercial Tort Claims, Schedule 8.19 Intellectual Properties, Schedule  8.20 Labor Matters, Schedule 8.21 Healthcare Filings, Schedule 9.7 Existing  Liens, Schedule 9.8(b) Permitted Indebtedness, Schedule 9.10 Transactions  With Affiliates, Schedule 9.17 Post-Closing Obligations, Schedule 10.1 Leases |

 

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| 10.207 |   | Revolving Credit Note  dated September 27, 2004, executed by Prospect Medical Holdings, Inc.,  and Prospect Medical Group, Inc., made payable to Residential Funding Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.208 |   | Term Note dated September 27,  2004, executed by Prospect Medical Holdings, Inc., and Prospect Medical  Group, Inc., made payable to Residential Funding Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.209 |   | Subordinated  Intercompany Note dated September 27, 2004, executed by Prospect Medical  Holdings, Inc., Prospect Medical Systems, Inc., Pinnacle Health  Resources, Nuestra Familia Medical Group, Inc., Prospect Medical Group, Inc.,  Santa Ana/Tustin Physicians Group, Inc., Pegasus Medical Group, Inc.,  Antelope Valley Medical Associates, Inc., Prospect Health Source Medical  Group, Inc., Prospect Professional Care Medical Group, Inc.,  Prospect NWOC Medical Group, Inc., APAC Medical Group, Inc.,  StarCare Medical Group, Inc., Sierra Medical Management, Inc.,  Sierra Primary Care Medical Group, A Medical Corporation(5)                                                                                                                               |
| 10.210 |   | Credit Succession Agreement, dated September 27, 2004,  entered into by and among Jacob Y. Terner, M.D., Prospect Medical Holdings, Inc.,  Prospect Medical Group, Inc., Prospect Medical Systems, Inc., Sierra  Medical Management, Inc., Pinnacle Health Resources, the following  subsidiaries of Prospect Medical Group: Sierra Primary Care Medical Group, A  Medical Corporation, Santa Ana/Tustin Physicians Group, Inc., Pegasus  Medical Group, Inc., Antelope Valley Medical Associates, Inc.,  Nuestra Familia Medical Group, Inc., Prospect Health Source Medical  Group, Inc., Prospect Professional Care Medical Group, Inc.,  Prospect NWOC Medical Group, Inc., APAC Medical Group, Inc.,  StarCare Medical Group, Inc. and Residential Funding Corporation(5) |
| 10.211 |   | Subordination Agreement dated September 27, 2004, by and  among Prospect Medical Systems, Inc., Sierra Medical Management, Inc.,  Pinnacle Health Resources, Prospect  Medical Holdings, Inc., Prospect Medical Group, Inc., each  of the subsidiaries of Prospect Medical Group, Inc., signatory hereto,  and Residential Funding  Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.212 |   | Pledge Agreement, dated  as of September 27, 2004 among Jacob Y. Terner, M.D. and Residential  Funding Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.213 |   | Pledge Agreement, dated  as of September 27, 2004 among Prospect Medical Group, Inc., and  Residential Funding Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.214 |   | Pledge Agreement, dated  as of September 27,2004 among Prospect Medical Holdings, Inc., and  Residential Funding Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.215 |   | Pledge Agreement, dated  as of September 27,2004 among Prospect Medical Systems, Inc., and  Residential Funding Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.216 |   | Collateral Assignment of Transaction Documents has been executed  and delivered as of September 27, 2004, by and between Sierra  Medical Management, Inc., and Residential Funding Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.217 |   | Collateral Assignment of Transaction Documents has been executed  and delivered as of September 27, 2004, by and between Pinnacle Health  Resources and Residential Funding Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.218 |   | Collateral Assignment of Transaction Documents has been executed  and delivered as of September 27, 2004, by and between Prospect Medical  Systems, Inc., and Residential Funding Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.219 |   | Guaranty Inducement and  Offset Agreement, dated as of September 27, 2004, entered into by and among Prospect Medical Group, Inc.,  Prospect Medical Holdings, Inc., Prospect Medical Systems, Inc., Sierra Medical Management, Inc., and  Pinnacle Health Resources, Sierra Primary Care Medical Group, A  Medical Corporation, Santa Ana/Tustin Physicians Group, Inc., Pegasus  Medical Group, Inc., Antelope Valley Medical Associates, Inc.,  Nuestra Familia Medical Group, Inc., Prospect Health Source Medical  Group, Inc., Prospect Professional Care Medical Group, Inc.,  Prospect NWOC Medical Group, Inc., APAC Medical Group, Inc., and  StarCare Medical Group, Inc., and Residential Funding Corporation(5)                                                   |

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| 10.220 |   | Power of Attorney  executed by Prospect Medical Holdings, Inc., Prospect Medical Systems, Inc., Sierra Medical Management, Inc.,  Pinnacle Health Resources, Prospect Medical Group, Inc., Sierra  Primary Care Medical Group, A Medical Corporation, Santa Ana/Tustin Physician  Group, Inc., Pegasus Medical Group, Inc., Antelope Valley Medical  Associates, Inc., Nuestra Familia Medical Group, Inc., Prospect  Health Source Medical Group, Inc., Prospect Professional Care Medical  Group, Inc., Prospect NWOC Medical Group, Inc., APAC Medical Group, Inc.,  and StarCare Medical Group, Inc., to Residential Funding Corporation, under  that certain Loan and Security Agreement, dated as of September 27,  2004(5)                                                          |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.221 |   | Form of Business  Associate Agreement, effective September 27, 2004, entered into by and  among APAC Medical Group, Inc., and Residential Funding Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.222 |   | Form of Business  Associate Agreement, effective September 27, 2004, entered into by and  among Prospect Health Source Medical Group, Inc., and Residential  Funding Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.223 |   | Form of Business  Associate Agreement, effective September 27, 2004, entered into by and  among Prospect Professional Care Medical Group, Inc., and Residential  Funding Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.224 |   | Form of Business  Associate Agreement, effective September 27, 2004, entered into by and  among Nuestra Familia Medical Group, Inc., and Residential Funding  Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.225 |   | Form of Business  Associate Agreement, effective September 27, 2004, entered into by and  among Prospect NWOC Medical Group, Inc., and Residential Funding  Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.226 |   | Form of Business  Associate Agreement, effective September 27, 2004, entered into by  and among StarCare Medical Group, Inc., and Residential Funding  Corporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.227 |   | Form of  Limited Consent, Omnibus Amendment No. 1 to the Loan Documents and  Joinder Agreement, dated as of July 20, 2005, entered into by and among  Residential Funding Corporation, Prospect Medical Holdings, Inc.,  Prospect Medical Group, Inc., and Prospect Medical Management, Inc.(6)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.228 |   | Form of stock  option agreement used for incentive stock options granted under the  registrant’s 1998 Stock Option Plan, as amended(7)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.229 |   | Form of stock  option agreement used for non-qualified stock options granted under the  registrant’s 1998 Stock Option Plan, as amended(7)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.230 |   | Limited Consent, Omnibus  Amendment No. 3 and Joinder Agreement to the Loan Documents among  Residential Funding Corporation, Prospect Medical Holdings, Inc.,  Prospect Medical Group, Inc., Prospect Medical Systems, Inc.,  Pinnacle Health Resources, Sierra Medical Management, Inc., Sierra  Primary Care Medical Group, Nuestra Familia Medical Group, Inc., Santa  Ana/Tustin Physicians group, Inc., Pegasus Medical Group, Inc.  Antelope Valley Medical Associates, Inc., Prospect Health Source Medical  Group, Inc., Prospect Professional Care Medical Group, Inc., Prospect  NWOC Medical Group, Inc. APAC Medical group, Inc., Starcare Medical  Group, Inc., Prospect Hospital Advisory Services, Inc., and Genesis  Healthcare of Southern California, Inc.(8) |
| 14.1   |   | Code of Ethics(8)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 21.1   |   | List of Subsidiaries of  Prospect Medical Holdings, Inc.(3)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 23.1   |   | Consent of Ernst &  Young, LLP(8)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 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(8)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 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(8)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 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(8)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |

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| 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(8) |
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(1)          Previouslyfiled as an exhibit to our Form 10 registration statement (the “Form 10”)on May 27, 2004, and incorporated herein by reference.

(2)          Previouslyfiled as an exhibit to our registration statement on Form S-1 (File No. 333-63801)on September 18, 1998, and incorporated herein by reference.

(3)          Previouslyfiled as an exhibit to Amendment No. 1 to the Form 10 on May 27,2004, and incorporated herein by reference.

(4)          Previouslyfiled as an exhibit to Amendment No. 2 to the Form 10 on August 27,2004, and incorporated herein by reference.

(5)          Previouslyfiled as an exhibit to Amendment No. 3 to the Form 10 on October 21,2004, and incorporated herein by reference.

(6)          Previouslyfiled as an exhibit to our registration statement on Form S-1 (File No. 333-124915)on July 21, 2005, and incorporated herein by reference.

(7)          Previouslyfiled as an exhibit to our Form 8-K report filed on September 20,2005.

(8)          Filedherewith.

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