**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, 2006**

**CommissionFile Number 1-32203**

**PROSPECT MEDICAL HOLDINGS, INC.**

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

 

Securities registeredpursuant to Section 12(b) of the 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 ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe 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 past90 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 by referencein Part III of this Form 10-K or any amendment to this Form 10-K. o Yes   x No

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (check one):
| Large accelerated  filer  o | Accelerated filer  o | Non-accelerated filer  x |
|---------------------------------------|--------------------------------|------------------------------------|

 

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 31,2006 (the last business day of our most recently completed second fiscalquarter) was approximately $24,038,960 based upon the closing price for shares ofour common stock as reported by the American Stock Exchange on such date.

As of December 19,2006, 7,348,053 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, 2007, areincorporated by reference in Part III of this report.

 

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**Table of ContentsForm 10-K**

|               | ** ** | **PART I**                                                                                                     |   |   |
|---------------|------------|---------------------------------------------------------------------------------------------------------------------|--------|--------|
| Item 1.       |       | Business                                                                                                            |   | 3      |
| Item 1A.      |       | Risk Factors                                                                                                        |   | 38     |
| Item  1B.     |       | Unresolved Staff Comments                                                                                           |   | 51     |
| Item 2.       |       | Properties                                                                                                          |   | 51     |
| Item 3.       |       | Legal Proceedings                                                                                                   |   | 53     |
| 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                                                         |   | 75     |
| Item  8.      |       | Financial Statements and  Supplementary Data                                                                        |   | 75     |
| Item  9.      |       | Changes in and Disagreements  with Accountants on Accounting and Financial Disclosure                               |   | 76     |
| Item 9A. |       | Controls and Procedures                                                                                             |   | 76     |
| Item 9B. |       | Other Information                                                                                                   |   | 76     |
|          | ** ** | **PART III**                                                                                                   |   |   |
| Item  10.     |       | Directors and Executive  Officers and Corporate Governance                                                          |   | 77     |
| Item  11.     |       | Executive Compensation                                                                                              |   | 77     |
| Item  12.     |       | Security Ownership of  Certain Beneficial Owners and Management and Related Stockholder Matters                     |   | 77     |
| Item  13.     |       | Certain Relationships and Related  Transactions, and Director Independence                                          |   | 77     |
| Item  14.     |       | Principal Accounting Fees  and Services                                                                             |   | 77     |
|          | ** ** | **PART IV**                                                                                                    |   |   |
| Item  15.     |       | Exhibits and Financial  Statement Schedules                                                                         |   | 77     |
| Signatures    |       | 101                                                                                                                 |

 

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**PART I**

**Item 1.**                        Business.

Prospect Medical Holdings, Inc. is a health caremanagement services organization. We provide management services to affiliatedphysician organizations that operate as independent physician associations (“IPAs”)or medical clinics. Our affiliated physician organizations enter intoagreements with health maintenance organizations (“HMOs”) to provide enrolleesof the HMOs with a full range of medical services in exchange for fixed,prepaid monthly fees known as “capitation” payments.

The IPAs contract with physicians (primary care andspecialist) and other health care providers to provide all of their medicalservices. The medical clinics employ their primary care physicians, whichprovide the vast majority of their medical services, while contracting withspecialist physicians and other health care providers to provide other requiredmedical services.

Through our two management subsidiaries—ProspectMedical Systems and Sierra Medical Management—we have entered into long-termagreements to provide management services to each of our affiliated physicianorganizations in exchange for a management fee. The management services weprovide include negotiation of contracts with physicians and HMOs, physicianrecruiting and credentialing, human resources services, claims administration,financial services, provider relations, member services, case managementincluding utilization management and quality assurance, data collection, andmanagement information systems. For further discussion of these services, seeItem 1, “Business—Management Services Agreements.”

Our two management subsidiaries currently providemanagement services to thirteen affiliated physician organizations, includingProspect Medical Group, eleven other affiliated physician organizations thatProspect Medical Group owns or controls, and one affiliated physicianorganization that is a joint venture in which Prospect Medical Group owns a 50%interest. We have utilized Prospect Medical Group, which was our firstaffiliated physician organization, to acquire the ownership interest in all ofour other affiliated physician organizations. Thus, while Prospect MedicalGroup is itself an affiliated physician organization that does the samebusiness in its own service area as all of our other affiliated physicianorganizations do in theirs, Prospect Medical Group also serves as a holdingcompany for our other affiliated physician organizations. In addition to ourtwo management subsidiaries, in connection with our November 1, 2005 acquisitionof Genesis HealthCare of Southern California, we entered into a contract withan independent management company, American Medical Management. This contractexpired on November 1, 2006.

Physician organizations, by California law, may onlybe owned by physicians. We have designated Jacob Y. Terner, M.D., our Chairmanand Chief Executive Officer, to be the owner of all of the capital stock ofProspect Medical Group. As such he indirectly controls Prospect Medical Group’sownership interest in each of our other affiliated physician organizations. Dr. Terneris also the Chief Executive Officer of Prospect Medical Group and all of ourother affiliated physician organizations that Prospect Medical Group owns. Dr. Terneris the Chief Executive Officer of one of the two general partners of our jointventure affiliated physician organization.

We control each affiliated physician organizationthrough an assignable option agreement that we have entered into through ourmanagement subsidiary, Prospect Medical Systems, with Dr. Terner andProspect Medical Group. The assignable option agreement gives us the right todesignate a successor physician to buy the capital stock of Prospect MedicalGroup from Dr. Terner for nominal consideration. The assignable option agreementallows 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.”

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For financial reporting purposes, we are deemed tocontrol Prospect Medical Group under U.S. Generally Accepted AccountingPrinciples (see Item 7, “Financial Information—Management’s Discussion andAnalysis of Financial Condition and Results of Operations—Critical Accounting Policies—Consolidationof Financial Statements”) and are therefore required to consolidate thefinancial statements of Prospect Medical Group with those of our managementsubsidiaries.

The thirteen affiliated physician organizations thatwe currently manage through our subsidiaries include Prospect Medical Group,which is an IPA wholly owned by Dr. Terner, eight IPAs wholly owned byProspect Medical Group, two medical clinics wholly owned by Prospect MedicalGroup, one IPA in which Prospect Medical Group has a 55% controlling interest,and one IPA which is a joint venture in which Prospect Medical Group owns a 50%interest through another affiliated physician organization. In July 1999,we entered into the joint venture partnership agreement with an unrelated thirdparty, AMVI/IMC Health Network, Inc. (“AMVI”), in order to aggregatesufficient Medicaid enrollees to qualify for participation in the CalOPTIMAMedicaid (Medi-Cal in California) program in Orange County, California. We owna 50% interest in the joint venture partnership, although our portion of thebusiness is operated autonomously. In accordance with the joint venturepartnership agreement, profits and losses are not split in accordance with thepartnership ownership interest, but rather, are directly tied to the results ofour portion of the business. Separate from any earnings we generate from ourportion of the business within the joint venture, we also earn fees formanagement services we provide to our partner in the joint venture. We account forour interest in the joint venture using the equity method of accounting. Weinclude in our financial statements only the net results attributable to thoseMedicaid enrollees specifically identified as assigned to us, together with themanagement fee that we charge for managing those Medicaid enrolleesspecifically assigned to the other joint venture partner. Operations for thejoint venture are similar to our other affiliated physician organizations, withthe distinction that all enrollees are Medicaid beneficiaries.

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Information about ourthirteen affiliated physician organizations 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 California(2)                  |       | IPA             |       | Prospect Medical Group (100%)                                                                |       | Prospect Medical Systems   |

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(1)          Prospect Medical Systemsand Sierra Medical Management are wholly owned direct subsidiaries of ProspectMedical Holdings.

(2)          Acquired November 1,2005. Operations included in our financial statements effective November 1,2005.

Our affiliated physician organizations providedmedical services to a combined total of approximately 171,000 HMO enrollees at September 30,2006. AMVI Prospect Health Network enrollees include approximately 7,000enrollees that we manage for our own economic benefit, and 7,100 enrollees thatwe manage for the economic benefit of our partner in this joint venture, forwhich we earn management fee income. Currently, our affiliated physicianorganizations have contracts with approximately twelve HMOs, from which ourrevenue is primarily derived. HMOs offer a comprehensive health care benefitspackage in exchange for a monthly capitation fee per enrollee, which does notvary regardless of the quantity of medical services required or used. HMOsenroll members by entering into contracts with employer groups or directly withindividuals to provide a broad range of health care services for a prepaidcharge, with 

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minimal deductibles or co-paymentsrequired of the members. All of the contracts between our affiliated physicianorganizations and the HMOs provide for the provision of medical services to theHMO enrollees by the affiliated physician organization to the HMO enrollees inconsideration for the prepayment of the fixed monthly capitation fee paid by theHMOs.

We, through our management subsidiaries, control theexpense for the medical component of the costs of our affiliated physicianorganizations by “sub-capitating” all primary care physicians and many of thespecialist physicians that provide the medical services to the HMO enrollees.Sub-capitation is an arrangement that exists when an organization being paidunder capitated contracts with an HMO, in turn contracts with other providerson a capitated basis, for a portion of the original capitated premium. Forthose specialties for which we cannot, or do not, choose to obtain asub-capitated contract, we negotiate discounted fee-for-service contracts. Bycontract, our affiliated physician organizations generally do not assumeresponsibility for the costs of providing medical services (“medical costs”)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 business has grown through theacquisition of IPAs by Prospect Medical Group. Our plan is for Prospect MedicalGroup to continue to acquire additional IPAs.

We believe that different IPAs present differentmedical cultures and are best served by local medical management. Therefore, wetypically attempt to retain the senior medical management of the entities thatwe acquire or with which we affiliate.

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

Our profit growth as a consolidated business isprimarily driven by increasing our revenue through acquisitions by ProspectMedical Group, and in parallel, reducing the administrative expenses of ouraffiliated physician organizations and management subsidiaries. We select ouracquisition candidates based in large part on a history of profitableoperations or where we can foresee a synergy, such as, opportunities foreconomies of scale through a consolidation of management functions, acompetitive environment with respect to hospital and physician services, and ageographic proximity to current operations or a material share of the potentialacquisition candidate’s own local market. Upon completion of every IPAacquisition, one of our management subsidiaries enters into a long-termmanagement services agreement with the newly-acquired physicianorganization.

In effecting an acquisition, our affiliated physicianorganizations generally acquire medical assets, including such things as HMOcontracts, provider contracts and patient records. If related non-medicalassets are to be acquired as part of the acquisition, such as, managementcontracts, furniture, fixtures or equipment, non-medical personnel or realproperty leases, these are acquired by one of our management subsidiaries. Insome cases, the stock of an acquisition candidate is acquired rather than itsassets.

With respect to any acquisition of assets or stock ofan acquisition candidate that is being acquired by one of our affiliatedphysician organizations, we, or one or more of our affiliated entities, mayadvance 

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cash, or, in some cases,stock to that affiliated physician organization, for use in consummating theacquisition.

Advances from our management subsidiaries to theaffiliated physician organization are covered by the terms of the respectivemanagement services agreement, which obligate the affiliated physicianorganization to repay the advance. Specifically, our management servicesagreements give the manager the authority to advance funds to the affiliatedphysician organization in order for the affiliated physician organization tomeet its financial obligations. The management services agreements allow themanager and the affiliated physician organization to set the terms of suchadvances. The advances are deemed loans that are reflected as a payable orreceivable, as applicable, in the financial statements of each entity and arerepayable upon demand. Cash advances among our affiliated physicianorganizations are inter-company in nature and are eliminated inconsolidation in our financial statements.

Furthermore, Prospect Medical Group, our affiliatephysician organization which is the owner of all or a significant portion ofthe capital stock of each of our other affiliated physician organizations, hasexecuted a security agreement with its manager, Prospect Medical Systems,covering all of Prospect Medical Group’s obligations to Prospect MedicalSystems under its management services agreement. The collateral pledged undersuch security agreement is all accounts and other assets of Prospect MedicalGroup. The manager could technically foreclose on such collateral if its loanwas not repaid. However, because of our affiliate relationship with thephysician organizations that we manage, we are able to control the timing ofthe repayment of any loans by our affiliated physician organizations. Thesecurity interest of Prospect Medical Systems has, however, been subordinatedto our loans under our senior secured credit facility until such time as theloans under that facility have been paid in full.

Advances from our affiliated physician organizationstous or one of our management subsidiaries are covered by the terms of a cashmanagement agreement, which obligates the recipient of the advance to repay it.These advances, like advances from our management subsidiaries to ouraffiliated physician organizations, are reflected in the financial statementsof each entity as a payable or receivable, as applicable.

Our executive management team consists of seasonedoperational, physician, financial, contracting, and administration executives,who have extensive experience in the healthcare industry.Jacob Y. Terner, M.D., our Chairman, Chief Executive Officer anda Director since November 1996, has held positions as a physician, medicalprofessor, and corporate executive. Dr. Terner was a member of thevoluntary faculty at the University of Southern California, School of Medicinefor approximately thirty years and holds the title of Emeritus ClinicalProfessor of Obstetrics and Gynecology. Prior to his tenure with our company, Dr. Ternerserved as Chairman of the Board and Chief Executive Officer of Century MediCorp, Inc.,a publicly-traded HMO and vertically integrated health-managementorganization until its October 1992 merger with Foundation HealthCorporation. Each of our senior executives has more than ten years of generalbusiness and/or health care experience.

Our principal executive offices are located at 400Corporate Pointe, Suite 525, Culver City, CA, 90230. Our telephone numberis (310) 338-8677. Our web site address is *www.prospectmedicalholdings.com*.A copy of this filing is posted on our web site.

A chart of the organizational structures of both thecompany and Prospect Medical Group is set forth on the next page.

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**ORGANIZATIONAL STRUCTURE OF OUR BUSINESS**

****

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**Summary of theStructure 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 venture operations.

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 CareIndustry 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 aneffective way 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 and hamperedthe application of the traditional controls used by managed care organizations.Physicians increasingly are responding to these pressures within the managedcare industry by affiliating with organizations such as our company to mitigatetheir economic risk and perform the non-medical management andadministrative 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, primarilythrough the acquisition of selected IPAs by Prospect Medical Group.

As of December 1, 2006 there were approximately156 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.

Our subsidiaryProspect Medical Systems conducts substantially all of its operations in Orangeand Los Angeles Counties of Southern California, while our subsidiary SierraMedical Management conducts certain medical management operations in theAntelope Valley region in northern Los Angeles County, 

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and shares some functions with Prospect MedicalSystems in Orange County. Our affiliated physician organizations are listedbelow:

| 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 operatinginformation and trend data, to enable rapid and proactive management action,where necessary.

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Additionally, wehave developed significant knowledge capital with separate departments tomanage the key areas of our affiliated physician organizations operations.These departments 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 171,000HMO enrollees as of September 30, 2006. 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 large numberof 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 37.2 million as of March 2006.According to the latest survey by Cattaneo and Stroud, Inc. (a for-profitCalifornia managed care industry research group funded, in part, by theCalifornia Healthcare Foundation), approximately 17.3 million individuals, orapproximately 47% of California residents were enrolled in HMOs as of March 2006,representing a decrease of approximately 68,937 HMO enrollees compared to March 2005.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 theCalifornia population utilizing either an HMO or a PPO (discountedfee-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, 2006** |
|---------------------------------------------------|------------|------------|--------------------------------------------------|
| **Affiliated Physician Organizations**  | ** ** | ** ** | ** **                                       | **Primary  Care  Physicians** | ** ** | **Specialists** | ** ** | **Enrollees** | ** ** | **Area of Operations** |
| Prospect Medical  Group, Inc.                |       |       | 472                                              |   |   |   | 18085 |   |   | 31,500 |   | Orange, Los  Angeles & Riverside Counties |
| Prospect Health Source  Medical Group, Inc.  |       |       | 179                                              |   |   |   | 4464 |   |   | 19,000 |   | West Los Angeles |
| Sierra Primary Care  Medical Group, Inc.(1)  |       |       | 97                                               |   |   |   | 4574 |   |   | 11,300 |   | Antelope Valley (Los Angeles  County) |
| Pegasus Medical  Group, Inc.                 |       |       | 101                                              |   |   |   | 4531 |   |   | 3,600 |   | Antelope Valley (Los Angeles  County) |
| Nuestra Familia Medical  Group, Inc.         |       |       | 195                                              |   |   |   | 3775 |   |   | 5,000 |   | East Los Angeles |
| Antelope Valley Medical  Associates, Inc.    |       |       | 101                                              |   |   |   | 4547 |   |   | 7,200 |   | Antelope Valley (Los Angeles  County) |
| AMVI / Prospect Health  Network(5)                |       |       | 804                                              |   |   |   | 4670 |   |   | 14,100 |   | Orange County |
| Prospect Professional  Care Medical Group(2) |       |       | 336                                              |   |   |   | 7106 |   |   | 26,000 |   | East Los  Angeles & Orange County |
| Prospect NWOC Medical Group, Inc.(3)    |       |       | 257                                              |   |   |   | 6002 |   |   | 11,200 |   | North Orange County |
| StarCare Medical  Group, Inc.(3)(4)          |       |       | 318                                              |   |   |   | 5685 |   |   | 23,500 |   | North Orange County |
| APAC Medical  Group, Inc.(3)(4)              |       |       | 291                                              |   |   |   | 5490 |   |   | 2,700 |   | Central Orange County |
| Genesis HealthCare of  Southern California(6)     |       |       | 301                                              |   |   |   | 3389 |   |   | 16,300 |   | North Orange County |
| Totals                                            |       |       | 3,452                                            |   |   |   | 72,318 |   |   | 171,400 |   |   |
|                                                   |            |            |                                                  |  |  |  |  |  |  |  |  |  |  |  |

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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 approximately7,000 enrollees that we manage for our own economic benefit, and7,100 enrollees that we manage for the economic benefit of our partner inthis joint venture, for which we earn management fee income.

(6)          Acquisitioncompleted as of November 1, 2005.

**EnrollmentStatisticsAs of September 30**

| ** ** | ** ** | **1998**   | ** ** | **1999**    | ** ** | **2000**   | ** ** | **2001**    | ** ** | **2002**    | ** ** | **2003**    | ** ** | **2004**    | ** ** | **2005**    | ** ** | **2006**    | ** ** |
|------------|------------|------------|------------|-------------|------------|------------|------------|-------------|------------|-------------|------------|-------------|------------|-------------|------------|-------------|------------|-------------|------------|
| Commercial |       | 83,000     |       | 87,000      |       | 83,000     |       | 105,000     |       | 102,000     |       | 136,200     |       | 168,500     |       | 144,900     |       | 140,300     |       |
| Medicare   |       | 8,200      |       | 8,800       |       | 7,800      |       | 9,800       |       | 7,000       |       | 11,200      |       | 15,500      |       | 12,500      |       | 14,100      |       |
| Medi-Cal   |       | 6,700      |       | 7,600       |       | 6,700      |       | 6,300       |       | 8,500       |       | 13,700      |       | 14,400      |       | 14,500      |       | 17,000      |       |
| **Totals** | ** ** | **97,900** | ** ** | **103,400** | ** ** | **97,500** | ** ** | **121,100** | ** ** | **117,500** | ** ** | **161,100** | ** ** | **198,400** | ** ** | **171,900** | ** ** | **171,400** | ** ** |

 

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 theAMVI/Prospect Health Network joint venture. The number of enrollees included inthe above table 

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for which we providemanagement services to our joint venture partner, but in which we have nobeneficial ownership interest, was 4,000, 5,600, 7,100, 7,100, 7,300 and 7,100 as of September 30,2000, 2001, 2002, 2003, 2004, 2005 and 2006, respectively.

Commercial and Medicare enrollmentstatistics for Genesis HealthCare of Southern California, as of itsNovember 1, 2005 acquisition date, totaled approximately 14,900, and1,100, respectively. Genesis has no Medi-Cal enrollees.

**RevenueConcentration Statistics of our Affiliated Professional OrganizationsFor the Fiscal Years Ended September 30, 2004, 2005 and 2006**

Forthe fiscal years ended September 30, 2004, 2005 and 2006 our affiliated physicianorganizations recognized capitation revenue of $125,860,567, $129,143,656 and $131,436,858,respectively. During those periods, the four largest clients of our affiliatedphysician organizations, PacifiCare of California, Health Net of California,Blue Cross of California and Blue Shield of California accounted forapproximately 80%, 79% and 79% 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,  2004** | ** **      | **Capitation  Revenue**  | ** ** | **September 30,  2005** | ** ** | **Capitation  Revenue**  | ** ** | **September 30,  2006** | ** ** | **Capitation  Revenue**  | ** ** |
| PacifiCare  |       | $                            | 40,903,464      |                     |       | 32                           | %          |                     | $          | 40,155,679                   |       |                     | 31         | % |   | $ | 39,337,714 |   |   | 30 | % |   |
| Health Net  |       | 25,933,742                   |            |                     | 21         | %                            |       | 25,224,324               |       |                         | 20         | %                        |       | 27,113,638 |   |   | 21 | % |   |
| Blue Cross  |       | 19,899,135                   |            |                     | 16         | %                            |       | 21,365,598               |       |                         | 17         | %                        |       | 20,948,066 |   |   | 16 | % |   |
| Blue Shield |       | 13,467,152                   |            |                     | 11         | %                            |       | 14,802,756               |       |                         | 11         | %                        |       | 15,954,577 |   |   | 12 | % |   |
| **Totals**  | ** ** | **$**                        | **100,203,493** | ** **               | ** ** | **80**                       | **%**      | ** **               | **$**      | **101,548,357**              | ** ** | ** **               | **79**     | **%** | ** ** | **$103,353,995** | ** ** | ** ** | **79** | **%** | ** ** |
|             |            |                              |                 |                          |            |                              |            |                          |            |                              |            |                          |            |  |  |  |  |  |  |  |  |  |

 

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

As of December 1, 2006, our affiliated physicianorganizations were listed as having a combined market share (based on number ofHMO enrollees served) of approximately 8.6 percent in Orange County (123,000—enrolleescompared to 1,436,100 total enrollees in Orange County), and approximately 1.0 percentin Los Angeles County (48,400 enrollees compared to 4,659,820 total enrolleesin Los Angeles County).

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**Management Fees andRevenue 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 deduction forcosts 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 an adjustmentof the management fee for AMVI/Prospect Health Network is appropriate, anadjustment would require negotiation with the joint venture partner.

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 toenrollees assigned to AMVI’s division of the joint venture, one of ourmanagement companies, Prospect Medical Systems, is compensated $3.00 per memberper month for the Medicaid enrollees, and 11% of hospital capitation revenuesreceived by them for Healthy Families enrollees. We record these amounts asrevenue. For the management services we provide to enrollees assigned to ourdivision of the joint venture, Prospect Medical Systems is compensated $4.70 permember per month for the Medicaid enrollees and 11% of hospital capitationrevenues received for Healthy Families enrollees. We eliminate theseintercompany amounts in consolidation. The fee we charge AMVI is lower than ourown, as a result of matching a competing management services proposal that AMVIreceived from another management company. AMVI does not receive any managementfees from the 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 management subsidiaries have the right, undertheir management services agreements, to control the depository accounts of theaffiliated 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 thepatient utilization 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. Contracts aretypically based on a percentage of the Medicare fee schedule.

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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 the responsibilityof 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 direct theenrollees 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 physician organizationsare not capitated. The terms of the particular risk-sharing arrangementallocate responsibility to the respective parties when the cost of servicesexceeds a budget, which results in a “deficit,” and permit the parties to sharein any amounts remaining in the budget, known as a “surplus,” which occurs whenactual cost is less than the budgeted amount. The amount of non-capitated andhospital costs in any period could be affected by factors beyond our control,such as changes in treatment protocols, new technologies and inflation. To theextent that such non-capitated and hospital costs are higher than anticipated,revenue paid to our affiliated physician organizations may not be sufficient tocover the risk-sharing deficits they are responsible for paying, which couldreduce our revenues and profitability. It is our experience that “deficit”amounts for hospital costs are applied to offset any “surplus” amount we wouldotherwise be entitled to receive. We have historically not been required to reimbursethe HMOs 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.

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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**Our AffiliatedPhysician 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 physician organizations.

As of September 30, 2006, our affiliatedphysician organizations employed 13 physicians (including two part timephysicians), and had independent contracts with approximately 75,800physicians.

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 OptionAgreement**

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 Medical Systemsand Prospect Medical Group. We paid nominal consideration ($100) for theassignable 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 the managementservices 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 MedicalGroup, as well as a director and Chief Executive Officer of Prospect MedicalHoldings, Inc., each of our management company subsidiaries except PMS,and each of our other affiliated physician organizations, except forAMVI/Prospect Health Network and Nuestra 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 ourmedical directors. Each affiliated physician organization enters into thefollowing types of contracts for the provision of physician and ancillaryhealth services:

*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 ServicesAgreements**

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 physicianorganization’s gross revenues. We also receive an incentive bonus approximating40% of the profit of our affiliated physician organizations. In the event of aloss, our management fee is reduced by approximately 50% of the affiliatedphysician organization’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 medical director.

·       *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 PublicRelations**

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 2006 Cattaneo and Stroudestimates, total HMO enrollment in Los Angeles County was approximately 4,761,320 of which Prospect hadapproximately 48,400 enrollees, or approximately 1%. HMO enrollment in OrangeCounty was estimated at approximately 1,437,400**** of which Prospect had approximately 123,000 enrollees, or approximately8.6%.

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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       |       |                      | 9.1        | %                                                                                                 |       |
| Heritage Provider  Network                  |       | 288,000       |       |                      | 6.2        | %                                                                                                 |       |
| La Vida Medical  Group                      |       | 167,800       |       |                      | 3.6        | %                                                                                                 |       |
| Facey Medical  Foundation                   |       | 118,000       |       |                      | 2.5        | %                                                                                                 |       |
| Los Angeles  County Dept of Health Services |       | 92,000        |       |                      | 2.0        | %                                                                                                 |       |
| Lakeside Medical  Group                     |       | 88,500        |       |                      | 1.9        | %                                                                                                 |       |
| Community Medical  Group of the West Valley |       | 82,050        |       |                      | 1.8        | %                                                                                                 |       |
| Health Care LA,  IPA                        |       | 87,850        |       |                      | 1.9        | %                                                                                                 |       |
| All Others including  Kaiser                |       | 3,261,820     |       |                      | 70.0       | %                                                                                                 |       |
| **Sub-Total**                               | ** ** | **4,611,420** | ** ** | ** **                | **99.0**   | **%**                                                                                             | ** ** |
| Prospect Health  Source Medical Group       |       | 19,000        |       |                      |       |                                                                                              |       |
| Sierra Primary  Care Medical Group          |       | 11,300        |       |                      |       |                                                                                              |       |
| Antelope Valley  Medical Group              |       | 7,200         |       |                      |       |                                                                                              |       |
| Pegasus Medical  Group                      |       | 3,600         |       |                      |       |                                                                                              |       |
| Nuestra Familia  Medical Group              |       | 5,000         |       |                      |       |                                                                                              |       |
| Prospect  Professional Care Medical Group   |       | 2,300         |       |                      |       |                                                                                              |       |
| **Sub-Total—Prospect**                 | ** ** | **48,400**    | ** ** | ** **                | **1.0**    | **%**                                                                                             | ** ** |
| **Grand Totals**                            | ** ** | **4,659,820** | ** ** | ** **                | **100**    | **%**                                                                                             | ** ** |

 

InOrange County, California our largest competitors include:

| **Competition**                            | ** ** | ** **    | ** ** | **Estimated  Enrollment** | ** ** | **% of Total Enrollment  of Major Competition  Including Prospect** | ** ** |
|--------------------------------------------|------------|---------------|------------|---------------------------|------------|---------------------------------------------------------------------------------------------------|------------|
| St. Joseph  Heritage Healthcare            |       | 187,900       |       |                      | 13.1       | %                                                                                                 |       |
| Monarch  Healthcare                        |       | 175,100       |       |                      | 12.2       | %                                                                                                 |       |
| Greater Newport  Physicians Medical Group  |       | 113,300       |       |                      | 7.9        | %                                                                                                 |       |
| Bristol Park  Medical Group                |       | 91,400        |       |                      | 6.4        | %                                                                                                 |       |
| All Others  including Kaiser               |       | 745,400       |       |                      | 51.9       | %                                                                                                 |       |
| **Sub-Total**                              | ** ** | **1,313,100** | ** ** | ** **                | **91.4**   | **%**                                                                                             | ** ** |
| **Prospect  Affiliates**                   | ** ** | ** **    | ** ** | ** **                | ** ** | ** **                                                                                        | ** ** | ** ** | ** ** |
| Prospect Medical  Group                    |       | 31,500        |       |                      |       |                                                                                              |       |
| AMVI/Prospect  Health Network              |       | 14,100        |       |                      |       |                                                                                              |       |
| Prospect  Professional Care Medical Group  |       | 23,700        |       |                      |       |                                                                                              |       |
| Prospect NWOC  Medical Group               |       | 11,200        |       |                      |       |                                                                                              |       |
| Star Care Medical  Group                   |       | 23,500        |       |                      |       |                                                                                              |       |
| APAC Medical  Group                        |       | 2,700         |       |                      |       |                                                                                              |       |
| Genesis  HealthCare of Southern California |       | 16,300        |       |                      |       |                                                                                              |       |
| **Sub-Total—Prospect**                | ** ** | **123,000**   | ** ** | ** **                | **8.6**    | **%**                                                                                             | ** ** |
| **Grand Totals**                           | ** ** | **1,436,100** | ** ** | ** **                | **100**    | **%**                                                                                             | ** ** |
|                                            |            |               |            |                           |            |                                                                                                   |            |  |  |  |  |

 

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According to Cattaneo and Stroud, between 1996and December 1, 2006, 186 medical groups and independent physicianassociations throughout California have closed, with 46.2% of the closures dueto financial problems. This has reduced the number of competitors in ourservice area and in our opinion, this consolidation among physicianorganizations will likely continue. Cattaneo and Stroud reports that, atDecember 1, 2006, there were 309 medical groups and independent physicianassociations in California, including 156 small, medium and large, independentphysician associations.

Additionally, theCalifornia Department of Managed Health Care (“DMHC”) has mandated certainfinancial statement solvency requirements of medical groups and independentphysician associations including cash to claims ratios, positive workingcapital and 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 opportunitiesfor us.

Basedon the December 2006 statewide Cattaneo and Stroud statistics, we believethat the combined enrollment of our affiliated physician organizations is theeighth largest in California.

| **Physician Organization**             | ** ** | ** **                                                                                                           | ** ** | **Service Area** | ** ** | **Estimated Enrollment** | ** ** |
|---------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------------------|------------|
| Kaiser Foundation                           |       | California                                                                                                           |       |                  | 6,335,200  |                          |       |
| HealthCare Partners  Medical Group          |       | Los Angeles  County   Orange County                                                                                  |       |                  | 425,400    |                          |       |
| Hill Physicians Medical  Group              |       | Alameda County   Contra Costa County   Placer County   Sacramento County   San Francisco County   Solano County |       |                  | 392,800    |                          |       |
| Brown & Toland  Medical Group |       | Marin County   San Mateo County   San Francisco                                                                 |       |                  | 256,900    |                          |       |
| Heritage Provider  Network                  |       | Los Angeles  County   Riverside County   San Bernardino County                                                       |       |                  | 255,300    |                          |       |
| Primecare Medical  Network                  |       | Los Angeles  County   Riverside County   San Bernardino County                                                       |       |                  | 222,800    |                          |       |
| St. Joseph Heritage  Medical                |       | San Bernardino County  Orange County                                                                                 |       |                  | 187,900    |                          |       |
| Prospect Medical Group  and Subsidiaries    |       | Los Angeles  County   Orange County                                                                                  |       |                  | 176,100    |                          |       |
| Monarch Healthcare                          |       | Orange County                                                                                                        |       |                  | 175,100    |                          |       |
| Sharp Community  Medical Group         |       | San Diego County                                                                                                     |       |                  | 169,000    |                          |       |
| La Vida Medical Group                       |       | Los Angeles County                                                                                                   |       |                  | 167,800    |                          |       |

 

Some of our competitorsare larger than us, have greater resources and may have longer-establishedrelationships with buyers of their services, giving them greater leverage incontracting with physicians and HMOs. Such competition may make it difficult toenter into affiliations with physician organizations on acceptable terms and tosustain profitable 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.

*Corporate Practice of Medicine and ProfessionalLicensing*

Federal and state lawsspecify who may practice medicine and limit the scope of relationships betweenmedical practitioners and other parties. Under these laws, we are prohibitedfrom practicing medicine or exercising control over the provision of medicalservices. We do not employ physicians to provide medical services, exertcontrol over medical decision-making or represent to the public that weoffer medical services. We have entered into management services agreementswith our affiliated physician organizations that reserve exclusive control andresponsibility for all aspects of the practice of medicine and the delivery ofmedical services to the physician organizations. Some states have interpretedmanagement agreements with physicians as unlawful fee splitting. Although thelaws in these states have been subjected to limited judicial and regulatoryinterpretation, we believe that our contractual arrangements with physiciannetworks, hospitals, or physician groups are appropriate and that we are incompliance with applicable state laws in relation to te corporate practice ofmedicine and fee-splitting. However, regulatory authorities or other parties,including our affiliated physicians, may assert that, despite thesearrangements, we are engaged in the corporate practice of medicine or that ourcontractual arrangements with our affiliated professional contractorsconstitute unlawful fee-splitting, in which case we could be subject to civilor criminal penalties, our contracts could be found legally invalid andunenforceable (in whole or in part) or we could be required to restructure ourcontractual arrangements with our affiliated professional contractors.  Moreover, changes in the corporate practiceof medicine or fee-splitting 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 knownas the “Anti-kickback Statute” prohibits the knowing or willful offer,solicitation, payment or receipt of anything of value (direct or indirect,overt or covert, in cash or in kind) which is intended to induce the referralof patients covered by federal reimbursement programs, or the ordering of itemsor services reimbursable under those programs. This law also prohibitsremuneration that is intended to induce the recommendation of, or furnishing,or the arranging for, the provision of items or services reimbursable underfederal reimbursement programs. This law has been broadly interpreted by anumber of courts to prohibit remuneration that is offered or paid for otherwiselegitimate purposes if the circumstances show that one purpose of thearrangement is to induce referrals. The penalties for violations of this lawinclude criminal sanctions and exclusion from federal healthcare programs.

To address concerns aboutthe implementation of the Anti-kickback Statute, the federal government adoptedregulations with exceptions, or “safe harbors,” for some transactions andactivities that will not be deemed to violate the Anti-kickback Statute, suchas sales of physician practices, management and personal services agreements,employee relationships, and referrals within group practices consisting of 

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“active”investors. The failure to qualify under a safe harbor, while potentiallysubjecting the activity to greater regulatory scrutiny, does not render theactivity illegal per se. One safe harbor on which we rely applies to managementcontracts meeting specified criteria.

There are several aspectsof our relationships with physicians to which the Anti-kickback Statute may berelevant. The government may construe some of the marketing and managed carecontracting activities that we historically performed as arranging for thereferral of patients to the physicians with whom we 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 ofpatients, because compensation arrangements between the physician organizationsand the primary care physicians who make referrals are designed to discouragereferrals to the extent they are medically unnecessary. These physicians arepaid either on a sub-capitation or fee-for-service basis and do not receive anyfinancial benefit 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 hospitalservices. In addition to the conduct directly prohibited by the law, thestatute also prohibits “circumvention schemes” that are designed to obtainreferrals indirectly that cannot be made directly. The penalties for violatingthe law include a refund of any Medicare or Medicaid payments for services thatresulted from an unlawful referral, civil fines and exclusion from the Medicareand Medicaid programs.

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 costs and decrease ourprofitability. Many states, including California, have similar self-referrallaws that provide for similar penalties.

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*Fraud and Abuse*

Existing federal lawsgoverning Medicaid, Medicare and other federal health care programs, as well assimilar state laws, impose a variety of fraud and abuse prohibitions on theCompany. These laws are interpreted broadly and enforced aggressively bymultiple government agencies, including the Office of Inspector General of theDepartment of Health and Human Services (the “OIG”), the Department of Justiceand various state authorities. In addition, in the Deficit Reduction Act of2005, Congress created a new Medicaid Integrity Program to enhance federal andstate efforts to detect Medicaid fraud, waste and abuse and provide financialincentives for states to enact their own false claims acts as an additionalenforcement tool against Medicaid fraud and abuse.  Violations of these laws are punishable bysubstantial penalties, including monetary fines, civil penalties, criminalsanctions (in the case of the anti-kickback law), exclusion from participationin government-sponsored health care programs, and forfeiture of amountscollected in violation of such laws, any of which could have an adverse effecton our business and results of operations.

*HIPAAAdministrative Simplification and Privacy Requirements*

The Administrative Simplification Provisions of HIPAArequire the use of uniform electronic data transmission standards for healthcare claims and payment transactions submitted or received electronically.These provisions are intended to encourage electronic commerce in the healthcare industry. On August 17, 2000, the Department of Health and HumanServices (“HHS”) published final regulations establishing electronic datatransmission standards that all health care providers must use when submittingor receiving certain health care transactions electronically. We were requiredto comply with the standards by October 16, 2003.

HIPAA also requires HHS to adopt standards to protectthe privacy and security of individually identifiable health-relatedinformation. We were required to comply with privacy regulations released byHHS by April 14, 2003. The privacy regulations regulate the use anddisclosure of individually identifiable health-related information,whether communicated electronically, on paper or orally. The regulations alsoprovide patients with significant new rights related to understanding andcontrolling how their health information is used or disclosed. HHS releasedfinal security regulations on February 20, 2003. The security regulationsbecame mandatory on April 20, 2005 and require health care providers toimplement administrative, physical and technical practices to protect thesecurity of individually identifiable health information that is maintained ortransmitted electronically.

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 anyfederal or state privacy-related laws that are more restrictive than theprivacy regulations issued under HIPAA. These statutes vary and could imposeadditional penalties.

We believe we haveachieved compliance with the privacy and electronic health care transaction standardsof HIPAA. To date, the cost of compliance with these regulations has not beenmaterial. We believe that the ongoing cost of compliance with these regulationswill not have a material adverse effect on our business, financial position,results of operations or cash flows.

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*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.

**Health PlanLicensing and Regulation**

The California Department of Managed Health Care (“DMHC”)is responsible for licensing and regulating health plans in California underthe Knox-Keene Health Care Service 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 imposesnumerous requirements on health plans regarding the provision of care to healthplan enrollees. HMOs, in turn, require their contracted physician organizationsto comply 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 arebound by many of these same provisions as embodied in their contracts withplans.

Our affiliated physicianorganizations typically enter into contracts with HMOs, pursuant to which theaffiliated physician organizations are paid on a capitated (per member/permonth) basis. Under capitation arrangements, health care providers bear therisk, subject to specified loss limits, that the total costs of providingmedical services 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 DMHC has instituted financial solvency regulationsmandated by California Senate Bill 260. The regulations are intended to providea formal mechanism for monitoring the financial solvency of capitated physiciangroups. Management believes that our affiliated physician organizations thatare subject to these regulations will be able to comply with them. However,these regulations could limit the company’s ability to use its cash resourcesto make future acquisitions.

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 

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organization’s totalunpaid claims liability. The regulations require a cash-to-claims ratio of 0.60beginning January 1, 2006; 0.65 beginning July 1, 2006; and 0.75beginning 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 ratio onSeptember 30, 2006, was 1.46.

*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 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 

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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, cost controlson hospitals and mandatory health insurance coverage for employees. The costsof implementing some of these proposals would be financed, in part, byreduction 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 RegulatoryRequirements**

The health care industryis governed by a framework of federal and state laws, rules and regulationsthat are extensive and complex and for which, in many cases, the industry hasthe benefit of only limited judicial and regulatory interpretation. If we orone of our affiliated physician organizations is found to have violated theselaws, rules or regulations, our business, financial condition and results ofoperations could be materially adversely affected. Moreover, health carecontinues to attract legislative interest and public attention. Changes inhealth care legislation or government regulation may restrict our existingoperations, limit the expansion of our business or impose additionalcompliance, requirements and costs, any of which could have a material adverseeffect on our business, financial condition, results of operations and thetrading price of our stock. In addition to the regulations referenced above,our operations may also be affected by changes in ethical guidelines andoperating standards of professional and trade associations such as the AmericanMedical Association. Changes in existing ethical guidelines or professionalorganization standards, adverse judicial or administrative interpretations ofsuch guidelines and standards, or enactment of new legislation could require usto make costly changes to our business that would reduce our profitability.

**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, $7,150,000 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 PhysiciansGroup, Inc, StarCare Medical Group, Inc., Pegasus Medical Group, Inc.Sierra Primary Medical Group, Inc., Genesis HealthCare of SouthernCalifornia and Prospect Medical Group, Inc. maintain managed care errorsand omissions insurance (professional liability) in a minimum coverage amountof $1,000,000 per claim and $3,000,000 in the aggregate. The managed careerrors and omissions policy also provides directors and officers insurance forthe corporate entity in a minimum coverage amount of $1,000,000 per claim and$1,000,000 in the aggregate.

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We also require thephysicians that our affiliated physician organizations contract with asindependent contractors to maintain malpractice insurance with minimum policylimits of $1,000,000 million per claim and $3,000,000 in the aggregate.The employed physicians at Sierra Medical Group and Pegasus Medical Group arecurrently insured under policies with annual policy limits of $1,000,000 perclaim and $3,000,000 in the aggregate, that cover malpractice on a “claims made”basis, which includes vicarious coverage for each entity (covers the corporateentity as well as the physician).

Our insurance, and theinsurance of our affiliated physician organizations, contain customaryexclusions and exceptions from coverage. Additionally, we are at risk for ourself-insured retention (“deductible”) on certain policies such as $1,000 forour property policy and $75,000 for the managed care errors and omissionsinsurance.

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.

**History and Development of Our Business**

In October 1986Prospect Medical Group was formed by physician shareholders of anotherprofessional corporation called Yorba Linda Medical Group to provide a vehiclefor the physician shareholders to focus on managed care, while Yorba LindaMedical Group continued its focus on fee-for-service patients. Our ChiefExecutive Officer prior to Dr. Terner, Dr. DeNicola, was ashareholder of Yorba Linda Medical Group and Prospect Medical Group. In 1996the shares of Prospect Medical Group owned by all of the Yorba Linda MedicalGroup physicians (other than Dr. DeNicola) were redeemed and the formershareholders were issued shares of common stock of Prospect Medical Systems,which is now one of our management subsidiaries. Prospect Medical Systems hadbeen formed in 1995 to acquire all of Prospect Medical Group’s non-professionalassets and assume all of its administrative and management functions. ProspectMedical Systems had nominal operations until 1996.

As part of the 1996transaction with Prospect Medical Group and Prospect Medical Systems, a whollyowned subsidiary of the company was merged into Prospect Medical Systems, withProspect Medical Systems being the surviving corporation and a wholly ownedsubsidiary of the company. The company, then called Med-Search, Inc.,changed its name to Prospect Medical Holdings. Med-Search, Inc. wasincorporated on May 12, 1993 as a Delaware corporation and was thesuccessor by merger to a corporation called Energy Search Inc., a Utahpublic corporation. Prior to the 1996 merger, we, as Med-Search, providedmanaged care and medical practice management services to a Californiaprofessional corporation, Interstate Care Providers, doing business in VenturaCounty, California.

The physician shareholdersof Prospect Medical Systems ultimately exchanged their shares in ProspectMedical Systems with those of Prospect Medical Holdings. The exchange of shareswas treated as a reorganization of companies under common control. As theshareholders of Prospect Medical Group became the majority stockholders in themerged company through these transactions, under applicable 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 our growth strategy through a series of acquisitions andaffiliations, primarily through Prospect Medical Group.

Since the 1996 merger,Prospect Medical Group has acquired twelve physician organizations for theaggregate consideration of approximately $48,608,000 in cash, promissory notesin the aggregate principal amount of $3,500,000 and the issuance ofapproximately 830,000 shares of our common stock. These acquisitions,summarized below, have provided us with substantial concentration of managed careenrollees in our three service areas of Southern California—North and CentralOrange County, West Los Angeles and the Antelope Valley region of Los AngelesCounty.

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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.

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 Oaks Hospitaland Health Center by Sherman Oaks Affiliated Physicians. Prospect Medical Groupalso assumed the provider 

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contracts and the name ofthis start-up independent physician association venture, which had no HMOcontracts and no enrollees 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 exclusivecontract with 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.

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, the combinedenrollment of StarCare Medical Group and APAC Medical Group was approximately44,000 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 commitmentspertaining to the medical clinics. We retained StarCare Medical Group in itscapacity as an IPA. As a condition of StarCare Medical Group’s sale of themedical clinics, the acquiring buyer executed a provider agreement withStarCare Medical Group in StarCare’s capacity as an IPA, which includes, amongother things, specific non-diversion and non-solicitation language as to theenrollees served by StarCare Medical Group.

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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 Southern Californiahad approximately 16,000 HMO enrollees.

**Executive Officers**

Thefollowing table summarizes the name, age, title and business experience for thepast five years of each of our executive officers. Other than as describedbelow, no family relationships exist between or among any of our officers anddirectors.

| **Name**              | ** ** | ** ** | ** ** | **Age**                                                    | ** ** | **Position** |
|-----------------------|------------|------------|------------|------------------------------------------------------------|------------|--------------|
| Jacob Y. Terner, M.D. |       | 72         |       | Chairman, Chief  Executive Officer and Director            |
| Catherine S. Dickson  |       | 37         |       | President, Chief  Operating Officer and Director           |
| Mike Heather          |       | 48         |       | Chief Financial Officer                                    |
| R. Stewart Kahn       |       | 55         |       | Executive Vice President  and Secretary                    |
| Linda Hodges          |       | 62         |       | Executive Vice President  of Compliance                    |
| Michael A. Terner     |       | 45         |       | Vice President, HMO  Contracting and Health Plan Relations |
| Donna Vigil           |       | 58         |       | Vice President, Finance                                    |

 

**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 where Dr. Terneris Chief Executive Officer, President, Treasurer and a Director of one of thetwo general partners; Sierra Primary Care Medical Group, where Dr. Ternerserves as Chief Executive Officer, Treasurer and a Director; and NuestraFamilia Medical Group, where Dr. Terner serves as Secretary and aDirector. Dr. Terner held the position of Clinical Professor of Obstetricsand Gynecology at the University of Southern California, School of Medicinefrom 1972 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 in December 1992.Dr. Terner is also a Director of Brotman Medical Center, 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 to Ms. Dickson’sappointment as our President and Chief Operating Officer, Ms. Dicksonserved as Vice President of Contracting and Credentialing for Prospect MedicalSystems since February 2000. Ms. Dickson has been with Prospect MedicalSystems since January 1998. Ms. Dickson has significant experienceacross a broad range of managed care divisions, including contract negotiationand implementation, claims adjudication, eligibility, utilization managementand credentialing. Before joining Prospect Medical Systems, Ms. Dicksonserved as an Associate Contract Administrator for Orange Coast Managed CareServices, Inc., the health care management company for the Sisters of St.Joseph Health Organization Independent Physician Association.

**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 

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affiliated physicianorganizations except for AMVI/Prospect Health Network, which is a joint venturepartner where Mr. Heather is Chief Financial Officer of one of the twogeneral partners. Most recently, Mr. Heather served as Co-Chief ExecutiveOfficer of WebVision, 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 from June 1992to 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 where Mr. Kahnis the Secretary of one of the two general partners. Mr. Kahn hasresponsibility for mergers and acquisitions and day-to-day business operationsof the company and its management subsidiaries. From 1987 to 1999, Mr. Kahnwas the President and Chief Executive Officer of Legend Capital Corporation, aconsulting firm specializing in financial, marketing, lending and accountingservices to the health care industry. Mr. Kahn has more than 30 yearsof experience in the commercial finance and equipment leasing industry and isintimately familiar with asset based lending, leveraged buyouts, merger andacquisition financing, and contractual and business matters.

**LindaHodges.****  **LindaHodges has served as our Executive Vice President of Compliance since August 1,2003. Previously, Ms. Hodges served as President and Chief OperationsOfficer of Prospect Medical Systems from November 1998 to July 2003,and she has performed a number of other senior management functions forProspect Medical Systems since 1996. Ms. Hodges has over 20 years ofhealth care related experience in management and operations. Ms. Hodgeshas also served in positions such as Interim Chief Executive Officer of VivaHealthPlan, Executive Director of Foundation Health Corporation (Southern CaliforniaRegion), and President of Loma Linda Health Plan, a wholly owned subsidiary ofCentury MediCorp, Inc.

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

**Michael A. Terner.****  **Michael A. Terner has served as ourVice President of HMO Contracting and Health Plan Relations since October 1,2003. From 1998 to 2003, Mr. Terner was a portfolio manager for Ocean ParkCapital Management, LLC, a private investment company. From 1994 through 1998, Mr. Ternerwas an independent financial consultant for various entities including ProspectMedical Holdings and the Columbia Charitable Foundation. From 1991 to 1993, hewas the Business Development Executive with Century Medicorp, and from 1990 to1991, Mr. Terner was involved in the health care consulting practice ofKPMG Peat Marwick. From 1983 to 1988, Mr. Terner was a risk arbitragetrader with LF Rothschild, Unterberg and Laterman Co. Mr. Terner receivedhis MBA from the Anderson Graduate School of Management at UCLA in 1990, andhis BA Degree from Harvard College in 1983. Mr. Terner is the son of JacobY. Terner, our Chief Executive Officer.

**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 for

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suchperiod, and have such authority, and perform such duties as are provided in ourBylaws, or as the Board of Directors may from time to time determine.

**Item 1A.**                RiskFactors

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

**Decreases in the number of HMO enrollees using ourprovider networks reduce our profitability and 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, 2002, 2003, 2004, 2005 and 2006, the decrease in thenumber of HMO enrollees using our provider networks was 3,600, 1,400, 20,700,26,500 and 16,400 respectively. Estimated revenue reductions associated withthe enrollment decreases for those periods were approximately, $3,500,000,$400,000, $8,200,000, $11,100,000 and $3,800,000, 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.

**Our working capitaldeficit could adversely affect our ability to satisfy our obligations as theycome due.**

We have historically been in a negative workingcapital position. Having a working capital deficit may signal an impairedability to pay debts as they come due.

We had negative working capital of $3,141,414,$681,960 and $123,898 as of September 30, 2004, 2005 and 2006,respectively. This represents the difference between our current assets and ourcurrent liabilities. The negative working capital is the result of a reductionin cash and cash equivalents that have been used to reduce our bank debt andcurrent liabilities incurred in operations and acquisitions, primarily related tomedical expense claims.

As of the fiscal yearsended 2004, 2005 and 2006, our indebtedness for capital leases, subordinatedseller notes, and notes to our bank totaled $15,008,554, $8,166,667 and$12,000,000. We have historically used cash reserves and cash flow fromoperations and equity offerings to reduce our indebtedness and fundacquisitions. This, and our recording of reserves for incurred but not reportedhealthcare expense claims, have been the primary reasons for our negativeworking capital position at September 30, 2004, 2005 and 2006.

**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, 2006, goodwill totaled $37,838,169 andother intangible assets totaled $1,738,475 for a combined total of $39,576,643 andrepresented approximately 59% 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 

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pooling-of-interest methodof accounting. SFAS No. 141 also states that acquired intangible assetsshould be separately recognized upon meeting certain criteria. Such intangibleassets include, but are not limited to, trade and service marks, non-competeagreements, customer lists and licenses.

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 certain indicatorsare encountered. We have adopted SFAS No. 142. A two-step impairmenttest is to be used to identify potential goodwill impairment and to measure theamount of goodwill impairment loss to be recognized (if any). The first step ofthe goodwill impairment test, which is used to identify potential impairment,compares the fair value of a reporting unit with its carrying amount, includinggoodwill. If the fair value of a reporting unit exceeds its carrying amount,goodwill of the reporting unit is considered not impaired, thus the second stepof 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.

**We may not be able to make any additional significantacquisitions without first obtaining additional financing and obtainingthe consent of our commercial lender.**

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.

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

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 capital expenditures. We exceeded the 1.50maximum senior debt/EBITDA ratio as of September 30, 2004 and December 31,2004. Our actual senior debt/EBITDA ratio as of those two dates was 1.57 and1.51, respectively. RFC waived these covenant violations effective April 7,2005 and, in addition, agreed to exclude certain items from the covenantcomputations for a twelve month period, which enabled us to meet the minimumfixed charge coverage ratio at December 31, 2004. Effective September 302006, in order to enable the Company to meet the minimum fixed charge coverageratio, RFC amended the loan agreement to lower the required ratio through December 2006,and made certain allowances in the manner in which that ratio is calculated.There can be no assurance that we will be able to meet all of the financialcovenants and other conditions required by our loan agreement. RFC may notgrant waivers of future covenant violations and could also require fullrepayment of the loan, which would negatively impact our liquidity and precludeus from making further acquisitions.

**Substantially all of our revenues are generated fromcontracts with a limited number of HMOs, and if our affiliated physician organizationswere to lose HMO contracts or to renew HMO contracts on less favorable terms,our revenues and profitability could 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 cause uponnotice, and, upon renewal, are subject to annual negotiation of capitationrates, covered benefits and other terms and conditions.

We are particularly at risk with respect to thepotential loss or renewal on less favorable terms of contracts that our affiliatedphysician organizations have with four of these HMOs—PacifiCare of California,Blue Cross of California, Health Net of California and Blue Shield ofCalifornia.

For the fiscal year ended September 30, 2006,contracts with our four largest HMO clients accounted for approximately 79% 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 23% of our enrollment, our contract withBlue Cross of California accounted for approximately 20% of our enrollment, andour contract with Blue Shield of California accounted for approximately 14% ofour enrollment. During the fiscal year ended September 30, 2006, ourcontract with PacifiCare of California accounted for $39,337,714 in revenue, or30% of our total capitation revenue, our contract with Health Net of Californiaaccounted for $27,113,638 in revenue, or 21% of our total capitation revenue,our contract with Blue Cross accounted for $20,948,066 in revenue, or 16% ofour total capitation revenue and our contract with Blue Shield of Californiaaccounted for $15,954,577 in revenue, or 12% of our total capitation revenue.For the fiscal year ended September 30, 2006, PacifiCare, Blue Cross,Health Net and Blue Shield accounted for combined revenue of $103,353,995, orapproximately 79% of our total capitation revenue.

For the fiscal year ended September 30,2005, contracts with our four largest HMO clients accounted for approximately75% of our enrollment, of which our contract with PacifiCare of Californiaaccounted for approximately 22% of our enrollment, our contract with Health Netof California accounted for approximately 18% of our enrollment, our contractwith Blue Cross of California accounted for approximately 19% of ourenrollment, and our contract with Blue Shield of California accounted for 

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approximately16% of our enrollment. During the fiscal year ended September 30, 2005,our contract with PacifiCare of California accounted for $40,155,679 inrevenue, or 31% of our total capitation revenue, our contract with Health Netof California accounted for $25,224,324 in revenue, or 20% of our totalcapitation revenue, our contract with Blue Cross accounted for $21,365,598 inrevenue, or 17% of our total capitation revenue and our contract with BlueShield of California accounted for $14,802,756 in revenue, or 11% of our totalcapitation revenue. For the fiscal year ended September 30, 2005,PacifiCare, Blue Cross, Health Net and Blue Shield accounted for combinedrevenue of $101,548,357, or approximately 79% of our total capitation revenue.

The loss of contracts withany one of these HMOs could significantly reduce our revenues andprofitability.

We have one year automaticallyrenewable contracts with PacifiCare of California, Blue Cross of California,Health Net of California and Blue Shield of California, unless either partyprovides the other party with 180-days’ notice of such party’s intent notto renew. Under limited circumstances, the HMOs may immediately terminate thecontracts for cause; otherwise, termination for cause requires 90 days’prior written notice with an opportunity to cure. There can be no assurancethat we will be able to renew any of these contracts or, if renewed, that theywill contain terms favorable to us and our affiliated physician organizations.

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

Our success depends inlarge part on our effective management of health care costs, through controlover our affiliated physician organizations through the single shareholderownership model, controlling utilization of specialty care and other ancillarycare and purchasing services at competitive prices. Under the singleshareholder model, we have the right, under an assignable option agreement, todesignate the sole owner of all of the stock of Prospect Medical Group, whichis one of our affiliated physician organizations and also serves as a holdingcompany for all of our other affiliated physician organizations. Our ability todesignate the sole owner of Prospect Medical Group gives us the ability tocontrol the management and business policies of our affiliated physicianorganizations (except for one in which we have only a 50% joint ventureownership interest), including policies for the management of health carecosts.

We attempt to control thehealth care costs of our affiliated physician organizations’ HMO enrollees byemphasizing preventive care, monitoring compliance with pharmacy formularies(i.e., a list of approved pharmaceutical drugs that the HMOs will provide anenrollee at a lesser cost than other drugs), entering into risk sharingagreements with hospitals that have favorable rate structures, and requiringprior authorization for specialist physician referrals. If we cannot continueto improve our management of health care costs, our business, results ofoperations, financial condition, and ability to satisfy our obligations couldbe adversely affected.

Under all current HMO contracts, our affiliatedphysician organizations accept the financial risk for the provision of primarycare and specialty physician services, and some ancillary health care services.If we are unable to negotiate favorable prices or rates in contracts withproviders of these services on behalf of our affiliated physicianorganizations, or if our affiliated physician organizations are unable toeffectively control the utilization of these services, our profitability couldbe reduced or eliminated. Our ability to manage health care costs is alsodiminished to the extent that we are unable to sub-capitate the specialists inour service areas at competitive rates. To the extent that our HMO enrolleesrequire more frequent or extensive care, our operating margins may be reducedand the revenues derived from our capitation contracts may be insufficient tocover the costs of the services provided. If our medical costs substantiallyexceed our revenues we may be required to infuse additional capital to maintainour provider network and HMO contracts, and there are no assurances that wewill achieve profitability after the infusion of capital.

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**Our revenue and profitability could be significantlyreduced and could also fluctuate significantly from period to period underMedicare’s new Risk Adjusted payment methodology.**

In calendar 2004, CMS began a four year phase-in of arevised compensation model for Medicare beneficiaries enrolled in MedicareAdvantage plans. Previously, monthly capitation revenue was based on age, sexand location.

CMS’s revised payment model seeks to compensateMedicare Managed Care organizations based on the sickness (“acuity”) of eachindividual enrollee. Health Plans/IPA’s with sicker enrollees will receivemore, and those with healthier enrollees will receive less. This is referred toby CMS as “Risk Adjustment.”

Significant ongoing office visits by members, andsubmission of encounter data is required in order to receive incrementalrevenue, or not lose revenue for any given member. This requires a great dealof continuous effort on our part, and co-operation on the parts of ourcontracted physicians and members. We have not always been able to gain thisco-operation from the contracted physicians and members, or devote theresources necessary to obtain incremental Risk Adjustment revenue, or avoidhaving previously received revenue taken back from us.

Additionally, because of the time required by CMS toprocess all of the submitted encounter data from all participating entities, wetypically do not find out until the latter part of the calendar year whatadjustments will be made to our Medicare revenue for the year, at which timethose adjustments to revenue, which have historically been very significant,are recorded.

In fiscal 2005, we received approximately $4.0 millionin incremental Risk Adjustment revenue for calendar 2005. This was primarilyreceived in our fiscal fourth quarter and was recorded in that quarter. Infiscal 2006, we were required to give back approximately $1.5 million in RiskAdjustment revenue. Again, this adjustment became known, and was recorded, inour fiscal fourth quarter, even though the majority of the adjustment relatedto earlier periods.

Given the deadlines forsubmitting data to CMS, and CMS’s processing time in order to calculate theseRisk Adjustment revenue changes, we have no way of reliably estimating theimpact of Risk Adjustment until such time as those adjustments are made knownby CMS. As such, retroactive Risk Adjustments will be recorded each year in thequarter they become known, notwithstanding that a significant portion of thoseadjustments will relate to earlier periods. These adjustments will continue tobe significant.

**Our operatingresults could be adversely affected if our actual health care claims exceed ourreserves.**

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, 2004, 2005 and 2006we could retire approximately 156%, 147% and 146%, 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 disbursement of claims checks near those dates, the status ofspecifically reserved items as of those dates, the level of borrowings made asof the given dates and whether there have been any recent acquisitions, and theamount of cash included as part of those 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 

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termination of the HMOcontract, 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 30,2004, 2005 and 2006, we estimated our IBNR at $13,323,622, $11,532,328 and$11,400,000 respectively. Given the uncertainties inherent in such estimates, thereserves 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.

**We may be exposed to liability or fail to estimate IBNRclaims accurately if we cannot process our increased volume ofclaims 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.

**Medicare and private third-party payer costcontainment efforts and reductions in reimbursement rates could reduce our revenueand 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-sharing arrangements that our affiliatedphysician organizations have with HMOs and hospitals could result in theircosts exceeding the corresponding revenues, which could reduce or eliminate anyshared risk profitability.**

Most of our affiliatedphysician organizations’ agreements with HMOs and hospitals contain risk-sharingarrangements under which the affiliated physician organizations can earnadditional compensation by coordinating the provision of high quality,cost-effective health care to enrollees, but they may also be required toassume a portion of any loss sustained from these arrangements, therebyreducing our net income. Risk-sharing arrangements are based upon the cost ofhospital services or other services for which our physician organizations arenot capitated. The terms of the particular risk-sharing arrangement allocateresponsibility to the respective parties when the cost of services exceeds abudget, which results in a “deficit,” and permit the parties to share in anyamounts remaining in the budget, known as a “surplus,” which occurs when actualcost is less than the budgeted amount. The amount of non-capitated andhospital costs in any period could be affected by factors beyond our control,such as changes in treatment protocols, new technologies and inflation. To theextent that such non-capitated and hospital costs are higher than anticipated,revenue paid to our affiliated physician organizations may not be sufficient tocover the risk-sharing deficits they are responsible for, which could reduceour revenues and profitability. It is our experience that “deficit” amounts forhospital costs are applied to offset any future “surplus” amount we wouldotherwise be entitled to receive. We have historically not been required to 

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reimbursethe HMOs 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 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. Netrisk-pool surpluses (deficits) were $(21,610), $1,151,373 and $3,346,204 forthe fiscal years ended September 30, 2004, 2005 and 2006, respectively.

In addition to hospitalrisk-sharing arrangements, many HMOs also provide a risk-sharing arrangementfor pharmaceutical costs. Unlike hospital pools where nearly all of the HMOcontracts mandate participation by our affiliated physician organizations inthe risk sharing for hospital costs, a lesser number of the HMO contractsmandate participation in a pharmacy risk-sharing arrangement, and although(unlike hospital pools) our affiliated physician organizations are generallyresponsible for their 50% allocation of pharmacy cost deficits, the deficitamounts of pharmacy costs have to date not had a material effect on ourrevenue.

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 wedo not successfully integrate the operations of acquired physicianorganizations 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 difficultand time consuming to integrate the acquired organization’s managementservices, including information systems, claims administration, and case management,as well as administrative functions, and, while at the same time managing alarger entity with a differing history, business model and culture. Managementmay be required to develop working relationships with providers with whom theyhave had no previous business experience. Management also may not be able toobtain economies of scale from utilizing existing specialists for enrollees inour same service networks. Integration of acquired entities is vital for us tobe able to operate effectively and to control medical and administrative costs.If we are not successful in integrating acquired operations on a timely basis,or at all, our business could be disrupted and we may not be able to realizethe anticipated benefits of our acquisitions, including cost savings. There maybe substantial unanticipated costs associated with acquisition and integrationactivities, any of which could result in significant one-time charges toearnings or otherwise adversely affect our operating results.

**Whenwe acquire operations that have historically operated at a loss, we may not beable to reverse thoselosses and operate those businesses at a profit, which could reduce ourearnings.**

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. We 

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attemptto reduce operating losses of such acquired businesses by negotiating bettercapitation rates from the HMOs, negotiating better pricing with the specialistphysicians by trading patient volume in exchange for a sub-capitation paymentor discounted pricing, and consolidating administrative and back-officefunctions. Although we were successful in the turn-around of Health Source byemploying these strategies, no assurance can be given that we can repeat ourperformance in the event we acquire another physician organization that hashistorically operated at a loss. In the event we are not able to reverse thosetrends and operate the assets profitably, our net earnings could be reduced.

**If weare unable to identify suitable acquisition candidates or to negotiate orcomplete acquisitions onfavorable terms, our prospects for growth could be limited.**

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 currentstockholders or could increase our indebtedness and cost 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.

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

The managed care industryis highly competitive and is subject to continuing changes in the ways in whichservices are provided and providers are selected and paid. We are subject tosignificant competition both with respect to physicians affiliating with ouraffiliated physician organizations, and in seeking contracts to manage otherIPAs.

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.

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

We and our affiliatedphysician organizations are subject to numerous federal and state statutes andregulations that are applicable to health care organizations and businessesgenerally, including the corporate practice of medicine prohibition, federaland state anti-kickback laws and federal and state laws regarding the use anddisclosure of patient health information. If our business operations are foundto be in violation of any of the laws and regulations to which we are subject,we may be subject to the applicable penalty associated with the violation, includingcivil and criminal penalties, damages, fines, and increased legal expenses, wemay be required to make costly changes to our business operations, and we maybe excluded from government reimbursement programs. The laws and regulationsthat we and our affiliated physician organizations are subject to are complexand subject to varying interpretations. Any action against us or our affiliatedphysician organizations 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.

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

**Future reforms inhealth 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 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. 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 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, 2006, was 1.46.

**Whenever we seek to acquire an IPA, an HMO that has acontract with that IPA could potentially refuse to consent to thetransfer of its contract, and this could deter us from completing theacquisition or could deprive us of the enrollees and revenues associated withthat HMO contract if we chose to complete the acquisition without the HMO’sconsent.**

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 

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IPA. Asa result, whenever we seek to acquire an IPA, the acquisition may beconditioned upon the IPA’s ability to obtain such consent from the HMOs withwhich it has contracted. Therefore, an acquisition could be delayed while anHMO seeks to determine whether it will consent to the transfer of the IPA.While in our experience the HMOs limit their review to satisfying their regulatoryresponsibility to ensure that, following the acquisition, the IPApost-acquisition will meet certain financial and operational thresholds, thelanguage in many of the HMO agreements give the HMO the ability to decline togive their consent if they simply do not want to do business with the acquiringentity. If an HMO is unwilling for any reason to give its consent, this coulddeter us from completing the acquisition, or, if we complete an acquisitionwithout obtaining an HMO’s consent, we could lose the benefit of the enrolleesand revenues associated with that HMO’s contract.

**Our profitability could be adversely affected by anychanges that would reduce payments to HMOs under government-sponsoredhealth care programs.**

Although our affiliated physician organizations do notdirectly contract with the Centers for Medicare & Medicaid Services (afederal agency within the U.S. Department of Health and Human Services), duringthe fiscal year ended September 30, 2004, our affiliated physicianorganizations received $43,490,025 or approximatley 35% of capitation revenues,derived from payments made to the affiliated physician organizations from HMOsthat contract with Medicare, Medicaid and other government-sponsoredhealth care 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 ended September 30, 2005, ouraffiliated physician organizations received $46,791,854 in revenues from HMOsthat contract with Medicare, Medicaid and other government-sponsoredhealth care programs, which represents approximately 37% of capitationrevenues.

For the year ended September 30,2006, our affiliated physician organizations received $45,397,090 in revenuesfrom HMOs that contract with Medicare, Medicaid and other government-sponsoredhealth care programs, which represents approximately 35% of capitationrevenues.

**Our revenues and profits could be diminished if welose the services of key physicians 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 disabled, terminate their employment agreements or providercontracts, or otherwise become unable or unwilling to continue generatingrevenues at the current level, or practicing medicine within the physicianorganization. Enrollees who have been served by such physicians could choose toenroll with competitors physician organizations, reducing our revenues andprofits. Moreover, we may not be able to attract other physicians into ouraffiliated physician organizations to replace the services of such physicians.

**Because our business is currently limited to theSouthern California area, any reduction in our revenues and profitability from alocal economic downturn would not be offset by operations in other geographicareas.**

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, ourenrollment and our revenues may decline, which could significantly reduce ourprofitability.

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

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,improvements or replacements as we expand and as new technologies becomeavailable. We may also be required to modify our management information systemsin order to comply with new government regulations. For example, regulationsadopted under the federal Health Insurance Portability and Accountability Actof 1996 beginning in August 2000 have required us to begin complying withnew electronic 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 30,2004, 2005 and 2006, we estimate that the costs incurred by us to upgrade andmodify our management information system exclusive of any employee expense havetotaled approximately $540,000, $230,000 and $210,000. These amounts do notinclude any of the costs associated with running our company’s informationsystems department, which currently approximate $2 million annually.

**If we were to lose the services of Dr. Terner orother key members of management, we might not be able to replace them in a timelymanner with qualified personnel, which could disrupt our business and reduceour profitability 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 replacement quicklyto avoid disrupting our business and reducing our profitability and revenuegrowth. We compete with other companies for executive talent, and it may not bepossible for us to recruit a qualified candidate on a timely basis, or at all.Currently, we do not maintain any life insurance on our key managementpersonnel, and the only members of our management team that have employmentagreements at this time are Dr. Terner and Mr. Heather. Although wehave not entered into an employment agreement with Ms. Dickson, our Boardof Directors has approved the payment to her of six months’ salary as aseverance package 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. 

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Dr. Ternerwas further ordered to pay a civil penalty in the amount of $225,750 under theInsider Trading and Securities Fraud Enforcement Act of 1988.

**We and our affiliated physician organizations maybecome subject to claims of medical malpractice or HMO bad-faith liabilityclaims for which our insurance coverage may not be adequate. Such claims could materiallyincrease our costs and 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.

**Fluctuations in our quarterly operating results maymake it difficult to predict our future results of operations, which coulddecrease the market value of our common stock.**

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, CMS risk adjustment calculations,and the capitated nature of our revenues. Historically, the affiliatedphysician organizations and HMOs generally reconcile differences between actualand estimated amounts relating to HMO incentive payment arrangements by thethird quarter of each calendar year. In the event that the affiliated physicianorganizations and HMOs are unable to reconcile such differences, extensivenegotiation, arbitration or litigation relating to the final settlement ofthese amounts may occur. Any delay in the settlement of these amounts mayresult in our being unable to 

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recordanticipated income. As our network expands to include additional IPAs, thetiming of these reconciliations may vary; this variation in timing may causeour results not to be directly comparable to corresponding quarters in otheryears. Our financial statements also include estimates of costs for coveredmedical benefits incurred by enrollees, which costs have not yet been reportedby the providers (incurred but not reported claims). While these estimates arebased on information available to us at the time of calculation, actual costsmay differ from our estimates of such amounts. If the actual costs differsignificantly from the amounts we have estimated, adjustments will be requiredand quarterly results may be affected. Quarterly results may also be affectedby movements of HMO members from one HMO to another, particularly duringperiods of open enrollment for HMOs, which occur primarily in September, October andJanuary of each year. Additionally, the completion of acquisitions causesfluctuations in our quarterly results, as results of the acquired entities areconsolidated with our results for periods following the acquisitions. Thesefactors can make our quarterly results not be directly comparable to theresults in corresponding quarters of other years, making it difficult topredict our future results of operations. As a result, our results ofoperations may fluctuate significantly from period to period, which coulddecrease the value of our common stock.

**The NASD hasconducted 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 we are not able to develop or sustain an activetrading market for our common stock, it may be difficult for stockholders todispose of their common stock.**

Our common stock was the subjectof limited and sporadic trading on the OTC Bulletin Board from 1996 to 1999. Noliquid trading market has existed for our common stock since 1999. Trading ofour common stock on the American Stock Exchange began on May 11, 2005. Itis uncertain whether we will be able to continue to meet the requirements forlisting on the American Stock Exchange, or an alternative exchange or market,or that an active trading market for our common stock will develop. If we donot maintain our American Stock Exchange listing or listing on another exchangeor market and an active market in our common stock does not develop, it may bemore difficult for stockholders to dispose of their common stock and coulddiminish significantly the market value of our common stock.

**Even if an active market develops for our commonstock, the market price of our stock 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.

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**If our common stock becomes subject to the SEC’s pennystock rules, our stockholders 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.**

**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                                            |       | 5  years; 2010                |       |                           | $          | 42,978 |   |   |
| Sierra Primary Care Medical Group(3) |       | Lancaster, CA |       | Shares space with   Antelope Valley   Medical Associates   and Sierra Medical   Management |       | 6.5 years; 2012               |       |                           | $14,809    |   |   |
| 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                 |       |                           | $          | 7,812 |   |   |

 

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**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                                                       |       | 5  years; 2010                |       |                           | $          | 42,978 |   |   |
| Prospect Medical  Systems(2)  |       | Santa  Ana, CA        |       | Shares  space with   Prospect Medical   Group                                                       |       | 5  years; 2011                |       |                           | $          | 20,400 |   |   |
| Sierra Medical  Management(3) |       | Lancaster,  CA        |       | Shares  space with   Sierra Primary Care   Medical Group and   Antelope Valley   Medical Associates |       | 6.5  years; 2012              |       |                           | $          | 14,809 |   |   |
| Sierra Medical  Management(3) |       | Lancaster,  CA        |       | Shares  space with   Sierra Primary Care   Medical Group                                            |       | 1  year; 2007                 |       |                           | $          | 1,700 |   |   |
| Sierra Medical  Management(3) |       | Lancaster, CA         |       | Shares space with   Sierra Primary Care                                                             |       | 3 year; 2009                  |       |                           | $          | 1,350 |   |   |

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(1)          Prospect Medical Groupincludes all affiliated physician organizations that are wholly-owned subsidiariesof Prospect Medical Group.

(2)          On January 27,2004, Prospect Medical Systems executed a 6th Addendum to itsoffice lease that provided for an increase in space of 5,298 square feeteffective November 1, 2004, at which date, the base rent increased to$42,978.

The Company leasedadditional space in July, 2006 adjacent to the Santa Ana facilities forapproximately 12,015 square feet. The lease agreement term is for a 60 months,through 2011, with starting monthly lease payments of approximately $20,400 .

(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 30,2006, we and our affiliated physician organizations had a total of 367employees. The employees are not subject to any collective bargainingagreements. We believe that employee relations are good.

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**Item 3.**                        LegalProceedings.

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

**Item 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, 2006.

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**PART II**

**Item 5.**                        Marketfor Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases 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 |   |   |
| 2006                                         |       |       |       |                           |       |                          |       |   |   |
| First Quarter                                |       |       | $          | 6.00                           |       |                          |       | $ | 4.26 |   |   |
| Second Quarter                               |       |       | $          | 7.25                           |       |                          |       | $ | 4.80 |   |   |
| Third Quarter                                |       |       | $          | 6.31                           |       |                          |       | $ | 5.15 |   |   |
| Fourth Quarter                               |       |       | $          | 6.15                           |       |                          |       | $ | 5.50 |   |   |

 

As of December 20, 2006, we had approximately 251record owners and approximately 657 beneficial 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 cash dividends in the past and donot plan to do so in the near future. Under our credit facility, we areprohibited from declaring or paying any dividends or distributions of earningsto our stockholders.

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**Item 6.**                        SelectedFinancial Data

**Selected FinancialData**

Set forth below is ourselected consolidated financial data for the five fiscal years ended September 30,2006 derived from our audited consolidated financial statements. You shouldread the selected consolidated financial data in conjunction with ourconsolidated financial statements and related notes included herein and with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations.”Amounts are in thousands except for per share and enrollment data:

| ** **                                                      | ** ** | **Year Ended September 30** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                      | ** ** | **2002**                                   | ** ** | **2003(1)** | ** ** | **2004(2)** | ** ** | **2005** | ** ** | **2006(3)** | ** ** |
| **Statement of Operations Data:**                               | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                                                        |       | $                                          | 69,170     |   | $ | 66,542 |   | $ | 129,516 |   | $ | 133,518 |   | $ | 135,796 |   |
| Cost of revenues                                                |       | 49,929                                     |       | 46,740 |   | 95,975 |   | 96,371 |   | 97,184 |   |
| Gross margin                                                    |       | 19,241                                     |       | 19,802 |   | 33,541 |   | 37,147 |   | 38,612 |   |
| Operating  expenses                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| General and administrative                                      |       | 17,248                                     |       | 18,200 |   | 24,335 |   | 27,229 |   | 30,205 |   |
| Depreciation and amortization                                   |       | 580                                        |       | 540 |   | 733 |   | 948 |   | 1,513 |   |
|                                                            |       | 17,828                                     |       | 18,740 |   | 25,068 |   | 28,177 |   | 31,718 |   |
| Operating income  from unconsolidated joint venture             |       | 511                                        |       | 728 |   | 207 |   | 88 |   | 1,400 |   |
| Operating income                                                |       | 1,924                                      |       | 1,790 |   | 8,680 |   | 9,058 |   | 8,294 |   |
| Investment income                                               |       | 151                                        |       | 59 |   | 76 |   | 400 |   | 913 |   |
| Interest expense                                                |       | (322                                       | )          | (195 | ) | (91 | ) | (958 | ) | (1,107 | ) |
| Interest expense,  net                                          |       | (171                                       | )          | (136 | ) | (15 | ) | (558 | ) | (194 | ) |
| Equity in losses,  and write down, of unconsolidated investment |       | —                                     |       | — |   | — |   | (1,000 | ) | — |   |
| Income before  income taxes                                     |       | 1,753                                      |       | 1,654 |   | 8,665 |   | 7,500 |   | 8,100 |   |
| Income tax  provision                                           |       | (483                                       | )          | (683 | ) | (3,525 | ) | (3,415 | ) | (3,194 | ) |
| Minority interest                                               |       | (9                                         | )          | (16 | ) | (13 | ) | (12 | ) | (16 | ) |
| Net income                                                      |       | $                                          | 1,261      |   | $ | 955 |   | $ | 5,127 |   | $ | 4,073 |   | $ | 4,890 |   |
| Basic earnings  per share                                       |       | $                                          | 0.26       |   | $ | 0.23 |   | $ | 1.19 |   | $ | 0.83 |   | $ | 0.71 |   |
| Diluted earnings per  share                                     |       | $                                          | 0.26       |   | $ | 0.22 |   | $ | 0.68 |   | $ | 0.48 |   | $ | 0.60 |   |

 

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| ** **                                       | ** ** | **As of September 30** | ** ** |
|--------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                       | ** ** | **2002**                              | ** ** | **2003(1)** | ** ** | **2004(2)** | ** ** | **2005** | ** ** | **2006(3)** | ** ** |
| **Balance Sheet Data:**                          | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Assets:                                          |       |                                  |       |   |   |   |   |   |   |   |   |
| Cash and Cash  Equivalents                       |       | $                                     | 4,566      |   | $ | 6,517 |   | $ | 20,330 |   | $ | 16,949 |   | $ | 16,623 |   |
| Other Current  Assets                            |       | 2,931                                 |       | 2,151 |   | 4,218 |   | 5,702 |   | 8,145 |   |
| Fixed Assets                                     |       | 1,114                                 |       | 1,022 |   | 1,606 |   | 1,202 |   | 1,286 |   |
| Other Assets  (Primarily Goodwill)               |       | 17,300                                |       | 24,899 |   | 34,134 |   | 33,878 |   | 40,603 |   |
| Total Assets                                     |       | $                                     | 25,911     |   | $ | 34,589 |   | $ | 60,288 |   | $ | 57,731 |   | $ | 66,657 |   |
| Liabilities and  Shareholders’ Equity:      |       |                                  |       |   |   |   |   |   |   |   |   |
| Current  Liabilities                             |       | $                                     | 17,075     |   | $ | 25,364 |   | $ | 27,689 |   | $ | 23,332 |   | $ | 24,892 |   |
| Long-Term  Liabilities                           |       | 2,861                                 |       | 2,003 |   | 9,648 |   | 7,398 |   | 7,880 |   |
| Minority Interest                                |       | 74                                    |       | 80 |   | 64 |   | 65 |   | 82 |   |
| Total  Shareholders’ Equity                 |       | 5,901                                 |       | 7,142 |   | 22,887 |   | 26,936 |   | 33,803 |   |
| Total Liabilities  and Shareholders’ Equity |       | $                                     | 25,911     |   | $ | 34,589 |   | $ | 60,288 |   | $ | 57,731 |   | $ | 66,657 |   |
| **HMO  Enrollment:(4)(5)**                       | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Commercial                                       |       | 102,000                               |       | 136,200 |   | 168,500 |   | 144,900 |   | 140,300 |   |
| Medicare                                         |       | 7,000                                 |       | 11,200 |   | 15,500 |   | 12,500 |   | 14,100 |   |
| Medi-Cal                                         |       | 8,500                                 |       | 13,700 |   | 14,400 |   | 14,500 |   | 17,000 |   |
| **Total Enrollment**                             | ** ** | **117,500**                           | ** ** | **161,100** | ** ** | **198,400** | ** ** | **171,900** | ** ** | **171,400** | ** ** |

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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 statements of income 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)          The balance sheet andoperating results of Genesis HealthCare of Southern California have beenincluded in the consolidated financial statements after its November 1, 2005acquisition date.

(4)          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.

(5)          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 economicbenefit of our partner in the AMVI/Prospect Health Network joint venture. Thenumber of enrollees included in the above table for which we provide managementservices to our joint venture partner, but in which we have no beneficialownership interest, was 5,600, 7,100, 7,100,7,300 and 7,100 as of September 30,2002, 2003, 2004, 2005, and 2006 respectively.

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**Item 7.**                        Management’sDiscussion and Analysis of Financial Condition and Results of Operations

The following discussionof our financial condition and results of operations should be read togetherwith the financial statements and related notes included in this registrationstatement. This discussion and analysis contains forward-lookingstatements that involve risks and uncertainties. Our actual results may differsignificantly from the results discussed in the forward-lookingstatements. Factors that might cause or contribute to such a differenceinclude, but are not limited to, those discussed under “Risk Factors” andelsewhere in this registration statement.

***Executive Overview***

**General Operations**

We are a Southern California health care company thatprovides management and administrative services to affiliated physicianorganizations that have entered into agreements with HMOs to provide medicalservices to approximately 171,400 HMO enrollees (as of September 30, 2006)in Orange and Los Angeles counties.

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 ofPerformance (Year Ended September 30, 2006 as compared to 2005)**

·       Themember months decreased by approximately 0.3% compared to the prior year.

·       Revenueincreased by approximately 2% compared to the prior year.

·       Themedical cost ratio decreased from 72.62% to 72.23% compared to the prior year.

·       Generaland administrative expenses increased approximately 11% compared to the prioryear.

·       Operatingincome decreased by approximately 8% compared to the prior year.

·       Dilutedearnings per share increased by 25% compared to the prior year.

·       Totalcash and cash equivalents decreased by $325,898, or approximately 2% comparedto the prior year.

·       Total bank debt increasedby $3,833,333 or approximately 47% compared to the prior year.

**Highlights ofPerformance (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.

·       Totalbank debt decreased by $6,841,887 or approximately 46% compared to the prioryear.

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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 156 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 2006 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-affiliatedphysician organizations, from Brotman Medical Center (in which we have aminority interest), and from our partner in the AMVI/Prospect joint venture.The fee is either a fixed percentage of revenue of the non-affiliated physicianorganization, 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), private indemnityhealth insurance, and cash payments by patients.

For the year ended September 30, 2006, ascompared to 2005, we experienced a slight increase in revenues, primarily dueto the Genesis acquisition in November 2005 and net increases in risk pool revenue.These increases were offset by declines in enrollment.

For the year ended September 30,2005, as compared to 2004, we experienced a slight increase in revenues,primarily due to inclusion of full 12 months of revenue from our 2004acquisitions and net increases in our Medicare enrollees’ Risk Adjustmentfactors. These rate increases were offset by declines in enrollment.

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**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 not have a contract with our affiliated physicianorganizations; and salaries, benefits and other compensation paid to physiciansthat are employees of our affiliated physician organizations (Sierra PrimaryCare Medical Group and Pegasus Medical Group). Our medical expenses alsoinclude an estimate of claims that have been incurred but 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, andmarketing.

**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 

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assumptionsmade by us using information available at the time the estimates are made.Actual results could differ materially from those estimates.

**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 Interpretation No. 46, “Consolidation of VariableInterest Entities, an interpretation of ARB No. 51” (FIN 46) we are required toconsolidate our affiliated physician organizations. The operations of ouraffiliated physician organizations have a significant impact on our financialstatements. All inter-company accounts and balances have been eliminatedin 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.

Variability in capitation revenue has increasedbeginning in calendar 2004, when Medicare began a four year phase-in of arevised capitation model referred to as “Risk Adjustment.” Under the new model,capitation with respect to Medicare enrollees is subject to subsequentadjustment by CMS for the acuity of the enrollees to whom services wereprovided. Capitation for the current year is paid based on data submitted foreach enrollee for the preceding year. Capitation is paid at interim ratesduring the year and is adjusted in subsequent periods (generally in the fourthquarter) after the final data is compiled. Positive or negative capitationadjustments are made for seniors with conditions requiring more or lesshealthcare services than assumed in the interim payments. Since we do notcurrently have the ability to reliably predict these adjustments, periodicchanges in capitation amounts earned as a result of Risk Adjustment arerecognized when those changes are communicated from the health plans, generallyin the fourth quarter of the fiscal year to which the adjustments relate. Werecorded a $1.5 million reduction in revenue in the fourth quarter of fiscal2006 for risk adjustment factors and a $4 million increase in capitation in thecomparable 2005 period.

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.Uncollectible amounts are reported as bad debt expense and included in generaland administrative expenses.

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We also earn additional incentive revenue or incurpenalties under HMO contracts by sharing in the risk for hospitalization basedupon inpatient services utilized. Except for two contracts where we arecontractually obligated for down-side risk, shared risk deficits are notpayable unless and until we generate  future risk sharing surpluses. Risk pools aregenerally settled in the following year. Management estimates risk poolincentives based on estimated hospital utilization and associated costscompared to budget and, if available, interim risk pool settlements reported byhealth plans. These estimates are inherently uncertain and could differsignificantly from actual results. Differences between actual and estimatedsettlements are recorded when the final outcome is known. We also receiveincentives under “pay-for-performance” programs for quality medical care basedon various criteria. Pay-for-performance payments are generally recorded in thethird and fourth quarters of our fiscal year when such amounts are known since wedo not have the ability to reliably estimate these amounts. Risk pool andpay-for-performance incentives are affected by many factors, some of which arebeyond our control, and may vary significantly from year to year.

Management fee revenue isearned in the month the services have been delivered.

**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. The determination of our claimsliability and other healthcare costs payable is particularly important to thedetermination of our financial position and results of operations and requiresthe application of significant judgment by our management, and as a result, issubject to an inherent degree of uncertainty.

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

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 significantlyin the near term. Our reserve models use lag-based incurred claim estimates andtrended per member per month estimates, which are the most significantassumptions in determining our claims liability. The model considers claimspayment data for the past 25 months. For the months of service five months priorto the reporting date and earlier, we estimate our outstanding claims liabilitybased upon actual claims paid, adjusted for estimated completion factors.Completion factors seek to measure the cumulative percentage of claims expensethat will have been paid for a given month of service as of a date subsequentto that month of service. Completion factors are based upon historical paymentpatterns. For the four months of service immediately prior to the reportingdate, actual claims paid are not a reliable measure of our ultimate liability,given the delay inherent between the patient/physician encounter and the actualsubmission of a claim for payment. For these months of service we estimate ourclaims liability based upon trended per member per month (“PMPM”) costestimates. These estimates reflect recent trends in payments and expense,ultilization patterns, authorized services and other relevant factors.

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Thefollowing table presents the components of the change in accrued medical claimsfor the three years ended September 30, 2006:

| ** **                                            | ** ** | **Year Ended September 30** | ** **     |
|-------------------------------------------------------|------------|--------------------------------------------|----------------|
| ** **                                            | ** ** | **2004**                                   | ** **     | **2005** | ** ** | **2006** | ** ** |
| **IBNR at  Beginning of Year**                        | ** ** | **$**                                      | **10,557,426** | ** ** | **$** | **13,323,622** | ** ** | **$** | **11,532,328** | ** ** |
| Health Care Claims  Expense Incurred During the Year: |       |                                       |           |   |   |   |   |
| Related to Current Year                               |       | 44,699,711                                 |           | 46,030,847 |   | 50,587,185 |   |
| Related to Prior Year                                 |       | (2,327,044                                 | )              | (855,164 | ) | (854,595 | ) |
| **Total Incurred**                                    | ** ** | **42,372,667**                             | ** **     | **45,175,683** | ** ** | **49,732,590** | ** ** |
| **Health Care Claims Paid During  the Year**          | ** ** | ** **                                 | ** **     | ** ** | ** ** | ** ** | ** ** |
| Related to Current Year                               |       | (33,295,082                                | )              | (35,266,828 | ) | (39,488,526 | ) |
| Related to Prior Year                                 |       | (7,268,752                                 | )              | (11,700,149 | ) | (11,242,787 | ) |
| **Total Paid**                                        | ** ** | **(40,563,834**                            | **)**          | **(46,966,977** | **)** | **(50,731,313** | **)** |
| **IBNR  Acquired During the Year, net**               | ** ** | **957,363**                                | ** **     | **—** | ** ** | **866,395** | ** ** |
| **IBNR at End of Year**                               | ** ** | **$**                                      | **13,323,622** | ** ** | **$** | **11,532,328** | ** ** | **$** | **11,400,000** | ** ** |

 

Acquisition balances represent medical claimsliabilities of acquired entities as of the applicable purchase date. Ourstrategy of growth by acquisition increases the complexity and variabilityalready inherent in our claims estimation process. Our business in general, andthis area of our business in particular, is subject to uncertainty as to theoutcome and estimation of medical claims, which uncertainty is additionallyimpacted by our acquiring and integrating businesses previously not operated byus. Following an acquisition, we ensure that the IBNR methodology andcalculations for the acquired business are consistent with our own methodology andcalculations. Our IBNR models consider claims payment data for the currentmonth and the prior 24 months. During the 25-month period followingour acquisition, and to the extent that the prior owners’ experience andmanagement of medical expenses was different from ours, actual experience underour management and contracting will be reflected in the IBNR calculations. Weattempt to be consistently conservative in reserving for known and anticipatedmedical claims liabilities. This requires additional emphasis for recentlyacquired businesses. The favorable change in estimates related to prior yearsclaims in the above table reflect additional provisions for adverse deviation,which is consistently maintained.

We believe that the amount of our accrued medicalclaims is adequate to cover our ultimate liability for incurred claims as of September 30,2006 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, 2004, 2005, and 2006, wouldincrease or decrease by approximately $133,236, $115,323, and $114,000respectively.

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Thefollowing tables reflect (i) the change in estimated claims liability as ofSeptember 30, 2006 that would have resulted had we changed our completionfactors for all applicable months of service included in our IBNR calculation(i.e., for the preceding 5th through 25th months) by the percentages indicated; and (ii)the change in estimated claims liability as of September 30, 2006 that wouldhave resulted had we changed our trended PMPM factors for all applicable monthsof service included in our IBNR calculation (i.e., for the preceding 1stthrough 4th months) by the percentages indicated.

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

 

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

 

In addition to contractual reimbursements to providers,we also make discretionary incentive payments to physicians, which are in largepart based on the pay-for-performance and shared risk revenues and favorablesenior capitation risk adjustment payments. Since we record these revenuesgenerally in the third or fourth quarter of each fiscal year when theincentives and capitation adjustments due from the health plans are known, wealso record the discretionary physician bonuses in the same period. In fiscal2004 and 2005, we recorded discretionary incentive payments to providerstotaling $1,286,000 and $2,579,000, respectively. No discretionary incentiveswere recorded in fiscal 2006. Since incentives and risk adjustment revenuesform the basis for these discretionary bonuses, variability in earnings due tofluctuations in revenues are mitigated by reductions in bonuses awarded.

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 

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basis, or more frequentlyif certain indicators are present. Such indicators include adverse changes inmarket value and/or stock price, laws and regulations, profitability, cashflows, our ability to maintain enrollment and renew payor contracts onfavorable terms. A two-step impairment test is used to identify potentialgoodwill impairment and to measure the amount of goodwill impairment loss to berecognized (if any). The first step consists of estimating the fair value ofthe reporting unit based on recognized valuation techniques, which include aweighted combination of (i) the guideline company method that utilizesrevenue multiples for comparable publicly-traded companies, and (ii) adiscounted cash flow model that utilizes future cash flows, the timing of thosecash flows, and a discount rate (or weighted average cost of capital whichconsiders the cost of equity and cost of debt financing expected by arepresentative market participant) representing the time value of money and theinherent risk and uncertainty of the future cash flows. If the estimated fairvalue of the reporting unit is less than its carrying value, a second step isperformed to compute the amount of the impairment by determining the “impliedfair value” of the goodwill, which is compared to its corresponding carryingvalue.

The affiliated physicianorganizations, which share similar economic and operational characteristics,comprise a sole reporting unit. Our valuations have concluded that the fairvalue of Prospect Medical Holdings exceeded its carrying value, thus goodwillof Prospect Medical Holdings was not considered impaired during each fiscalyear test, since we adopted SFAS No. 142 for our fiscal year ended September 30,2002.

**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”,we record 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, 2006,we completed several business combinations. These business combinations are allaccounted for using the purchase method of accounting, and accordingly, the operatingresults of each acquisition have been included in our consolidated financialstatements since their effective date of acquisition. The purchase price foreach 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, identifiable intangible assets was originally being amortizedover a useful life of seven to ten years. During 2005, management determinedthat the useful life of identified intangibles was shorter than originallyexpected and the useful life was reduced to five years. The reduction inestimated useful life and related amortization period, resulted in increasedamortization of approximately $99,267 in fiscal 2006.

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Thefollowing table summarizes all business combinations for the five years ended September 30,2006.

| **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, tradename andcovenants not-to-compete. We require that our acquisition targets have cash ora 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 intangibleassets.

**Enrollment**

Thefollowing table presents our enrollment, inclusive of Medi-Cal lives we managefor the AMVI/Prospect Health Network joint venture, as of September 30,2005 and 2006, and the percentage change in enrollment between these dates:

| ** ** | ** ** | **2005**    | ** ** | **2006**    | ** ** | **% Change** | ** ** |
|------------|------------|-------------|------------|-------------|------------|-------------------|------------|
| Commercial |       | 144,900     |       | 140,300     |       |              | (3         | )% |   |
| Medicare   |       | 12,500      |       | 14,100      |       |              | 13         | % |   |
| Medi-Cal   |       | 14,500      |       | 17,000      |       |              | 17         | % |   |
| **Total**  | ** ** | **171,900** | ** ** | **171,400** | ** ** | ** **        | **(0.3**   | **)%** | ** ** |

 

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        | )% |   |
| MediCal    |       | 14,400      |       | 14,500      |       |              | 1          | % |   |
| **Total**  | ** ** | **198,400** | ** ** | **171,900** | ** ** | ** **        | **(13**    | **)%** | ** ** |

 

The decrease in enrollment as of September 30,2006 compared to September 30, 2005 is attributable primarily to decreasedmembership associated with physicians contracted to our IPAs, offset byincreases in enrollment through the acquisition of Genesis HealthCare ofSouthern California.

**Thedecrease in enrollment as of September 30, 2005 compared toSeptember 30, 2004 is attributable primarily to decreased membershipassociated with physicians contracted to our IPAs, with the largest decreasesbeing in the recently acquired IPAs where assimilation and integration into theProspect operations platform continued in fiscal 2006.**

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**Results ofOperations**

The following tables areprovided to facilitate the discussion of our operations for each of the threeyears in the period ended September 30, 2006.

| ** **                                                          | ** ** | **Year Ended September 30** | ** **  |
|---------------------------------------------------------------------|------------|--------------------------------------------|-------------|
| ** **                                                          | ** ** | **2005**                                   | ** **  | **2006** | ** ** | **Increase  (Decrease)** | ** ** | **%** | ** ** |
| **Revenues:**                                                       | ** ** | ** **                                 | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Capitation Revenue                                                  |       | $                                          | 129,143,656 |   | $ | 131,436,858 |   | $ | 2,293,202 |   | 2 | % |
| Fee for Service Revenue                                             |       | 2,232,059                                  |        | 2,074,104 |   | (157,955 | ) | (7 | )% |
| Management Fees                                                     |       | 806,788                                    |        | 1,233,027 |   | 426,239 |   | 53 | % |
| Other Operating Revenue                                             |       | 1,335,876                                  |        | 1,052,288 |   | (283,588 | ) | (21 | )% |
| **Total  Revenues**                                                 |       | 133,518,379                                |        | 135,796,277 |   | 2,277,898 |   | 2 | % |
| **Operating Expenses:**                                             | ** ** | ** **                                 | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Medical Costs                                                       |       | 96,371,197                                 |        | 97,184,202 |   | 813,005 |   | 1 | % |
| General and Administrative                                          |       | 27,228,736                                 |        | 30,205,352 |   | 2,976,616 |   | 11 | % |
| Depreciation and Amortization                                       |       | 948,017                                    |        | 1,513,170 |   | 565,153 |   | 60 | % |
| **Total  Operating Expenses**                                       |       | 124,547,950                                |        | 128,902,724 |   | 4,354,774 |   | 3 | % |
| **Operating  Income from Unconsolidated Joint Venture**             |       | 87,516                                     |        | 1,400,492 |   | 1,312,976 |   | 1500 | % |
| **Operating  Income**                                               |       | 9,057,945                                  |        | 8,294,046 |   | (763,899 | ) | (8 | )% |
| **Interest  Expense, net**                                          |       | (558,278                                   | )           | (194,013 | ) | 364,265 |   | (65 | )% |
| **Equity  in Losses, and Write Down, of Unconsolidated Investment** |       | (1,000,000                                 | )           | 0 |   | 1,000,000 |   | (100 | )% |
| **Income  Before Taxes**                                            |       | 7,499,667                                  |        | 8,100,033 |   | 600,366 |   | 8 | % |
| **Income  Tax Provision**                                           |       | 3,415,178                                  |        | 3,193,522 |   | (221,656 | ) | (6 | )% |
| **Minority  Interest**                                              |       | 11,930                                     |        | 16,476 |   | 4,546 |   | 38 | % |
| **Net  Income**                                                     |       | $                                          | 4,072,559   |   | $ | 4,890,035 |   | $ | 817,476 |   | 20 | % |
| **Diluted  Earnings Per Share**                                     |       | $                                          | 0.48        |   | $ | 0.60 |   | $ | 0.12 |   | 25 | % |
| **Medical Cost Ratio**                                              |       | 73                                         | %           | 72 | % |   |   |   |   |

 

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| ** **                                                          | ** ** | **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 | % |   |   |   |   |

 

***Fiscal Year Ended September 30, 2006 Comparedwith Fiscal Year Ended September 30, 2005***

Our total revenues for 2006, the largest portion ofwhich is capitation revenue, increased to $135,796,277 compared to $133,518,379for 2005, or an increase of 2%, primarily as a result of (i) the GenesisHealthCare of Southern California acquisition completed November 1, 2005, whichincreased revenue in 2006 by $10,459,374, and (ii) higher capitation rates infiscal 2006 on our core businesses (exclusive of acquisitions), whichcontributed $6,313,472 in increased capitation, offset by decreases incapitation rates for senior enrollees arising from Medicare’s moving to payingcapitation on a risk adjusted basis. We received and recorded as a reduction torevenue approximately $1.5 million in the fourth quarter of fiscal 2006 fromHMOs for risk adjustment factors, compared to positive capitation revenueadjustments of $4 million in the fourth quarter of fiscal 2005. Since thisrevenue could not previously be estimated by us, we recorded it upon receiptfrom the HMOs. Rate increases were partially offset by a decline in revenueassociated with decreased enrollment in our core operations in the currentperiod. During the year ended September 30, 2006, the number of enrolleesdecreased by approximately 16,400, resulting in an estimated revenue decreaseof $15,770,481 during the year.

Management fees, which represent approximately 1% oftotal revenues for both 2006 and 2005, increased by approximately 53% primarilyas a result of a new MSO agreement with Brotman Hospital and the OneCareproduct line.

Other operating revenue was $1,052,288 during 2006,compared to $1,335,876 for 2005, which decrease primarily results fromdecreased pay for performance monies received from our contracted HMOs forproviding, then demonstrating, higher levels of care to their enrollees. Theseincentives are 

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generally received in thethird and fourth quarters of our fiscal year and are recorded when such amountsare known.

The cost of medicalservices for 2006 increased to $97,184,202 compared to $96,371,197 for 2005, oran increase of $813,005. The overall increase in medical costs is the result ofthe Genesis HealthCare of Southern California acquisition which we operated foreleven months in fiscal 2006 ($8,682,912), increases in per member per month medicalcosts of $7,042,966 offset by enrollment declines in our core business($12,333,874) and a decrease in discretionary physician bonuses of $2,579,000.Our medical cost ratio (computed as medical costs to total capitation and fee-for-servicerevenue) for the 2006 period was approximately 72.8% and the medical cost ratiofor the 2005 period was approximately 73.4%. The primary components of thedifference were the result of the following factors. Approximately 1% of thenet decrease resulted from approximately $1,200,000 decrease in capitationexpense incurred on our specialist providers primarily because the Genesisacquisition had proportionately less capitated specialist contracts.Approximately 2% of the net decrease in medical cost ratio resulted fromapproximately $2,600,000 lower physician bonus expense reflecting lowerpay-for-performance and risk pool incentives and negative capitation riskadjustments in fiscal 2006. We also recorded higher healthplanpayments/recoveries for stop-loss insurance in 2006 along with a decrease inthe level of certain pharmacy and injectible costs. Our non-capitatedmedical costs increased by approximately $4,600,000 in relation to revenues andincreased the medical cost ratio by approximately 3% compared to the priorperiod due to higher claims per member rates due to increases in fee-for-servicecontract rates, a proportionately higher percentage of fee-for-servicecontracts in the Genesis acquisition and conversion of some provider contractsfrom capitation to fee-for-service.

General and administrativeexpenses for 2006 increased to $30,205,352 from $27,228,736 in 2005, or anincrease of 11%. As a percentage of our total revenues, our general andadministrative expense was 22% for 2006 compared to 20% for 2005. The increase ingeneral and administrative expenses was primarily the result of increases instaffing and fringe benefit costs, related primarily to staffing increases tointegrate prior acquisitions and prepare for future acquisitions. We also hadincreased costs for outside services related to Sarbanes-Oxley Act compliance,information technology consulting, and increased management fees related toGenesis.

Operating income decreasedto $8,294,046, or a decrease of approximately 8%, for 2006, as compared to $9,057,945for 2005, primarily as the result of a decline in members and the increase ingeneral and administrative costs.

Income from unconsolidatedjoint venture increased to $1,400,492 in fiscal 2006 from $87,516 in fiscal2005, as a result of increased profitability from the participation in theCalOptima OneCare program for Medicare/MediCal eligible beneficiaries effectiveJanuary 1, 2006.

Depreciation andamortization expense for 2006 was $1,513,170 compared to $948,017 for 2005, oran increase of 60%, as a result of increased amortization of certain assetsacquired in connection with the Genesis acquisition completed in 2006. Theincrease was also due to accelerating, effective April 1, 2005, the rate ofamortization of identifiable intangibles acquired in the February 1, 2004acquisitions of Northwest Orange County and Gateway Medical Group andaffiliates, as well as depreciation expenses associated with increased capitalexpenditures.

Interest expense (net ofinvestment income) for 2006 decreased to $194,013 compared to $558,278 for2005, as a result of the higher yields on our investments, partially offset byadditional interest on the $4 million GMAC Residential Funding Corporationcredit facility to finance the November 2005 Genesis acquisition.

Our income tax expense for 2006 of $3,193,522decreased $221,656 from $3,415,178 for 2005, or a decrease of approximately 6%.Our effective tax rate was 39% in 2006 and 46% in 2005. Our 2005 effective taxrate was higher primarily due to a valuation allowance we established in 2005against any potential 

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benefit we may derive fromthe capital losses we sustained from our unconsolidated equity investment inBrotman Medical Center.

Our net income for 2006was $4,890,035 or $.60 per diluted share, as compared to $4,072,559, or $0.48per diluted share, for 2005, which decrease is the result of the changesdiscussed above.

***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. Ournon-capitated medical costs increased in relation to revenues and increased themedical cost ratio 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 and administrativeexpenses was primarily the result of increases in staffing and fringe benefitcosts, related primarily to staffing increases being to integrate prioracquisitions and prepare for future acquisitions.

Operating income increased to $9,057,945, or an increaseof approximately 4%, for 2005, as compared to $8,679,714 for 2004, primarily asthe result of economies of scale we were able to achieve with the acquisitionof 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 investment 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 four 

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physician organizations.Partially offsetting this increase was an increase in interest income as aresult of increased cash balances in investment accounts and money marketfunds.

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 investmentin Brotman Medical Center.

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.

**Liquidity andCapital 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 operationsare healthcare capitation revenues, fee-for-service revenues, risk poolpayments and pay-for-performance incentives 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 strategies are designed to providesafety and preservation of capital, sufficient liquidity to meet cash flowneeds, the integration of investment strategy with our business operations andobjectives, and attainment of a competitive after-tax total return. AtSeptember 30, 2006, we invested a substantial portion of our cash in aportfolio that included Federal Home Loan bonds with an average maturity ofapproximately 60 days, and overnight and high yield money market funds. All ofthese amounts are classified as current assets and included in cash and cashequivalents in the accompanying balance sheets. A substantial portion of ourrecurring cash requirements is funded by advances from our managementsubsidiaries and affiliated physician organizations, some of which are subject tofinancial stability, tangible net worth and other requirements of the HMOs withwhich we do business. As of September 30, 2006, our subsidiaries were incompliance with these requirements. We are required by some of our HMOcontracts to set aside certain amounts in restricted certificates of deposit tosecure our ability to pay medical claims. These restricted certificates ofdeposit, with an average maturity of approximately 115 days as of September 30,2006, are included in investments in the accompanying financial statements.

The affiliated physician organizations must alsocomply with a minimum working capital, tangible net equity (TNE), cash toclaims ratio and claims payment requirements prescribed by the CaliforniaDepartment of Managed Health Care. TNE is defined as net assets lessintangibles and amounts due from affiliates, plus subordinated obligations. At September30, 2006 the affiliated physician organizations were in compliance with theseregulatory requirements. Barring any change in regulatory requirements, webelieve that we will continue to be in compliance with these requirements atleast through the end of fiscal 2007. We also believe that our cash resourcesand internally generated funds will be sufficient to support our operations,regulatory requirements and capital expenditures for at least the next 12months.

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Certain details of cash flows from operatingactivities, investing activities and financing activities for the fiscal yearsended September 30, 2006 and 2005 are described below.

In the future, we expect some level of increasing cashflow from operations due to the inclusion of earnings from the November 1,2005 acquisition of Genesis HealthCare, some additional savings derived fromthe elimination of duplicate functions and related costs, and some amount ofrevenue enhancements as a result of increased rates from HMO contract renewals.These expected positive impacts on operating cash flows derived fromacquisitions will be partially offset by ongoing loss of member enrollment,especially at newly acquired medical groups undergoing transition to ouroperating model and platform. Also, if our profitably increases, we will incur,and have to fund, an increased tax burden. With each new acquisition, we alsoacquire new operating and other obligations, which have to be funded. Since wetarget 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 and capital resourceconsiderations in the future include the anticipation that we will be investingsignificantly more in property, improvements and equipment as we integratefuture acquisitions. These additional investments in technology and automationwill be funded from existing cash reserves and cash generated from operations.Because any future acquisitions will be funded through some combination ofcash, borrowings and our stock, we continue to evaluate a variety of equity andborrowing sources.

We are also periodically required to provide lettersof credit in favor of the HMOs with which we do business. Letters of credittotaling approximately $836,000 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 organization, Prospect Medical Group, in order to meet certaincontracting requirements with the HMOs. This personal guarantee arrangement wasterminated effective January 19, 2005, following the Company’s assessmentthat it was no longer needed in order for the Company to meet its tangible netequity requirements. In the event that we were challenged to meet the tangiblenet equity requirements of Prospect Medical Group in the future, the absence ofthis personal guarantee would impact our liquidity.

As more fully discussed elsewhere in this report, weare subject to certain financial covenants and other conditions required by ourloan agreement with Residential Funding Corporation (“RFC”), including amaximum senior debt/EBITDA ratio, minimum fixed charge coverage ratio, minimumconsolidated net worth, minimum liquidity and a limit on capital expenditures.We exceeded the 1.50 maximum senior debt/EBITDA ratio as of September 30, 2004and December 31, 2004. Our actual senior debt/EBITDA ratio as of those twodates was 1.57 and 1.51, respectively. Effective April 7, 2005, RFC waivedthese covenant violations. RFC has, in addition, agreed to exclude certainitems from the covenant computations for a twelve month period. The exclusionof certain items enabled us to meet the minimum fixed charge coverage ratio at December31, 2004. At September 30, 2006 we did not meet the minimum fixed charge coverageratio of 1.25. In December 2006, in order to enable the Company to meet theminimum fixed charge coverage ratio, RFC amended our Loan agreement to lowerthe required ratio effective for test periods ended September 30, 2006 throughDecember 2006 from 1.25 to 1.00, and made certain allowances in the manner inwhich that ratio is calculated. The amendment effectively waived the covenantviolation with regard to the fixed charge coverage ratio at September 30, 2006.We believe that we will be able to comply with the adjusted ratio through September30, 2007 and can continue to classify the outstanding debt as non-currentliabilities. However, there can be no assurance that the company will meetcompliance requirements in future periods. 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 furtheracquisitions.

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In September 2006, the $15,000,000 RFC creditagreement was amended to extend the expiration and maturity date from September27, 2007 to January 31, 2008. We expect to refinance our debt upon maturity inJanuary 2008.

In February 2005, we paid$475,000 to renew and expand the software licenses for our IDX managementinformation for a ten year period.

***Fiscal Year Ended September 30, 2006 Comparedwith Fiscal Year Ended September 30, 2005***

As of September 30, 2006, cash and cash equivalentswere $16,623,407, a decrease of $325,897 from September 30, 2005. The moresignificant components of this net decrease in cash are discussed below.

Net cash provided by operating activities was $787,012for the year ended September 30, 2006, compared with $5,073,634 for the yearended September 30, 2005. Net cash provided by operating activities for theyear ended September 30, 2006 was comprised primarily of net income of$4,890,035, depreciation and amortization of $1,513,170 and an increase indeferred income taxes of $1,346,336. These increases were partially offset byan increase in recoverable income taxes of $3,141,804, resulting mainly from anoverpayment of quarterly tax deposits, excess tax benefits from optionsexercised of $605,868, a decrease in accrued medical claims of $998,723resulting mainly from resolution of prior claims and lower enrollment,increases in risk pool receivables of $1,286,821 and decreases in accountspayable and other liabilities of $966,931.

Net cash used in investing activities totaled$6,891,948 for the year ended September 30, 2006, compared with $1,356,463 forthe year ended September 30, 2005. Net cash used in investing activities forthe year ended September 30, 2006 was comprised primarily of purchases ofproperty, improvements and equipment of $640,915; cash paid for the acquisitionof Genesis HealthCare of Southern California (net of cash received) of$6,596,080; partially offset by a decrease in restricted certificates of depositsrequired by the health plans of $293,273.

Net cash provided byfinancing activities totaled $5,779,039 for the year ended September 30, 2006,compared with net cash used by financing activities of $7,098,621 for the yearended September 30, 2005. Net cash provided by financing activities forthe year ended September 30, 2006 was comprised primarily of borrowings underthe GMAC credit facility, totaling $4,000,000 in a long term note, $2,500,000in a line of credit (net of repayments), and net proceeds of $1,339,838 fromoption exercises, plus associated tax benefits of $605,868, less debt repaymenttotaling $2,666,667.

***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 ended September 30,2005 was comprised primarily of net income of $4,072,559, depreciation andamortization of $948,017 and an increase in accounts payable and other accruedliabilities of $1,776,161, primarily due to an increase in physician bonusaccruals of $2,469,658. These increases were partially offset by the impact ofa decrease in accrued medical claims of $1,791,294 resulting mainly fromresolution 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.

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Net cash used by financingactivities totaled $7,098,621 for the year ended September 30, 2005,compared with net cash provided by financing activities of $18,528,266 for theyear ended September 30, 2004. Net cash used by financing activities forthe year ended September 30, 2005 was comprised primarily of debt repaymentsunder the GMAC credit facility, totaling $1,841,888 of the long term note and$5,000,000 of the line of credit; and costs related to the prior privateplacement of preferred stock.

*Working Capital*

We had negative working capital of $3,141,414,$681,960, and $123,898 at September 30, 2004, 2005 and 2006, respectively.We had cash and cash equivalents of $20,330,754, $16,949,304 and $16,623,407 atSeptember 30, 2004, 2005 and 2006, respectively. Our working capital ratio(current assets divided by current liabilities) was .89, .97 and .99 atSeptember 30, 2004, 2005 and 2006, respectively.

As of the fiscal yearsended 2004, 2005 and 2006 notes to our bank totaled $15,008,554, $8,166,667 and$12,000,000 respectively. We have historically used cash reserves and cash flowfrom operations and equity offerings to reduce our indebtedness and fund acquisitions.This, and our recording of reserves for incurred but not reported healthcareexpense claims, has been the primary reasons for our negative working capitalposition.

***CreditFacilities***

On September 27, 2004, we entered into a new seniorsecured credit facility with Residential Funding Corporation (RFC, a subsidiaryof General Motors Acceptance Corporation) that consists of $10,000,000 termloan and a $5,000,000 revolving credit facility.

The term loan requires repayment of principalinstallments of $166,667 per month until January 31, 2008, at which time theentire remaining unpaid balance is due. Amounts outstanding under the term loanbear interest at a rate of prime plus 2% per annum.

We may borrow, make repayments and re-borrow under therevolving credit facility until January 31, 2008. Amounts outstanding under therevolving 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 payable monthly,calculated on the difference between the average daily usage of the revolvingcredit facility during each month and $5,000,000, the maximum amount of therevolving 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.

We are allowed to use the proceeds of the facility forour ordinary working capital and general corporate needs. We may not use loanproceeds for acquisitions, stock repurchases or dividend payments without theprior 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.

In November 2005, in connection with the acquisitionof Genesis Healthcare of Southern California, RFC provided us with additionalterm loan debt financing of $4,000,000, on terms identical to our existing 

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term loan. This additionalterm loan requires monthly principal payments of $66,667 until January 31,2008, at which time the remaining unpaid balance is due.

Through an amendment in September 2006, the creditfacilities were extended from September 27, 2007 to January 31, 2008 on the sameterms and conditions including monthly installment payments and balloon paymentfor unpaid balance.

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, the availabilityand terms of which will depend upon market and other conditions. Our ability toissue any debt or equity instruments in a public or private sale may also berestricted under certain circumstances pursuant to contractual restrictions inagreements 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, 2006, which arepayable in our fiscal years ending September 30:

| ** **                      | ** ** | **Total**                        | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011 and  Thereafter** | ** ** |
|---------------------------------|------------|----------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|-------------------------------|------------|
| ** **                      | ** ** | **(000’s eliminated)** | ** ** |
| Line of credit(1)               |       | $                                | 2,500      |     | $          | 2,500    |       | $        | —     |     | $          | —                        |       | $ | — |   |   | $ | — |   |   |
| Long term debt(1)               |       | 9,500                            |       | 2,800    |       | 6,700    |       | —   |       | —   |       |                          | —     |   |   |
| Operating lease  commitments(2) |       | 7,142                            |       | 1,803    |       | 1,620    |       | 1583     |       | 1291     |       |                          | 845        |   |   |
| Interest(3)                     |       | 1,077                            |       | 860      |       | 217      |       |     |       |     |       |                          |       |   |   |
|                            |       | 20,219                           |       | 7,963    |       | 8,537    |       | 1,583    |       | 1,291    |       |                          | 845        |   |   |
|                                 |            |                                  |            |          |            |          |            |          |            |          |            |                               |            |  |  |  |  |  |  |  |  |

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(1)          Theline of credit and long term debt due to our bank matures on January 31,2008. See Note 6 to the consolidated financial statements for adescription of our long term debt.

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(2)          SeeNote 8 to the September 30, 2006 consolidated financial statementsfor a description of our minimum lease commitments under non-cancelableoperating leases.

(3)          Interestis based on interest rates in effect as of September 30, 2006.

At September 30,2006, we have $9,495,235 in risk pool deficits that are not payable until andunless we generate future risk sharing surpluses. When the HMO contractsterminate, any remaining risk pool deficits will be waived.

**Item 7A.**                Quantitativeand Qualitative Disclosures Regarding Market Risk

As of September 30,2006, we had cash and cash equivalents of $16,623,407. Cash equivalents consistof highly liquid securities with original maturities of up to three months. Weinvest a substantial portion of our cash equivalents in Federal Home Loan bondsand overnight, high yield money market funds. We also had $836,244 ofinvestments, primarily consisting of restricted, interest-bearing certificatesof deposit required by various HMOs with whom we do business. These investmentsare subject to interest rate risk and will decrease in value if the marketrates increase. All non-restricted investments are maintained at fair marketvalue on the balance sheet. Money market funds are not typically subject tomaterial market risk. In addition, we have the ability to hold these investmentsuntil maturity, and as a result, we would not expect the value of theseinvestments to decline significantly as a result of a sudden change in marketinterest rates. Declines in interest rates over time will reduce our investmentincome. Assuming a hypothetical 10% change in interest rates, there would be nomaterial impact on our future earnings and cash flows related to theseinstruments, or their fair value.

The fair value of our bankdebt with Residential Funding Corporation is affected by changes in marketinterest rates. As of September 30, 2006, the carrying value of our termloan and outstanding advances under the credit agreement approximated itsestimated fair value. Considerable judgment is required to develop estimates offair value. Accordingly, the estimate is not necessarily indicative of theamount we could realize in a current market exchange. The use of differentmarket assumptions and/or estimation methodologies may have a material effecton the estimated fair value amounts. Our credit facility is interest ratesensitive, however. A 100 basis point adverse movement (increase) in interestrates would have decreased our net income for fiscal year 2004, 2005 and 2006by approximately $17,000, $186,000, and $105,000 respectively. For termsrelating to our long-term debt, see Note 6 of the Notes to ConsolidatedFinancial Statements.

**Item 8.**                        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, 2005 and 2006                                               |       |     | F-3        |   |   |
| Consolidated Statements of  Income for the Years Ended September 30, 2004, 2005 and 2006                     |       |     | F-4        |   |   |
| Consolidated Statements of  Shareholders’ Equity for the Years Ended September 30, 2004, 2005 and  2006 |       |     | F-5        |   |   |
| Consolidated Statements of  Cash Flows for the Years Ended September 30, 2004, 2005 and 2006                 |       |     | F-6        |   |   |
| Notes to Consolidated  Financial Statements                                                                       |       |     | F-7        |   |   |
| Report of Independent  Registered Public Accounting Firm                                                          |       |     | F-34       |   |   |
| Schedule II—Valuation and  Qualifying Accounts                                                               |       |     | F-35       |   |   |
|                                                                                                                   |            |          |            |        |  |  |  |

 

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

All other schedules areomitted because they are not required or the information is included elsewherein the consolidated financial statements.

**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 of DisclosureControls 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 30,2006 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 30,2008.

**Item 9B.**               OtherInformation.

Not applicable.

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**PART III**

**Item 10.**                 Directors,Executive Officers and Corporate Governance.

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 2007 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 2007 Annual Meeting of Stockholders is incorporated herein byreference.

**Item 12.**                 SecurityOwnership of Certain Beneficial Owners and Management and Related Stockholder Matters.

The information requiredunder this Item is incorporated by reference from our definitive proxystatement for the 2007 Annual Meeting of Stockholders under the caption “SecurityOwnership of Certain Beneficial Owners and Management.”

**Item 13.**                 CertainRelationships and Related Transactions, and Director Independence.

The information set forthin the section entitled “Certain Relationships and Related Transactions”contained in our definitive Proxy Statement for our 2007 Annual Meeting ofStockholders is incorporated herein by reference.

**Item 14.**                 PrincipalAccounting Fees and Services.

The information requiredunder this Item is incorporated by reference from our definitive proxystatement for the 2007 Annual Meeting of Stockholders under the caption “Disclosureof Auditor Fees.”

**PART IV**

**Item 15.**                 Exhibits andFinancial Statement Schedules

Thefinancial statements and financial statement schedule listed under Item 8are included in this report beginning on page F-1. The followingexhibits have been filed with, or are incorporated by reference, in thisreport:
| 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 |

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|        |   | 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)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   |   | 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                                                                                                                                                                                                                                                                                    |

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| 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 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                                                                                                                                                                                                                                                         |

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| 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)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |

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| 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)          |
| 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)                                                                                                                    |

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| 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)                                                                                                                                                                                                                          |
| 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)                                                                          |

 

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| 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.                                                                                                                                                                                                                                                                            |

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| 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)                                                                       |

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| 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)                                                                                                                                                                                                                                                        |

86

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| 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)                                                                                                                |

87

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| 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)                                                                                                                                                                                                                                                                              |

88

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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)                                                                                                                                                                                                                       |

89

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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)                                                                 |

90

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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)                                                                                               |

 

91

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| 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) |

92

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| 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)      |
| 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) |

93

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| 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)                                                                          |

94

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| 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)   |

95

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| 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)                                                                                                                                                                                                                                                                    |
| 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)                                                                                                                                                                                                                                                                                                                    |

96

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| 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 |
| 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)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |

97

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| 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)                                                  |
| 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)                                              |

98

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| 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 |   | Form of Limited Consent,  Omnibus Amendment No. 3 and Joinder Agreement to the Loan Documents,  dated as of November 1, 2005, 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)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |

 

99

----

----

(1)          Previously filed as anexhibit to our Form 10 registration statement (the “Form 10”) on May 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.

100

----

**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 28,  2006 | By:      | /s/  JACOB Y. TERNER, M.D.              |
|                          |     | Jacob Y. Terner,  M.D.                  |
|                          | * * | *Chairman  and Chief Executive Officer* |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on thedates indicated.

|                           | **Signature** | ** **                                  | ** ** | ** **              | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|---------------------------|---------------|---------------------------------------------|------------|-------------------------|-----------|------------|------------|------------|----------|------------|
| /s/ JACOB Y. TERNER, M.D. |          | Chairman, Chief  Executive Officer          |       | December 28,  2006 |
| Jacob  Y. Terner, M.D.    |          | and Director (Principal  Executive Officer) |       |                    |
| /s/ MIKE  HEATHER         |          | Chief Financial  Officer (Principal         |       | December 28, 2006  |
| Mike  Heather             |          | Financial and Accounting  Officer)          |       |                    |
| /s/ CATHERINE  DICKSON    |          | President, Chief  Operating Officer         |       | December 28, 2006  |
| Catherine  Dickson        |          | and Director                                |       |                    |
| /s/ DAVID  A. LEVINSOHN   |          | Director                                    |       | December 28, 2006  |
| David  A. Levinsohn       |          |                                        |       |                    |
| /s/ KENNETH  SCHWARTZ     |          | Director                                    |       | December 28, 2006  |
| Kenneth  Schwartz         |          |                                        |       |                    |
| /s/ JOEL  S. KANTER       |          | Director                                    |       | December 28, 2006  |
| Joel  S. Kanter           |          |                                        |       |                    |
| /s/ GENE  E. BURLESON     |          | Director                                    |       | December 28, 2006  |
| Gene E. Burleson          |          |                                        |       |                    |

 

 

101

----

**INDEX TO FINANCIALSTATEMENTS ANDFINANCIAL STATEMENT SCHEDULE**

|                                                                                                                   | ** ** | Page |
|-------------------------------------------------------------------------------------------------------------------|------------|------|
| Report of Independent Registered Public Accounting  Firm                                                          |       | F-2  |
| Consolidated  Balance Sheets as of September 30, 2005 and 2006                                               |       | F-3  |
| Consolidated  Statements of Income for the Years Ended September 30, 2004, 2005 and  2006                    |       | F-4  |
| Consolidated Statements of  Shareholders’ Equity for the Years Ended September 30, 2004, 2005 and  2006 |       | F-5  |
| Consolidated Statements of  Cash Flows for the Years Ended September 30, 2004, 2005 and 2006                 |       | F-6  |
| Notes to Consolidated  Financial Statements                                                                       |       | F-7  |
| Report of Independent  Registered Public Accounting Firm                                                          |       | F-34 |
| Schedule  II—Valuation and Qualifying Accounts                                                               |       | F-35 |

 

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 30,2005 and 2006, and the related consolidated statements of income, shareholders’equity and cash flows for each of the three years in the period endedSeptember 30, 2006. These financial statements are the responsibility ofthe Company’s management. Our responsibility is to express an opinion on thesefinancial statements 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 and audit of the Company’sinternal control over financial reporting. Our audits included consideration ofinternal control over financial reporting as a basis for designing auditprocedures that are appropriate in the circumstances, but not for the purposeof expressing an opinion on the effectiveness of the Company’s internal controlover financial reporting. Accordingly, we express no such opinion. An auditalso includes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, and evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the consolidatedfinancial position of Prospect Medical Holdings, Inc., atSeptember 30, 2005 and 2006, and the consolidated results of itsoperations and its cash flows for each of the three years in the period endedSeptember 30, 2006, in conformity with U.S. generally accepted accountingprinciples.

Asdiscussed in Note 1 to the consolidated financial statements, ProspectMedical Holdings, Inc. changed its method of accounting for Share-Based Paymentsin accordance with Statement of Financial Accounting Standards No. 123(revised 2004) on October 1, 2005.
|                          | /s/ ERNST &  YOUNG LLP |   |
|--------------------------|---------------------------------|--------|
| Los Angeles,  California |                            |
| December 22,  2006  |                            |

 

F-2

----

**PROSPECT MEDICAL HOLDINGS, INC.**

**CONSOLIDATED BALANCE SHEETS**

|                                                                                                                                                  | ** ** | **September 30** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                       | ** ** | **2005**              | ** ** | **2006** | ** ** |
| **Assets**                                                                                                                                       |       |                  |       |   |   |
| Current assets:                                                                                                                                  |       |                  |       |   |   |
| Cash and cash  equivalents                                                                                                                       |       | $                     | 16,949,304 | ** ** | **$** | **16,623,407** | ** ** |
| Investments,  primarily restricted certificates of deposit                                                                                       |       | 1,100,000             | ** ** | **836,244** | ** ** |
| Risk pool  receivables                                                                                                                           |       | 57,267                | ** ** | **1,418,973** | ** ** |
| Other receivables,  net of allowances of $802,000 and $509,000 at September 30,  2005 and 2006                                         |       | 1,940,536             | ** ** | **1,916,883** | ** ** |
| Notes receivable,  current portion                                                                                                               |       | 52,160                | ** ** | **176,265** | ** ** |
| Prepaid expenses  and other                                                                                                                      |       | 646,932               | ** ** | **645,466** | ** ** |
| Refundable income  taxes                                                                                                                         |       | —                | ** ** | **2,493,035** | ** ** |
| Deferred income  taxes, net                                                                                                                      |       | 1,904,137             | ** ** | **657,678** | ** ** |
| Total current  assets                                                                                                                            |       | 22,650,336            | ** ** | **24,767,951** | ** ** |
| Property, improvements and equipment:                                                                                                            |       |                  | ** ** | ** ** | ** ** |
| Land                                                                                                                                             |       | 40,620                | ** ** | **40,620** | ** ** |
| Leasehold  improvements                                                                                                                          |       | 726,973               | ** ** | **984,934** | ** ** |
| Equipment                                                                                                                                        |       | 3,342,385             | ** ** | **3,478,435** | ** ** |
| Furniture and  fixtures                                                                                                                          |       | 546,523               | ** ** | **782,087** | ** ** |
|                                                                                                                                             |       | 4,656,501             | ** ** | **5,286,076** | ** ** |
| Less accumulated  depreciation and amortization                                                                                                  |       | (3,454,282            | )          | **(3,999,863** | **)** |
| Property,  improvements and equipment, net                                                                                                       |       | 1,202,219             | ** ** | **1,286,213** | ** ** |
| Notes receivable,  less current portion                                                                                                          |       | 572,979               | ** ** | **413,577** | ** ** |
| Deposits                                                                                                                                         |       | 583,226               | ** ** | **613,087** | ** ** |
| Goodwill                                                                                                                                         |       | 31,404,328            | ** ** | **37,838,169** | ** ** |
| Other intangible  assets, net                                                                                                                    |       | 1,317,614             | ** ** | **1,738,475** | ** ** |
| Total assets                                                                                                                                     |       | $                     | 57,730,702 | ** ** | **$** | **66,657,472** | ** ** |
| **Liabilities and shareholders’ equity**                                                                                                    |       |                  | ** ** | ** ** | ** ** |
| Current liabilities:                                                                                                                             |       |                  | ** ** | ** ** | ** ** |
| Accrued medical  claims and other health care costs payable                                                                                      |       | $                     | 11,532,328 | ** ** | **$** | **11,400,000** | ** ** |
| Accounts payable  and other accrued liabilities                                                                                                  |       | 9,799,968             | ** ** | **8,191,849** | ** ** |
| Current maturities  of long-term debt                                                                                                            |       | 2,000,000             | ** ** | **5,300,000** | ** ** |
| Total current  liabilities                                                                                                                       |       | 23,332,296            | ** ** | **24,891,849** | ** ** |
| Long-term  debt less current maturities                                                                                                          |       | 6,166,667             | ** ** | **6,700,000** | ** ** |
| Deferred income  taxes                                                                                                                           |       | 1,045,696             | ** ** | **1,145,573** | ** ** |
| Other long-term  liabilities                                                                                                                     |       | 185,000               | ** ** | **34,712** | ** ** |
| Total liabilities                                                                                                                                |       | 30,729,659            | ** ** | **32,772,134** | ** ** |
| Minority interest                                                                                                                                |       | 65,405                | ** ** | **81,881** | ** ** |
| Shareholders’ equity:                                                                                                                       |       |                  | ** ** | ** ** | ** ** |
| Preferred stock,  $.01 par value, 5,000,000 shares authorized, none issued                                                                       |       | —                |       | **—** |   |
| Common stock, $.01  par value, 40,000,000 shares authorized, 6,640,362 and 7,186,977 issued and  outstanding at September 30, 2005 and 2006 |       | 66,403                | ** ** | **71,869** | ** ** |
| Additional paid-in  capital                                                                                                                      |       | 18,373,487            | ** ** | **20,345,805** | ** ** |
| Retained earnings                                                                                                                                |       | 8,495,748             | ** ** | **13,385,783** | ** ** |
|                                                                                                                                             |       | 26,935,638            | ** ** | **33,803,457** | ** ** |
| Total liabilities  and shareholders’ equity                                                                                                 |       | $                     | 57,730,702 | ** ** | **$** | **66,657,472** | ** ** |

 

See accompanying notes.

F-3

----

**PROSPECT MEDICAL HOLDINGS, INC.CONSOLIDATED STATEMENTS OF INCOME**

| ** **                                                                | ** ** | **Year ended September 30** | ** **  |
|---------------------------------------------------------------------------|------------|--------------------------------------------|-------------|
| ** **                                                                | ** ** | **2004**                                   | ** **  | **2005** | ** ** | **2006** | ** ** |
| Revenues                                                                  |       | $                                          | 129,516,437 |   | $ | 133,518,379 | ** ** | **$** | **135,796,277** | ** ** |
| Cost of revenues                                                          |       | 95,975,041                                 |        | 96,371,197 | ** ** | **97,184,201** | ** ** |
| Gross margin                                                              |       | 33,541,396                                 |        | 37,147,182 | ** ** | **38,612,076** | ** ** |
| Operating expenses:                                                       |       |                                       |        |   |   |   |   |
| General and administrative                                                |       | 24,335,510                                 |        | 27,228,736 | ** ** | **30,205,352** | ** ** |
| Depreciation and amortization                                             |       | 732,806                                    |        | 948,017 | ** ** | **1,513,170** | ** ** |
|                                                                      |       | 25,068,316                                 |        | 28,176,753 | ** ** | **31,718,522** | ** ** |
| Operating income  from unconsolidated joint venture                       |       | 206,634                                    |        | 87,516 | ** ** | **1,400,492** | ** ** |
| Operating income                                                          |       | 8,679,714                                  |        | 9,057,945 | ** ** | **8,294,046** | ** ** |
| Investment income                                                         |       | 75,717                                     |        | 400,356 | ** ** | **913,068** | ** ** |
| Interest expense                                                          |       | (90,803                                    | )           | (958,634 | ) | **(1,107,081** | **)** |
| Interest expense,  net                                                    |       | (15,086                                    | )           | (558,278 | ) | **(194,013** | **)** |
| Equity in losses,  and write down, of unconsolidated investment           |       | —                                     |        | (1,000,000 | ) | **—** |   |
| Income before  income taxes                                               |       | 8,664,628                                  |        | 7,499,667 | ** ** | **8,100,033** | ** ** |
| Income tax  provision                                                     |       | 3,524,704                                  |        | 3,415,178 | ** ** | **3,193,522** | ** ** |
| Net income before  minority interest                                      |       | 5,139,924                                  |        | 4,084,489 | ** ** | **4,906,511** | ** ** |
| Minority interest                                                         |       | (12,681                                    | )           | (11,930 | ) | **(16,476** | **)** |
| Net income                                                                |       | $                                          | 5,127,243   |   | $ | 4,072,559 | ** ** | **$** | **4,890,035** | ** ** |
| Net earnings per  common share:                                           | ** ** | ** **                                 |        |   |   |   |   |
| Basic:                                                                    | ** ** | ** **                                 |        |   |   |   |   |
| Basic earnings per share                                                  |       | $                                          | 1.19        |   | $ | 0.83 | ** ** | **$** | **0.71** | ** ** |
| Weighted average number of common shares outstanding                      |       | 4,321,799                                  |        | 4,915,537 | ** ** | **6,913,405** | ** ** |
| Diluted:                                                                  |       |                                       |        |   |   |   |   |
| Diluted earnings per share                                                |       | $                                          | 0.68        |   | $ | 0.48 | ** ** | **$** | **0.60** | ** ** |
| Weighted average  number of common and common dilutive shares outstanding |       | 7,547,140                                  |        | 8,470,411 | ** ** | **8,106,652** | ** ** |

 

See accompanying notes.

F-4

----

**PROSPECT MEDICAL HOLDINGS, INC.CONSOLIDATED STATEMENTS OF 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, 2003             |       | 4,163,705              |       | $                 | 41,637     |                  | —     |                 | $          | —                           |       | $                          | 8,153,978      |                              |       | $             | (349,522   | ) |   | $ | (704,054 | ) | $ | 7,142,039 |   |
| Issuance of  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  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 |   |
| Options exercised                               | ** ** | **546,615**            | ** ** | **5,466**         |       | **—**            |       | **—**           | ** ** | **1,334,372**                    |       |                       | **—**     |                              |       | **—**    | ** ** | **1,339,838** | ** ** |
| Tax benefit of  options exercised               |       | **—**             |       | **—**        |       | **—**            |       | **—**           | ** ** | **605,868**                      |       |                       | **—**     |                              |       | **—**    | ** ** | **605,868** | ** ** |
| Stock based  compensation                       |       | **—**             |       | **—**        |       | **—**            |       | **—**           | ** ** | **32,078**                       |       |                       | **—**     |                              |       | **—**    | ** ** | **32,078** | ** ** |
| Net income                                      |       | **—**             |       | **—**        |       | **—**            |       | **—**           |       | **—**                       |       |                       | **—**     |                              | ** ** | **4,890,035** | ** ** | **4,890,035** | ** ** |
| Balance at  September 30, 2006             | ** ** | **7,168,977**          | ** ** | **$**             | **71,869** |                  | **—** |                 | **$**      | **—**                       | ** ** | **$**                      | **20,345,805** |                              |       | **$**         | **—** |   | ** ** | **$** | **13,385,783** | ** ** | **$** | **33,803,457** | ** ** |

 

See accompanying notes.

F-5

----

**PROSPECT MEDICAL HOLDINGS, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS**
|                                                                                               | ** ** | **Year ended September 30** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                    | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| **Operating activities**                                                                      |       |                                       |       |   | ** ** | ** ** | ** ** |
| Net income                                                                                    |       | $                                          | 5,127,243  |   | $ | 4,072,559 | ** ** | **$** | **4,890,035** | ** ** |
| Adjustments  to reconcile net income to net cash provided by (used in) operating  activities: |       |                                       |       |   | ** ** | ** ** | ** ** |
| Depreciation and amortization                                                                 |       | 732,806                                    |       | 948,017 | ** ** | **1,513,170** | ** ** |
| Equity in losses, and write down, of unconsolidated  investment                               |       | —                                     |       | 1,000,000 | ** ** | **—** | ** ** |
| Provision for bad debts                                                                       |       | 214,757                                    |       | 141,008 | ** ** | **106,036** | ** ** |
| Loss on disposal of assets                                                                    |       | 13,589                                     |       | 190,241 | ** ** | **1,691** | ** ** |
| Deferred income taxes, net                                                                    |       | (385,617                                   | )          | (49,390 | ) | **1,346,336** | ** ** |
| Change in deferred compensation                                                               |       | 116,651                                    |       | 232,871 | ** ** | **—** | ** ** |
| Stock based compensation                                                                      |       | 316,395                                    |       | — | ** ** | **32,078** | ** ** |
| Excess benefits from options exercised                                                        |       | —                                     |       | — | ** ** | **(605,868** | **)** |
| Changes  in assets and liabilities:                                                           |       |                                       |       |   | ** ** | ** ** | ** ** |
| Risk pool receivables                                                                         |       | 1,098,132                                  |       | 30,713 | ** ** | **(1,286,821** | **)** |
| Other receivables                                                                             |       | (147,498                                   | )          | (957,130 | ) | **(77,886** | **)** |
| Inventory                                                                                     |       | 5,399                                      |       | — | ** ** | **—** | ** ** |
| Prepaid expenses and other                                                                    |       | (424,240                                   | )          | (555,373 | ) | **7,711** | ** ** |
| Recoverable income taxes                                                                      |       | —                                     |       | — | ** ** | **(3,141,804** | **)** |
| Deposits and other assets                                                                     |       | (12,828                                    | )          | 35,251 | ** ** | **(32,012** | **)** |
| Accrued medical claims and other health care costs  payable                                   |       | (1,579,942                                 | )          | (1,791,294 | ) | **(998,723** | **)** |
| Accounts payable and other accrued liabilities                                                |       | (5,314,932                                 | )          | 1,776,161 | ** ** | **(966,931** | **)** |
| Net cash provided by (used in) operating activities                                           |       | (240,085                                   | )          | 5,073,634 | ** ** | **787,012** | ** ** |
| **Investing activities**                                                                      |       |                                       |       |   |   |   |   |
| Purchase of property, improvements and equipment                                              |       | (767,299                                   | )          | (282,945 | ) | **(640,915** | **)** |
| Proceeds from note receivable                                                                 |       | 169,637                                    |       | 273,469 | ** ** | **35,298** | ** ** |
| Cash paid for acquisitions, net of cash received                                              |       | (3,318,171                                 | )          | — | ** ** | **(6,560,892** | **)** |
| (Increase)/decrease in restricted certificates of  deposit                                    |       | (252,816                                   | )          | (587,313 | ) | **293,273** | ** ** |
| Capitalized expenses related to acquisitions                                                  |       | (305,685                                   | )          | 238,573 | ** ** | **(35,188** | **)** |
| Investment in unconsolidated entity                                                           | ** ** | —                                     |       | (1,000,000 | ) | **—** | ** ** |
| Other investing activities                                                                    | ** ** | —                                     |       | 1,753 | ** ** | **16,476** | ** ** |
| Net cash used in investing activities                                                         |       | (4,474,334                                 | )          | (1,356,463 | ) | **(6,891,948** | **)** |
| **Financing activities**                                                                      |       |                                       |       |   |   |   |   |
| Proceeds from sale of medical clinics                                                         |       | 300,000                                    |       | — |   | **—** |   |
| Repayment of note payable to shareholder                                                      |       | (500,000                                   | )          | — |   | **—** |   |
| Borrowings from term loan                                                                     |       | 10,000,000                                 |       | — | ** ** | **4,000,000** | ** ** |
| Cash paid for deferred financing costs                                                        |       | (254,424                                   | )          | — |   | **—** |   |
| Borrowings on line of credit                                                                  |       | 10,100,000                                 |       | 1,000,000 | ** ** | **4,500,000** | ** ** |
| Repayments on line of credit                                                                  |       | (8,900,00                                  | )          | (6,000,000 | ) | **(2,000,000** | **)** |
| Repayments of note payable and capital leases                                                 |       | (2,401,923                                 | )          | (1,841,888 | ) | **(2,666,667** | **)** |
| Proceeds (expenses) from issuance of common and  preferred stock                              |       | 10,184,613                                 |       | (256,733 | ) | **1,339,838** | ** ** |
| Excess tax benefits from options exercised                                                    |       | —                                     |       | — | ** ** | **605,868** | ** ** |
| Net cash provided by (used in) financing activities                                           |       | 18,528,266                                 |       | (7,098,621 | ) | **5,779,039** | ** ** |
| Increase (decrease) in cash and cash equivalents                                              |       | 13,813,847                                 |       | (3,381,450 | ) | **(325,897** | **)** |
| Cash and cash equivalents at beginning of year                                                |       | 6,516,907                                  |       | 20,330,754 | ** ** | **16,949,304** | ** ** |
| Cash and cash equivalents at end of year                                                      |       | $                                          | 20,330,754 |   | $ | 16,949,304 | ** ** | **$** | **16,623,407** | ** ** |
| **Supplemental disclosure of cash  flow information**                                         |       |                                       |       |   |   |   |   |
| Details of businesses  acquired:                                                              |       |                                       |       |   |   |   |   |
| Fair value of assets acquired                                                                 |       | $                                          | 19,161,171 |   | $ | — | ** ** | **$** | **9,329,556** | ** ** |
| Liabilities assumed or created                                                                |       | (8,661,171                                 | )          | — | ** ** | **(1,329,556** | **)** |
| Less cash acquired                                                                            |       | (7,181,829                                 | )          | — | ** ** | **(1,439,108** | **)** |
| Net cash paid for acquisition                                                                 |       | 3,318,171                                  |       | — | ** ** | **6,560,892** | ** ** |
| Common stock  issued in exchange for services rendered                                        |       | $                                          | 279,510    |   | $ | — |   | **$** | **—** |   |

 

See accompanying notes.

F-6

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**PROSPECT MEDICAL HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2006**

**1.**                 Operationsand Significant Accounting Policies

**Business and Basisof 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 currently manages the provision of prepaidhealth care services for its affiliated medical organizations in SouthernCalifornia. The Network consists of the following medical organizations as of September 30,2006 (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 NWOC, 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)Genesis HealthCare of Southern California (Genesis)

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.Separate from any earnings we generate from our portion of business within thejoint venture, we also earn fees for management services we provide to ourpartner in the joint venture. We account for our interest in the joint venturepartnership using the equity method of accounting. We include in our financialstatements only the net results attributable to those Medicaid enrolleesspecifically identified as assigned to us, together with the management feethat we charge for managing those 

F-7

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Medicaid enrolleesspecifically assigned to the other joint venture partner. Note 11 containssummarized unaudited financial information for the joint venture.

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 throughout theterm of the Management Agreement. In addition to the Management Agreement withPMG, 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 was for an initial term ofthree years and could not be terminated without cause, provided for a basecompensation and certain customary benefits. Since the agreement is only forthe employment of the nominee shareholder as the President of Prospect and notin his capacity as the nominee shareholder of PMG, the agreement does notaffect Prospect’s ability to change the nominee shareholder at will. PMG is thenominee shareholder of SPCMG, SATPG, PEG, AVM, PHS, PPM, PNW, PSC, APA, Nuestra(as to a 55% interest) and Genesis.

The Company’s Affiliates have each entered into aManagement Agreement whereby the Affiliate has agreed to pay a management feeto PMS or Sierra Medical Management, Inc. (SMM), as applicable (each ofwhich is a wholly owned subsidiary of Prospect). The fee is based in part onthe costs to the management company and on a percentage of revenues theAffiliate receives (i) for the performance of medical services by theAffiliate’s employees and independent contractor physicians and physicianextenders, (ii) for all other services performed by the Affiliates, and (iii) asproceeds from the sale of assets or the merger or other business combination ofthe Affiliate. The management fee also includes a fixed fee for marketing andpublic relations services. The revenue from which this fee is determinedincludes medical capitation, all sums earned from participation in any riskpools and all fee-for-service revenue earned. Except in the case of Nuestra andAMVI/Prospect, the Management Agreements have initial terms of 30 years,renewable for successive 10-year periods thereafter, unless terminated byeither party for cause. In the case of Nuestra, its Management Agreement has aninitial 10 year term renewable for successive 1 year terms. In thecase of AMVI/Prospect, its Management Agreement has a 1 year term withsuccessive 1 year renewal terms. In return for payment of the managementfee, Prospect has agreed to provide financial management, information systems,marketing, advertising, public relations, risk management, and administrativesupport for utilization review and quality of care. The Company has exclusivedecision-making authority with respect to the establishment andpreparation of operating and capital budgets, and the establishment of policiesand procedures for the Affiliates, and makes recommendations for thedevelopment of guidelines for selection and hiring of health careprofessionals, compensation payable to such personnel, scope of services to beprovided, patient acceptance policies, pricing of services, and contractnegotiation and execution. At its cost, Prospect has assumed the obligationsfor all facilities, medical and non-medical supplies, and employment ofnon-physician personnel of its affiliated medical clinics. All remaining fundsare remitted to the Affiliate, from which the Affiliate pays for the cost ofall 

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medical services. Themanagement fee earned by Prospect fluctuates based on the profitability of eachwholly-owned Affiliate. With the exception of PHS, Prospect is allocateda 50% residual interest in the profits above 8% of the profits or a 50%residual interest in the losses of the Affiliate, after deduction for costs tothe management company and physician compensation. Prospect is allocated a 40%residual interest in the profits or losses of PHS. The remaining balance isretained 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 Management Agreements.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 thefinancial statements, together with the management fee that the Company chargesAMVI for managing 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 EmergingIssues Task Force No. 97-2, “Application of FASB Statement No. 94 andAPB Opinion No. 16 to Physician Practice Management Entities and CertainOther Entities with Contractual Management Agreements” (EITF 97-2),would also be consolidated under the provisions of Interpretation No. 46,“Consolidation of Variable Interest Entities, an interpretation of ARBNo. 51” (FIN 46). The underlying entities (subsidiaries) have beendetermined to be variable interest entities due to the existence of a calloption under which the Company has the ability to require the holders of all ofthe voting common stock of the underlying subsidiaries to sell their shares ata fixed nominal price ($1,000) to another designated physician chosen by theCompany. This call option agreement represents rights provided through avariable interest other than the equity interest itself that caps the returnsthat could be earned by the equity holders. In addition, the Company has amanagement agreement with the subsidiaries and the holders of the voting commonstock of the subsidiaries which allows the Company to direct all of theactivities of the subsidiaries, retain all of the economic benefits and assumeall of the risks associated with ownership of the subsidiaries. In this manner,the Company has all of the economic benefits and risks associated with thesubsidiaries, but has disproportionately few voting rights (based on the termsof the equity). Substantially all of the activities of the subsidiaries areconducted on behalf of the Company and as such, the subsidiaries are variableinterest entities due to the fact that they violate the anti-abuse clauseprovisions in FIN 46. As the Company retains all of the economic benefits andassumes all of the risks associated with ownership of the subsidiaries, theCompany is considered to be the primary beneficiary of the activities of thesubsidiaries. As a result, the Company must consolidate the underlyingsubsidiaries under FIN 46. All significant intercompany transactions have beeneliminated 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** | ** ** |
|------------|------------|----------------|-------------|------------|------------|-------------|------------|
| 2004       |       |           | 168,500     |       |       | 15,500      |       |   | 14,400 |   |   |
| 2005       |       |           | 144,900     |       |       | 12,500      |       |   | 14,500 |   |   |
| **2006**   | ** ** | ** **     | **140,300** |       | ** ** | **14,100**  | ** ** | ** ** | **17,000** |   |   |

 

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**Related PartyTransactions**

We have an employment agreement with our ChiefExecutive Officer, Jacob Y. Terner that runs through August 1, 2008 and providesfor compensation of $250,000 per year. The agreement further provides that ifwe terminate Dr. Terner’s employment without cause, we will be required topay him $12,500 for each month of past service as our Chief Executive Officer,commencing as of July 31, 1996. The Company’s maximum contingentobligation under this termination provision was frozen at $1,237,500.

Prospect Medical Group, Inc. (PMG), which iswholly owned by Dr. Terner as the nominee physician shareholder, and whoseaccounts are consolidated in these financial statements under EITF 97-2,maintains an intercompany account receivable due from Prospect Medical Holdings, Inc.The intercompany receivable was created in connection with previousacquisitions. In the event that PMG is required by the health maintenanceorganizations (HMO’s) or regulatory agencies to maintain a positive tangiblenet equity and positive working capital, Dr. Terner had previously agreedto personally guarantee the intercompany account receivable due from ProspectMedical Holdings, Inc. up to a level sufficient to enable PMG to attainpositive 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 its 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.

**Medical Revenuesand Cost Recognition**

Revenuesare comprised of the following amounts:

| ** **      | ** ** | **Year Ended September 30** | ** **  |
|-----------------|------------|--------------------------------------------|-------------|
| ** **      | ** ** | **2004**                                   | ** **  | **2005** | ** ** | **2006** | ** ** |
| Capitation      |       | $                                          | 125,860,567 |   | $ | 129,143,656 | ** ** | **$** | **131,436,858** | ** ** |
| Fee for service |       | 2,546,444                                  |        | 2,232,059 | ** ** | **2,074,104** | ** ** |
| Management fees |       | 841,152                                    |        | 806,788 | ** ** | **1,233,027** | ** ** |
| Other           |       | 268,274                                    |        | 1,335,876 | ** ** | **1,052,288** | ** ** |
| Total revenues  |       | $                                          | 129,516,437 |   | $ | 133,518,379 | ** ** | **$** | **135,796,277** | ** ** |

 

Operating revenue of the Company consists primarily offees for medical services provided by the Affiliates under capitated contractswith various managed care providers including health maintenance organizations(HMOs) or under fee-for-service arrangements. Capitation revenue under HMOcontracts is prepaid monthly to the Affiliates based on the number of enrolleeselecting any one of the Affiliates as their health care provider. HMO contractsalso include provisions to share in the risk for hospitalization whereby theAffiliate can earn additional incentive revenue or incur penalties based uponthe utilization of hospital services. Except for two contracts, representing asmall percentage of the Company’s enrollees, where the Company is contractuallyobligated for downside risk, any shared risk deficits are not payable until andunless the Company generates future risk sharing surpluses, or if the HMOwithholds a portion of the capitation revenue to fund any risk share deficits.At the termination of the HMO contract, any accumulated risk share deficit isextinguished. Estimated shared-risk amounts receivable from the HMOs arerecorded based upon estimated hospital utilization and estimated associatedcosts incurred by assigned HMO enrollees, compared to budgeted costs. Estimatesare based on prior year experience, current year utilization, medical costtrends, interim settlement reports from HMOs and other information and areinherently subject to uncertainties. Risk pools for the prior contract yearsare generally final settled in the 

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third or fourth quarter ofthe following fiscal year. Differences between actual contract settlements andestimated receivables relating to HMO risk-sharing arrangements are recorded inthe year of final settlement.

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

Fiscal 2004, 2005 and 2006, net patient servicerevenues include approximately, $555,000, $1,007,000 and $2,376,000respectively, of additional revenues due to favorable settlements on prior contractualyear risk-sharing arrangements. At September 30, 2005 and 2006, contingentliabilities for risk-pool deficits that may be offset against future surpluseswere $11,612,172 and $9,495,235, respectively, based on the availableinformation from the health plans.

In addition to risk-sharing revenues, the Company alsoreceives incentives under “pay-for-performance” programs for quality medicalcare based on various criteria. These incentives, which are included in otherrevenues, are generally recorded in the third and fourth quarters of our fiscalyear and are recorded when such amounts are known.

Capitation revenue under HMO contracts (net of capitationwithheld to fund risk share deficits) is recognized in the month in which theAffiliates are obligated to provide services. Minor ongoing adjustments toprior months’ capitation, primarily arising from contracted HMOs’ finalizing ofmonthly patient eligibility data for additions or subtractions of enrollees,are recognized in the month they are communicated to the Company. Additionally,in calendar 2004, Medicare began a four year phase-in of a revised capitationmodel for managed care beneficiaries. Previously, monthly capitation revenuewas based on age, sex and location determined prospectively and was not subjectto adjustments. Under the revised payment model referred to as the “RiskAdjustment model,” Medicare compensates managed care organizations andproviders based on the sickness (“acuity”) of each individual enrollee. HealthPlans and providers with higher acuity enrollees will receive more and thosewith healthier enrollees will receive less. In 2006 Medicare is in the thirdyear of the four year phase-in period. Under Risk Adjustment, capitation is determinedbased on health severity measured using patient encounter data. Capitation ispaid on an interim basis based on data submitted for the enrollee for the precedingyear and is adjusted in subsequent periods (generally in the fourth quarter)after the final data is compiled. Positive or negative capitation adjustmentsare made for seniors with conditions requiring more or less healthcare servicesthan assumed in the interim payments. Since the Company does not currently havethe ability to reliably predict these adjustments, periodic changes incapitation amounts earned as a result of Risk Adjustment are recognized in theyear to which they relate, generally in the fourth quarter, when those changes arecommunicated by the health plans to the Company. We received and recorded as areduction to revenue approximately $1.5 million in negative capitationrisk adjustments in the fourth quarter of fiscal 2006 pertaining to fiscal 2006.In the fourth quarter of the fiscal 2005, the Company received and recorded$4 million in positive capitation risk adjustments pertaining to fiscal2005 services.

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.

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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. Under the OneCare contractwith CalOptima administered through the AMVI/Prospect joint venture, theCompany is required to pay medical costs at least equal to 85% of thecapitation revenue. The cost of health services is recognized in the period inwhich it is provided and includes an estimate of the cost of services whichhave been incurred but not yet reported. The estimate for accrued medical costsis based on projections of costs using historical studies of claims paid andadjusted for seasonality, utilization and cost trends. These estimates aresubject to trends in loss severity and frequency. Although considerablevariability is inherent in such estimates, management records its best estimateof the amount of medical claims incurred at each reporting period. Estimatesare continually monitored and reviewed and, as settlements are made orestimates adjusted, differences are reflected in current operations. SeeNote 10 for changes in claims estimates during each of the three yearsended September 30, 2006.

In addition to contractual reimbursements to providers,the Company also makes discretionary incentive payments to physicians, whichare in large part based on the pay-for-performance and shared risk revenues andfavorable senior capitation risk adjustment payments. Since the Company recordsthese revenues generally in the third or fourth quarter of each fiscal yearwhen the incentives and capitation adjustments due from the health plans areknown, the Company also records the discretionary physician bonuses in the sameperiod. In fiscal 2004 and 2005, the Company recorded discretionary incentivepayments to providers totaling $1,286,000 and $2,579,000. No discretionaryincentives were recorded in fiscal 2006.

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 and equipment are stated on thebasis of cost. Depreciation of equipment is provided using the straight-linemethod over the estimated useful lives of the assets, and amortization ofleasehold improvements is provided using the straight-line basis over theshorter of the lease period or the estimated useful lives of the leaseholdimprovements. Leasehold improvements are depreciated over 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.

Depreciation expense was$494,938 and $555,230 for the years ended September 30, 2005 and 2006,respectively.

**Goodwill and OtherIntangible Assets**

Goodwill and related intangible assets totaling$37,039,444 and $44,852,084 at September 30, 2005 and 2006, respectively(see tables below under this heading), arose primarily as the result of theacquisitions of the physician organizations. Related intangible assets consistof the fair value of acquired HMO contracts, covenants not-to-compete, tradename and enrollee membership.

Goodwill represents the excess of the considerationpaid and liabilities assumed over the fair value of the assets acquired,including identifiable intangible assets. In conjunction with theseacquisitions, 

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management of the Companyhas reviewed the allocation of the excess of costs (including costs incurredrelated to the acquisitions) over net assets acquired, and has determined, todate, that these costs (goodwill) are allocable primarily to the operatingplatforms acquired which allowed the Company to expand its geographicalterritory through the addition of the existing renewable HMO contracts includedin the acquisitions. These HMO contracts have historically been renewed eachyear with the acquired physician organizations and the HMOs are currently notoffering additional contracts to similarly situated physician organizations inthe same territories. Such acquisitions are discussed further in Note 2below.

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. Impairmentis the condition that exists when the carrying amount of goodwill exceeds itsimplied fair value. A two-step impairment test is used to identify potentialgoodwill impairment and to measure the amount of goodwill impairment loss to berecognized (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 SFAS No. 142. Similarly, the Company has also determinedthat the affiliated physician organizations represent a single operatingsegment for financial reporting under SFAS No. 131, “Disclosures aboutSegments of an Enterprise and Related Information,” since the Company presentssegment information externally the same way management uses financial datainternally to make operating decisions, allocate resources and assessperformance.

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 isless than its carrying value, a second 

F-13

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step is performed tocompute the amount of the impairment by determining the “implied fair value” ofthe goodwill, which is compared to its corresponding carrying value.

The annual impairment test, performed at September 30,2005 and 2006, indicated that the fair value of the Company’s net assetsexceeded the carrying value; thus goodwill was not impaired.

A summary schedule of theCompany’s acquisition costs and accumulated amortization of goodwill andintangibles related to the acquisitions at September 30, 2005 and 2006 isas follows:

| ** **                                | ** ** | **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 |   |

 

F-14

----

 

| ** **                                | ** ** | **Purchase  Price** | ** **     | **(Net Assets)  Liabilities  Assumed** | ** ** | **Total Purchase  Consideration in  Excess of Net  Tangible Assets  Acquired** | ** **     | **Professional  Fees and  Other  Related Costs** | ** **     | **Total**     | ** **  |
|-------------------------------------------|------------|---------------------|----------------|---------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|----------------|------------------------------------------------------------|----------------|---------------|-------------|
| **2006**                                  |       |                |           |                                        |       |                                                                                                    |           |                                                       |           |          |        |   |   |   |   |
| 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** | ** ** |
| Genesis                                   | ** ** | **8,000,000**       | ** **     | **(222,547**                                | **)**      | ** **                                                                                              | **7,777,453**  | ** **                                                 | ** **     | ** **    | **46,052**  |   | ** ** | **7,823,505** | ** ** |
| Other                                     | ** ** | **—**          | ** **     | **—**                                  | ** ** | ** **                                                                                              | **—**     | ** **                                                 | ** **     | ** **    | **140,819** |   | ** ** | **140,819** | ** ** |
|                                      | ** ** | **$**               | **45,108,000** | ** **                                  | **$**      | **(1,861,742**                                                                                          | **)**          | ** **                                                 | **43,246,258** | ** **    | ** **  | ** ** | **1,605,826** |   | ** ** | **44,852,084** | ** ** |
| Accumulated  amortization                 | ** ** | ** **          | ** **     | ** **                                  | ** ** | ** **                                                                                              | ** **     | ** **                                                 | ** **     | ** **    | ** **  |   | ** ** | **(5,376,916** | **)** |
|                                      | ** ** | ** **          | ** **     | ** **                                  | ** ** | ** **                                                                                              | ** **     | ** **                                                 | ** **     | ** **    | ** **  |   | ** ** | **$** | **39,475,168** | ** ** |
|                                           |            |                     |                |                                             |            |                                                                                                         |                |                                                            |                |               |             |  |  |  |  |  |  |  |  |  |

 

The tables above exclude unamortized deferred financingcosts of $202,949 and $101,476 at September 30, 2005 and 2006.

Other intangibles at September 30,are as follows:
|                           | ** ** | **2005**  | ** ** | **2006**   | ** ** | **Amortization  Period** | ** ** |
|---------------------------|------------|-----------|------------|------------|------------|--------------------------|------------|
| Customer  relations       |       | $         | 1,628,402  |       | $          | 2,613,202                |       | 3 – 4 years |   |
| Covenants not to  compete |       | 50,000    |       | 249,200    |       | 2 – 3 years         |       |
| Trade name                |       | —    |       | 194,800    |       | 1.5 years                |       |
| Deferred financing costs  |       | 304,424   |       | 304,424    |       | 3 years                  |       |
| Gross carrying value      |       | 1,982,826 |       | 3,361,626  |       |                     |       |
| Accumulated  amortization |       | (665,212  | )          | (1,623,151 | )          |                     |       |
| Other intangibles, net    |       | 1,317,614 |       | 1,738,475  |       |                     |       |
|                           |            |           |            |            |            |                          |            |  |  |

 

Amortization expense for the years ended September 30,2004, 2005 and 2006 was $213,130, $453,079 and $957,400, respectively.

Estimatedamortization expense for each succeeding year is as follows:

| 2007 |   | $       | 932,368 |   |
|------|--------|---------|---------|--------|
| 2008 |   | 533,857 |    |
| 2009 |   | 251,733 |    |
| 2010 |   | 20,517  |    |
| 2011 |   | —  |    |

 

F-15

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**Medical MalpracticeLiability 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. The Company renews the claims-made policy each year. Under themalpractice agreement with the carrier, the Company has pre-funded a tailliability policy to take effect in the event the claims-made policy is notrenewed. The cost of this tail policy in the amount of $176,600, was expensedin prior years.

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 potentially dilutiveshares computed using the treasury stock method. Such shares are excluded ifdetermined to be anti-dilutive. Common stock issued at below estimated fairvalue on the issuance date is included in weighted average number of commonshares as if such shares 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** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                             | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| Basic earnings per  common share:                      |       |                                       |       |   |   |   |   |
| Numerator—net income                              |       | $                                          | 5,127,243  |   | $ | 4,072,559 | ** ** | **$** | **4,890,035** | ** ** |
| Denominator—                                      |       |                                       |       |   | ** ** | ** ** | ** ** |
| Weighted average number of common shares outstanding   |       | 4,321,799                                  |       | 4,915,537 | ** ** | **6,913,405** | ** ** |
| Basic earnings per common share                        |       | $                                          | 1.19       |   | $ | 0.83 | ** ** | **$** | **0.71** | ** ** |
| Diluted earnings per  common share:                    |       |                                       |       |   | ** ** | ** ** | ** ** |
| Numerator—net income                              |       | $                                          | 5,127,243  |   | $ | 4,072,559 | ** ** | **$** | **4,890,035** | ** ** |
| Denominator—                                      |       |                                       |       |   | ** ** | ** ** | ** ** |
| Weighted average number of common shares outstanding   |       | 4,321,799                                  |       | 4,915,537 | ** ** | **6,913,405** | ** ** |
| Dilutive stock options, warrants and preferred  shares |       | 3,225,341                                  |       | 3,554,874 | ** ** | **1,193,247** | ** ** |
|                                                   |       | 7,547,140                                  |       | 8,470,411 | ** ** | **8,106,652** | ** ** |
| Diluted earnings  per common share                     |       | $                                          | 0.68       |   | $ | 0.48 | ** ** | **$** | **0.60** | ** ** |

 

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**

The Company has stock option agreements with certaindirectors, officers and employees. On October 1, 2005, the Company adoptedSFAS No. 123(R), “Share-BasedPayment,” by applying the modified prospective method and thesupplemental implementation guidance in Staff Accounting Bulletin (SAB) No. 107.SFAS No. 123(R) requires compensation cost for all share-basedpayments in exchange for 

F-16

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employee services(including employee stock options) to be measured at fair value and eliminatesthe intrinsic value method previously permitted under Accounting Principles Board(APB) Opinion 25, “Accounting forStock Issued to Employees” and SFAS No. 123 “Accounting for Stock-Based Compensation.”Under APB No. 25, compensation costs were recognized only to the extentthe market price of the underlying stock exceeded the exercise price on thedate of grant. Since the Company generally issues shared-based awards at orabove the market price of the underlying stock, these equity awards have nothistorically resulted in compensation expense.

Under the modified prospective method, prior periodsare not restated to reflect the impact of SFAS No. 123(R). Compensationcost is recognized for all awards granted, modified or settled subsequent tothe adoption date, or where the requisite service period has not been completedprior to the date of adoption. Compensation cost for awards granted prior to,but not vested as of the adoption date would be based on the same estimatedgrant-date fair value previously used for pro forma disclosure purposes underSFAS No. 123. Compensation costs for awards granted, modified, or settledafter the adoption date are measured and recognized in the financial statementsbased on their grant date fair value, net of estimated forfeitures over theawards’ service period, in accordance with SFAS No. 123(R). The Company adoptedthe Black-Scholes option pricing model for estimating stock-basedcompensation after it became a publicly traded entity in May 2005 and continuesto use the Black-Scholes option pricing model and a single option awardapproach to estimate the fair value of options granted. The adoption of SFAS No. 123Rdid not result in adjustments that are required to be reported as thecumulative effect of a change in accounting principle. Equity-basedcompensation, if any, is classified within the same line items as cashcompensation paid to employees. Cash retained as a result of excess taxbenefits relating to share-based payments are presented in the statement ofcash flows as a financing cash inflow. Previously, the cash retained fromexcess tax benefits was presented in operating cash flows.

The adoption of SFAS No. 123(R) did not havea significant effect on the Company’s financial position and results ofoperations since the Company fully vested all remaining unvested portions ofpreviously issued stock options in September 2005 and made insignificantgrants thereafter as discussed below. Because none of the stock options whosevesting was accelerated had exercise prices below the market value of theCompany’s stock, no expense was recognized upon the acceleration of vesting.The Company did not make other changes to the terms of the options, whichgenerally vest pro-rata over 2 years (the requisite service period) andexpire after 5 years from the date of grant.

Optionactivity for the year ended September 30, 2006 is summarized below:

| ** **                                                | ** ** | **Shares** | ** ** | **Weighted  Average Exercise  Price** | ** ** | **Aggregate  Intrinsic Vale** | ** ** | **Weighted  Average  Remaining  Contractual  Terms (months)** | ** ** |
|-----------------------------------------------------------|------------|------------|------------|--------------------------------------------|------------|------------------------------------|------------|--------------------------------------------------------------------|------------|
| Outstanding as of  September 30, 2005                |       | 3,375,863  |       |                                       | 3.89       |                               |       |                                                               |       |   |   |   |   |   |   |
| Granted                                                   |       | 35,500     |       |                                       | 5.67       |                               |       |                                                               |       |   |   |   |   |   |   |
| Exercised                                                 |       | (546,615   | )          |                                       | 2.51       |                               |       |                                                               |       |   |   |   |   |   |   |
| Forfeited                                                 |       | (52,501    | )          |                                       | 5.54       |                               |       |                                                               |       |   |   |   |   |   |   |
| Outstanding as of  September 30, 2006                |       | 2,812,247  |       |                                       | 4.15       |                               |       |                                                               | $          | 4,968,625 |   |   |   | 29 |   |   |
| Vested or  expected to vest as of September 30, 2006 |       | 2,788,914  |       |                                       | 4.14       |                               |       |                                                               | 4,963,958  |   |   |   | 29 |   |   |
| Exercisable as of  September 30, 2006                |       | 2,788,914  |       |                                       | 4.14       |                               |       |                                                               | $          | 4,963,958 |   |   |   | 29 |   |   |

 

The aggregate intrinsic value is calculated as thedifference between the exercise price of the underlying awards and the quotedprice of our common stock for those awards that have an exercise pricecurrently below the quoted value.

F-17

----

During the year ended September 30, 2006, thecompany granted 35,500 options and recognized compensation expense of $32,078(included in general and administrative expenses). During the year ended September 30,2006, options for 546,615 common shares were exercised for net proceeds ofapproximately $1,340,000 and 52,501 options were forfeited. The aggregateintrinsic value of the options exercised was $1,597,975. The Company realized nettax benefits of $605,868 from these exercises where the price paid was below thefair value of the common shares on the exercise date. The tax benefits reducedincome tax payable and increased additional paid-in capital. At September 30,2006, there are 23,333 in unvested awards. Compensation of $60,666 for theunvested awards will be recognized rateably over the two year vesting period.

Non-vestedoption activity for year ended Sptember 30, 2006 is summarized below:

| ** **                                        | ** ** | **Shares** | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|---------------------------------------------------|------------|------------|------------|---------------------------------------------------------|------------|
| Non-vested  balance as of September 30, 2005 |       | —     |       |                                                    | $          | — |   |   |
| Granted                                           |       | 35,500     |       |                                                    | 5.65       |   |   |
| Vested                                            |       | 12,167     |       |                                                    | 5.65       |   |   |
| Forfeited                                         |       | —     |       |                                                    | —     |   |   |
| Non-vested balance as of  September 30, 2006 |       | 23,333     |       |                                                    | $          | 5.65 |   |   |

 

The fair value of the options granted prior to theCompany becoming a public reporting entity in May 2005 was estimated atthe date of grant using the Minimum Value option model. Under SFAS No. 123non-public companies were permitted to use minimum-value method to estimatecompensation costs for pro-forma disclosure purposes, which effectively allowedthose companies to value employee stock options using an assumed volatility ofzero. The minimum value method is not an acceptable approach under SFAS No. 123(R) andthe minimum-value disclosures for the fiscal 2004 are no longer provided. Thefair value of the options granted after the Company became a public reportingentity was estimated at the date of the grant using the Black-Scholes optionpricing model.

Thefollowing table illustrates the effect on net income if the Company had appliedthe fair value recognition provisions for options granted inSeptember 2005 that were estimated using the Black-Scholes pricing model:

| Net income, as  reported                                                                            |   | $          | 4,072,559 |   |
|-----------------------------------------------------------------------------------------------------|--------|------------|-----------|--------|
| Add stock-based  compensation under the intrinsic value method, included in net income as  reported |   | 139,723    |      |
| Less stock-based  compensation under the fair value method                                          |   | (1,420,555 | )         |
| Pro forma net  income                                                                               |   | $          | 2,791,727 |   |
| Basic earnings  per share:                                                                          |   |       |      |
| As reported                                                                                         |   | $          | 0.83      |   |
| Pro forma                                                                                           |   | $          | 0.57      |   |
| Diluted earnings  per share:                                                                        |   |       |      |
| As reported                                                                                         |   | $          | 0.48      |   |
| Pro forma                                                                                           |   | $          | 0.33      |   |

 

F-18

----

The fair value for the 2005 option grants was estimatedbased on the following factors, expected term of 4 years, risk-free of 3.96%-4.18%,volatility of 71.4% and dividend yield of 0%.

Fair value for optionsgranted during the year ended September 30, 2006 was estimated with thefollowing weighted average assumptions:

| ** **                                                            | ** ** | **2006**    | ** ** |
|-----------------------------------------------------------------------|------------|-------------|------------|
| Market price of  the Company’s common stock on the date of grant |       | $           | 5.65-6.75  |   |
| Weighted average  expected life of the options                        |       | 4 years     |       |
| Risk-free  interest rate                                              |       | 4.35-4.67   | %          |
| Volatility                                                            |       | 53.00-63.00 | %          |
| Weighted average  expected volatility                                 |       | 53.03       | %          |
| Dividend yield                                                        |       | 0.00        | %          |
|                                                                       |            |             |            |  |

 

Thefollowing table is a summary of options outstanding under all of the Company’soption plans as of September 30, 2006:

| **Range of Exercise Prices** | ** ** | ** ** | ** ** | **Number   Outstanding** | ** ** | **Weighted  Average  Remaining   Contractual  Life (Months)** | ** ** | **Weighted   Average   Exercise Price** | ** ** | **Number   Exercisable** | ** ** | **Weighted   Average   Exercise Price** | ** ** |
|---------------------------------------------|------------|------------|------------|-------------------------------|------------|-------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|-------------------------------|------------|--------------------------------------------------------|------------|
| $3.00                                       |       |       | 1,407,150  |                          |       |                                                                    | 19         |                                                   |       |                          | $          | 3.00                                                   |       |   | 1,407,150 |   |   | $ | 3.00 |   |   |
| $4.86 -  $5.65                         |       |       | 1,125,597  |                          |       |                                                                    | 39         |                                                   |       |                          | $          | 5.00                                                   |       |   | 1,102,264 |   |   | $4.98 |   |   |
| $6.45 -  $7.15                         |       |       | 279,500    |                          |       |                                                                    | 38         |                                                   |       |                          | $          | 6.51                                                   |       |   | 279,500 |   |   | $ | 6.51 |   |   |
| $3.00 - $7.15                          |       |       | 2,812,247  |                          |       |                                                                    | 29         |                                                   |       |                          | $4.15      |                                                   |       | 2,788,914 |   |   | $4.14 |   |   |

 

**Cash and CashEquivalents**

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 ofFinancial Instruments**

The financial instruments reported in the accompanyingconsolidated balance sheets consist primarily of cash and cash equivalents, investments,accounts and notes receivable, notes payable and all other liabilities. Thecarrying amounts of current assets and liabilities approximate their fair valuedue to the relatively short period of time between the origination of theinstruments 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 termloan that bear interest at the prime rate plus applicable margin.

**Concentrations ofCredit Risk**

Financial instruments which potentially subject theCompany to concentrations of credit risk consist of cash held in financialinstitutions which exceeds the $100,000 insurance by the Federal DepositInsurance Corporation, shared-risk and receivables due from health plans. TheCompany’s credit risk with respect to receivables is limited since amounts aregenerally due from large HMOs. Management reviews the 

F-19

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financial condition of thefinancial institutions on a periodic basis and does not believe theconcentration of cash results in a high level of risk.

For the fiscal years endedSeptember 30, 2004, 2005 and 2006 our affiliated physician organizationsreceived 79%-80% of their revenues from four HMOs as follows:

| ** **  | ** ** | **Capitation  Revenue  Year Ended  September 30,  2004** | ** **  | **% of Total  Capitation  Revenue** | ** ** | **Capitation  Revenue  Year Ended  September 30,  2005** | ** ** | **% of Total  Capitation  Revenue** | ** ** | **Capitation  Revenue  Year Ended  September 30,  2006** | ** ** | **% of Total  Capitation  Revenue** | ** ** |
|-------------|------------|--------------------------------------------------------------------|-------------|-----------------------------------------------|------------|--------------------------------------------------------------------|------------|-----------------------------------------------|------------|--------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| PacifiCare  |       | $                                                                  | 40,903,464  |                                          |       | 32                                                                 | %          |                                          | $          | 40,155,679                                                         |       |                                          | 31         | % |   | $ | 39,337,714 |   |   | 30 | % |   |
| Health Net  |       | 25,933,742                                                         |        |                                          | 21         | %                                                                  |       | 25,224,324                                    |       |                                                               | 20         | %                                             |       | 27,113,638 |   |   | 21 | % |   |
| Blue Cross  |       | 19,899,135                                                         |        |                                          | 16         | %                                                                  |       | 21,365,598                                    |       |                                                               | 17         | %                                             |       | 20,948,066 |   |   | 16 | % |   |
| Blue Shield |       | 13,467,152                                                         |        |                                          | 11         | %                                                                  |       | 14,802,756                                    |       |                                                               | 11         | %                                             |       | 15,954,577 |   |   | 12 | % |   |
| Totals      |       | $                                                                  | 100,203,493 |                                          |       | 80                                                                 | %          |                                          | $          | 101,548,357                                                        |       |                                          | 79         | % |   | $ | 103,353,995 |   |   | 79 | % |   |

 

**Use of Estimates**

The preparation offinancial statements in conformity with U.S. generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe reported amounts of assets, liabilities, revenues and expenses, and thedisclosure of contingent assets and liabilities at the date and for the periodsthat the financial statements are prepared. Actual results could differ fromthose estimates. Principal areas requiring the use of estimates includesettlements under risk-sharing programs, medical receivables, determination ofallowances for uncollectible accounts, medical claims and accruals, impairmentof long-lived and intangible assets, professional and general liability claims,reserves for potential absorption of claims unpaid by insolvent providers,reserves for the outcome of litigation and valuation allowances for deferredtax assets.

**RecentPronouncements**

In May 2005, the Financial Accounting StandardsBoard (FASB) issued Statement No. 154 (SFAS No. 154), “Accounting Changes and Error Corrections,”which replaced APB Opinion No. 20, “AccountingChanges,” and SFAS No. 3, “ReportingChanges in Interim Financial Statements.” SFAS No. 154 requiresretrospective application to prior periods’ financial statements of voluntarychanges in accounting principles and changes required by a new accountingstandard when the standard does not include specific transition provisions.Previous guidance required most voluntary changes in accounting principle to berecognized by including in net income of the period in which the change wasmade the cumulative effect of changing to the new accounting principle. SFAS No. 154carries forward existing guidance regarding the reporting of the correction ofan error and a change in accounting estimate. SFAS No. 154 is effectivefor accounting changes and corrections of errors made in fiscal years beginningafter December 15, 2005. Adoption of SFAS No. 154 as of October 1,2006 is not expected to have a material effect on our consolidated financialposition or results of operations.

In July 2006, the FASB issued Interpretation No. (FIN)48, “Accounting for Uncertainty inIncome Taxes, an interpretation of SFAS No. 109 “Accounting forIncome Taxes.” FIN 48 clarifies the accounting for income taxes by prescribing theminimum recognition threshold a tax position is required to meet before beingrecognized in the financial statements. FIN 48 also provides guidance onderecognition, measurement, classification, interest and penalties, accountingin interim periods, disclosure and transition. In addition, FIN 48 excludesincome taxes from the scope of SFAS No. 5, “Accounting for Contingencies.” FIN 48 is effective for fiscalyears beginning after December 15, 2006. Differences between the amountsrecognized in the consolidated balance sheets prior to the adoption of FIN 48and the amounts reported after adoption are accounted for as acumulative-effect adjustment to the beginning 

F-20

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balance of retainedearnings. Adoption of FIN 48 as of October 1, 2007 is not expected to havea material effect on our consolidated financial position or results ofoperations.

In September 2006, the FASB issued SFAS No. 157, “FairValue Measurements.” This Statement defines fair value, establishes a frameworkfor measuring fair value in generally accepted accounting principles, andexpands disclosures about fair value measurements. This Statement applies underother accounting pronouncements that require or permit fair value measurements,the Board having previously concluded in those accounting pronouncements thatfair value is the relevant measurement attribute. Accordingly, this Statementdoes not require any new fair value measurements. This Statement is effectivefor financial statements issued for fiscal years beginning after November 15, 2007,and interim periods within those fiscal years. The Company is currentlyevaluating the impact of the provisions of SFAS No. 157.

In September 2006, the Securities and ExchangeCommission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 108 regardingthe process of quantifying financial statement misstatements. SAB No. 108states that registrants should use both a balance sheet approach and an incomestatement approach when quantifying and evaluating materiality of a misstatement.The interpretations in SAB No. 108 contain guidance on correctingerrors under the dual approach as well as provide transition guidance forcorrecting errors. This interpretation does not change the requirements withinSFAS No. 154 for the correction of an error in financial statements. SAB No.108 is effective for annual financial statements covering the first fiscal yearending after November 15, 2006. The Company will be required to adopt thisinterpretation for its fiscal year ending 2007.

Other recent accountingpronouncements issued by the FASB (including its Emerging Issues Task Force),the AICPA, and the SEC did not, or are not believed by management to, have amaterial impact on our present or future consolidated financial statements.

**Reclassifications**

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

**2.**                 Acquisitions

**Prospect NWOCMedical 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 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.

**Starcare Medical Group, Inc., APAC Medical Group, Inc.and Pinnacle Health Resources (the “Gateway” entities)**

On February 1, 2004, PMG, acquired the assets andassumed the liabilities of Starcare Medical Group, Inc. (StarCare) andAPAC Medical Group for a total of $4,000,000. Both entities became wholly ownedsubsidiaries of PMG. Also on that date, Prospect Medical Systems, Inc.acquired the management company for these medical groups, Pinnacle HeathResources, for $4,450,000. $660,000 of the purchase consideration was allocatedto identifiable intangibles, specifically enrolled member accounts, which isbeing amortized over 54 months. An additional $50,000 was paid for a covenantnot to compete. Related 

F-21

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acquisition costs totaled$353,398. Revenues and expenses for this acquisition have been included in ourconsolidated 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.

**Nuestra FamiliaMedical 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.

**Genesis HealthCareof Southern California**

On November 1, 2005, PMG acquired the outstandingstock of Genesis HealthCare of Southern California (Genesis) for $8,000,000 incash. The purchase price was funded using $4,000,000 of the Company’s existingcash and a $4,000,000 term loan from Residential Funding Corporation (RFC).Revenues and expenses for this acquisition have been included in ourconsolidated results starting November 1, 2005. $194,800 of the purchaseprice was allocated to tradename. $199,200 to a covenant not-to-compete and$984,800 for customer relations, which are being amortized on a straight-linebasis over 18 months to four years. The Company made a Section 338election, and expects $7,777,452 of total goodwill and intangibles to bedeductible for tax purposes.

Under the acquisition agreement, differences betweenthe estimated claims and tax liabilities recorded on the closing date and theultimate payment amounts will be paid to or received from the seller. The agreementalso guarantees certain minimum risk pool incentives for the 2005 calendaryear. To the extent actual amounts are less than the guaranteed amounts, wewill be entitled to receive monies up to $500,000 from the seller, in additionto any other amounts due. These amounts will be recorded as purchase priceadjustments if and when received. The seller also provides customaryindemnification of up to $1.5 million for eligible non-medical and non-taxclaims submitted within a two year period. The indemnification period isreduced ratably over 24 months. In conjunction with the acquisition, we haveentered into an employment agreement with the sole selling shareholder ofGenesis and two of its employees.

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The following tablesummarizes the estimated fair values of the assets acquired and liabilitiesassumed, as of the date of acquisition, for the Gateway entities PNW andGenesis.

| ** **                            | ** ** | **Gateway** | ** ** | **PNW**   | ** ** | **Genesis** | ** ** |
|---------------------------------------|------------|-------------|------------|-----------|------------|-------------|------------|
| Current assets                        |       | $           | 6,318,057  |      | $          | 3,514,923   |       | $ | 1,520,539 |   |
| Property, improvements  and equipment |       | 1,029,317   |       | —    |       |        |       |
| Goodwill                              |       | 7,301,318   |       | 29,118    |       | 6,398,652   |       |
| Identifiable intangibles              |       | 710,000     |       | 200,000   |       | 1,378,800   |       |
| Other assets acquired                 |       | 58,437      |       | —    |       | 31,565      |       |
| Total assets                          |       | 15,417,129  |       | 3,744,041 |       | 9,329,556   |       |
| Current liabilities                   |       | 6,368,562   |       | 1,744,041 |       | 1,329,556   |       |
| Long-term liabilities                 |       | 548,567     |       | —    |       | —      |       |
| Total liabilities  assumed            |       | 6,917,129   |       | 1,744,041 |       | 1,329,556   |       |
| Net assets acquired                   |       | $           | 8,500,000  |      | $          | 2,000,000   |       | $8,000,000 |   |
|                                       |            |             |            |           |            |             |            |  |  |  |

 

The following unauditedpro forma information for the year ended September 30, 2004 gives effectto the PNW and Gateway acquisitions as if they had occurred on October 1,2003. The unaudited pro forma information for the years endedSeptember 30, 2005 and 2006 gives effect to the acquisition of Genesis, asif it had occurred on October 1, 2004. Such unaudited pro formainformation is based on historical financial information with respect to theacquisition and does not include operational or other changes that might havebeen effected by the Company.

| ** **                 | ** ** | **Year ended September 30** | ** **  |
|----------------------------|------------|--------------------------------------------|-------------|
| ** **                 | ** ** | **2004**                                   | ** **  | **2005** | ** ** | **2006** | ** ** |
| ** **                 | ** ** | **(unaudited)**                            | ** **  |
| Net revenue                |       | $                                          | 144,861,104 |   | $ | 143,996,320 |   | $ | 136,685,731 |   |
| Net income                 |       | 5,402,438                                  |        | 4,230,102 |   | 4,919,300 |   |
| Basic earnings per share   |       | $                                          | 1.25        |   | $ | 0.86 |   | .71 |   |
| Diluted earnings per share |       | $                                          | 0.64        |   | $ | 0.50 |   | .61 |   |
|                            |            |                                            |             |  |  |  |  |  |  |  |

 

**Investment inBrotman 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 theHospital, including Prospect, hoped to help turn around the Hospital operationsand restore 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 afterSeptember 30, 2005, and, with its limited capital, may not ultimately beable to survive.

Based on the Hospital’s significant operatingdeficits, uncertain ability to increase revenues and cut costs, and limitedcapital, management of Prospect believes that the remaining investment inBrotman Medical Center at September 30, 2005 was impaired and wrote offits entire investment in the Hospital as of September 30, 2005.

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

The company has notrecognized any equity in earnings during 2006 as the Hospital continues toincur losses.

F-23

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**3.**                 PrivatePlacement

The Company entered into a Private Placement AgencyAgreement effective November 1, 2003. Per the terms of the agreement, theCompany offered for sale through Spencer Trask Ventures, Inc., and itsselected dealers, as exclusive agent for the Company, shares at $5.50 per shareof the Company’s Series A Convertible Preferred Stock, $0.01 par value pershare. Effective July 27, 2005, these shares were converted into commonstock on a 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 Investment Partners, LLC as a promotionalfee. 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 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 toprivate placement investors at an exercise price of $5.50 per share. Thesewarrants are exercisable at any time and expire 10 years from the date ofissuance. Because, effective July 27, 2005, the Company’s Series AConvertible Stock was, by its terms, automatically converted to shares ofcommon stock, these 453,047 warrants to buy Series A Convertible PreferredStock now effectively represent the right to buy a like number of shares ofcommon stock.

This offering wasfinalized on March 31, 2004, whereby a total of 2,265,237 shares ofpreferred stock were sold for gross proceeds of $12,458,802, related expensesof $2,439,061, and net cash proceeds of $10,019,741. The proceeds were used tocomplete the acquisitions of Starcare Medical Group, Inc., APAC MedicalGroup, Inc. and Pinnacle Health Resources, Inc. for $8,500,000 and torepay $1,750,000 borrowed through our bank line of credit to finance a portionof the cost to acquire Northwest Orange County Medical Group, Inc.

**4.**                 NotesReceivable

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

Currentand non-current portions of the notes receivable as of September 30, 2006were as follows:

| Total principal  outstanding | ** ** | **$**        | **589,842** | ** ** |
|------------------------------|------------|--------------|-------------|------------|
| Less current  maturities     | ** ** | **(176,265** | **)**       |
| Non-current portion          | ** ** | **$**        | **413,577** | ** ** |

 

F-24

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Futureminimum payments required under the notes receivable as of September 30,2006 are as follows:

| 2007                          | ** ** | **$**       | **190,704** | ** ** |
|-------------------------------|------------|-------------|-------------|------------|
| 2008                          | ** ** | **65,370**  | ** **  |
| 2009                          | ** ** | **391,630** | ** **  |
| 2010                          | ** ** | **—**  | ** **  |
| 2011                          | ** ** | **—**  | ** **  |
| Gross payments                | ** ** | **647,704** | ** **  |
| Amount  representing interest | ** ** | **(57,862** | **)**       |
| Total principal  outstanding  | ** ** | **$**       | **589,842** | ** ** |

 

**5.**                 IncomeTaxes

The Company accounts for income taxes under SFAS No. 109,“Accounting for Income Taxes” (SFAS No. 109), under which deferred incometax assets and liabilities are recognized for the differences between financialand income tax reporting bases of assets and liabilities based on enacted taxrates and laws.

Thecomponents of the provision for income taxes for the year ended September 30are as follows:

| ** ** | ** ** | **2004**  | ** ** | **2005**  | ** ** | **2006**      | ** ** |
|------------|------------|-----------|------------|-----------|------------|---------------|------------|
| Current:   |       |      |       |      |       |          |       |
| Federal    |       | $         | 3,112,220  |      | $          | 2,746,453     | ** ** | **$** | **1,410,516** | ** ** |
| State      |       | 913,266   |       | 738,031   | ** ** | **436,670**   | ** ** |
|       |       | 4,025,486 |       | 3,484,484 | ** ** | **1,847,186** | ** ** |
| Deferred:  |       |      |       |      | ** ** | ** **    | ** ** |
| Federal    |       | (358,650  | )          | (89,167   | )          | **1,075,233** | ** ** |
| State      |       | (142,132  | )          | 19,861    | ** ** | **271,103**   | ** ** |
|       |       | (500,782  | )          | (69,306   | )          | **1,346,336** | ** ** |
| Total:     |       |      |       |      | ** ** | ** **    | ** ** |
| Federal    |       | 2,753,570 |       | 2,657,286 | ** ** | **2,485,749** | ** ** |
| State      |       | 771,134   |       | 757,892   | ** ** | **707,773**   | ** ** |
|       |       | $         | 3,524,704  |      | $          | 3,415,178     | ** ** | **$** | **3,193,522** | ** ** |

 

F-25

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

| ** **                                          | ** ** | **2005**   | ** ** | **2006**       | ** ** |
|-----------------------------------------------------|------------|------------|------------|----------------|------------|
| State tax benefit                                   |       | $          | 202,992    | ** **     | **$**      | **126,793** | ** ** |
| Amortization                                        |       | (1,095,905 | )          | **(1,235,121** | **)**      |
| Depreciation                                        |       | 27,264     | ** ** | **53,463**     | ** ** |
| Allowances for  bad debts                           |       | 342,906    | ** ** | **218,259**    | ** ** |
| Deferred  compensation                              |       | 248,820    |       | —         |       |
| Vacation accrual  and other                         |       | 224,766    | ** ** | **217,882**    | ** ** |
| Accrued physician  bonuses                          |       | 798,972    | ** ** | **94,781**     | ** ** |
| Creditor reserve                                    |       | 85,680     |       | —         |       |
| Deferred rent                                       |       | 22,946     | ** ** | **35,644**     | ** ** |
| Charitable  contributions                           |       | —     | ** ** | **404**        | ** ** |
| Write off of  investment in Hospital (capital loss) |       | 400,000    | ** ** | **400,000**    | ** ** |
| Deferred income  tax asset (liability)              |       | 1,258,441  | ** ** | **(87,895**    | **)**      |
| Valuation  allowance (on capital loss)              |       | (400,000   | )          | **(400,000**   | **)**      |
| Net deferred income tax  asset (liability)          |       | $          | 858,441    | ** **     | **$**      | **(487,895** | **)** |

 

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 of incomeare summarized as follows for the years ended September 30:

| ** **                           | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Tax provision at  statutory rate     |       |     | 34         | %        |       |     | 34         | % |   |   | **34** | **%** |   |
| State taxes, net  of federal benefit |       |     | 6          |     |       |     | 6          |   |   |   | **6** | ** ** |   |
| Goodwill                             |       |     | 1          |     |       |     | —     |   |   |   | — | ** ** |   |
| Change in  valuation allowance       |       |     | —     |     |       |     | 6          |   |   |   | — | ** ** |   |
| Other                                |       |     | —     |     |       |     | —     |   |   |   | (1 | **)** |   |
|                                 |       |     | 41         | %        |       |     | 46         | % |   |   | **39** | **%** |   |

 

Taxes paid totaledapproximately $3,932,000, $3,586,000 and $4,297,000 for the years ended September 30, 2004, 2005 and2006, respectively.

**6.**                 Long-TermDebt

Long-termdebt consists of the following:

| ** **                                                                | ** ** | **September 30** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                | ** ** | **2005**              | ** ** | **2006** | ** ** |
| Term loan                                                                 |       | $                     | 8,166,667  | ** ** | **$** | **9,500,000** | ** ** |
| Revolving credit  facility, interest at prime rate plus applicable margin |       | —                | ** ** | **2,500,000** | ** ** |
|                                                                      |       | 8,166,667             | ** ** | **12,000,000** | ** ** |
| Less current  maturities                                                  |       | (2,000,000            | )          | **(5,300,000** | **)** |
|                                                                      |       | $                     | 6,166,667  | ** ** | **$** | **6,700,000** | ** ** |

 

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On September 27,2004, the Company entered into a senior secured credit facility withResidential Funding Corporation (RFC, a subsidiary of General Motors AcceptanceCorporation) that consists of a $10,000,000 term loan and a $5,000,000revolving 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 (8.75% and 10.25% atSeptember 30, 2005 and 2006, respectively). The Company may borrow, makerepayments and re-borrow under the revolving credit facility until September 27,2007. Amounts outstanding under the revolving credit facility bear interest ata rate of prime plus 0.5% per annum (7.25% and 8.75% as of September 30,2005 and 2006 respectively). The Company is charged an unused line fee of 0.25%per annum payable monthly, calculated on the difference between the averagedaily usage of the revolving credit facility during each month and $5,000,000,the maximum amount of the revolving credit commitment. Both the term loan andthe revolving credit facility are secured by substantially all of the Company’sassets, including the rights to receive capitation payments under HMOcontracts. The Company is subject to certain financial covenants under the loanagreement, including a maximum senior debt/EBITDA ratio, minimum fixed chargecoverage ratio, minimum consolidated net worth, minimum liquidity and a limiton capital expenditures. The Company is also restricted, without the lender’sconsent, from using net proceeds of any sale of equity securities except to paydown indebtedness under the loan agreement. The Company may borrow amounts upto $5,000,000 under the revolving credit facility of an amount based on apercentage of capitation payments received by the Company over the prior twomonth less the principal amount then outstanding under the term loan andamounts already outstanding under the revolving credit facility.

On September 28,2004, the Company borrowed $10,000,000 on the RFC term loan and paid off $662,682under a term loan and revolving credit facility with Comerica Bank. The Companyborrowed $5,000,000 on the RFC revolving credit facility on September 29,2004, which was repaid in full on October 4, 2004.

In November 2005, inconnection with the acquisition of Genesis, RFC provided the Company with anadditional $4 million term loan on terms similar to the existing term loan.This additional loan requires monthly principal payments of $66,667 untilSeptember 27, 2007, at which time the remaining unpaid balance is due. InSeptember 2006, the Company extended the maturity and expiration date of theterm loan and revolving credit facility to January 31, 2008.

The Company exceeded the1.50 maximum senior debt/EBITDA ratio as of September 30, 2004 and December 31,2004. The actual senior debt/EBITDA ratio on those two dates was 1.57and 1.51respectively. Effective April 7, 2005, RFC 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. At September 30, 2006, the Company reported a fixed charge coverageratio of 1.12 compared to the minimum required ratio of 1.25. InDecember 2006, the Company and RFC amended the credit agreement effectiveSeptember 30, 2006 to reduce the ratio to 1.00 for the test periods endedSeptember 30, 2006 through December 30, 2006. The minimum ratio fortest periods thereafter will remain at 1.25. The Company believes that it willbe able to comply with the adjusted minimum ratio through September 30,2007. As a result, scheduled payments due after twelve months have beenclassified as non-current at September 30, 2006.

Interest paid totaled$90,802, $958,634 and $1,107,081 in fiscal 2004, 2005, and 2006, respectively.

Scheduledpayments under current and long-term debt, as of September 30, 2006, areas follows:

| 2007                   | ** ** | **$**         | **5,300,000**  | ** ** |
|------------------------|------------|---------------|----------------|------------|
| 2008                   | ** ** | **6,700,000** | ** **     |
| Total minimum payments | ** ** | **$**         | **12,000,000** | ** ** |

 

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**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:

| ** **                           | ** ** | **2004**    | ** ** | **2005**                               | ** ** | **2006**    | ** ** |
|--------------------------------------|------------|-------------|------------|----------------------------------------|------------|-------------|------------|
| ** **                           | ** ** | **Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Outstanding,  beginning of year |       | 1,998,000   |       |                                   | $          | 2.82        |       |   | 2,681,500 |   |   | $ | 3.43 | ** ** |   | **3,375,863** | ** ** |   | **$** | **3.89** | ** ** |   |
| Granted                              |       | 739,700     |       |                                   | 5.00       |        |       | 705,313 |   |   | 5.65 | ** ** |   | **35,500** | ** ** |   | **5.67** | ** ** |   |
| Exercised                            |       | (30,000     | )          |                                   | 1.25       |        |       | — |   |   | — | ** ** |   | **(546,615** | **)** |   | **2.51** | ** ** |   |
| Forfeited                            |       | (26,200     | )          |                                   | 3.17       |        |       | (10,950 | ) |   | 5.93 | ** ** |   | **(52,501** | **)** |   | **5.54** | ** ** |   |
| Expired                              |       | —      |       |                                   | —     |        |       | — |   |   | — | ** ** |   | — | ** ** |   | **—** | ** ** |   |
| Outstanding, end  of year            |       | 2,681,500   |       |                                   | $          | 3.43        |       |   | 3,375,863 |   |   | $ | 3.89 | ** ** |   | **2,812,247** | ** ** |   | **$** | **4.15** | ** ** |   |
| Exercisable, end  of year            |       | 2,353,502   |       |                                   | $          | 3.23        |       |   | 3,375,863 |   |   | $ | 3.89 | ** ** |   | **2,788,914** | ** ** |   | **$** | **4.14** | ** ** |   |
| Price                                |       | $           | 1.25-$5.00 |                                   |       |        |       |   | $ | 1.25-$7.15 |   |   |   | ** ** |   | **$** | **3.00-$7.15** | ** ** |   | ** ** | ** ** |   |
|                                      |            |             |            |                                        |            |             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The weighted average remaining contractual life ofstock options outstanding at September 30, 2005 and 2006 was 37 months and29 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 as aresult of the modification during fiscal 2004 and 2005 was $108,762,and$232,871,respectively.

In 2006, the Company issued options to purchase 35,500common shares at an exercise price of $5.65 to $6.75. Stock-based compensation expenserecognized during fiscal 2004 and 2005 under the intrinsic method was $44,773and zero, respectively. Expense in fiscal 2006 under the fair value method was$32,078.

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 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.

F-28

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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 onJanuary 31, 2002 and expire on January 31, 2007. No value wasassigned to the issuance of these warrants as the exercise price exceeded thefair value of the underlying stock, estimated at $1.25 to $2.00 per shareduring this period, and there was either no or only nominal trading activity inthe stock. Consequently, the Company determined that the fair value of thewarrants was *de minimis*.

In conjunction with the March 2004 Private Placement(Note 3), the Company issued warrants to purchase 659,409 shares of theCompany’s common stock at $1.00 per share to Spencer Trask Investment Partners,LLC., as a promotional fee. These warrants are exercisable at any time andexpire on September 19, 2010. On November 3, 2003, 100,000 warrantswere exercised and 100,000 shares of common stock were issued. The originalwarrant certificate was cancelled and reissued for 559,409 warrants at the sameterms 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 ofSeries A Convertible Preferred Stock sold in the Private Placementoffering. Warrants to purchase 453,047 shares were issued. These warrants areexercisable at any time and expire 10 years from the date of issuance.Because the Series A Convertible Stock were automatically converted intoshares of common stock on July 27, 2005, these warrants now effectivelyrepresent the right to 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 March 2004 Private Placement,are exercisable at any time, and expire on June 15, 2011.

**8.**                 Commitmentsand Contingencies

**Leases**

The Company leasescertain buildings and equipment under operating leases. Certain building leasescontain renewal options for two consecutive five-year periods at the thenmarket rent.

Futureminimum rental payments required under operating leases that have initial orremaining non-cancelable lease terms in excess of one year as of September 30,2006 are as follows:

| ** ** | ** ** | **Operating  Leases** | ** **    |
|------------|------------|-----------------------|---------------|
| 2007       | ** ** | **$**                 | **1,803,578** | ** ** |
| 2008       | ** ** | **1,619,765**         | ** **    |
| 2009       | ** ** | **1,582,861**         | ** **    |
| 2010       | ** ** | **1,291,040**         | ** **    |
| 2011       | ** ** | **584,712**           | ** **    |
| Thereafter | ** ** | **260,362**           | ** **    |
|       | ** ** | **$**                 | **7,142,318** | ** ** |

 

Consolidated rent expensefor 2004, 2005, and 2006 was $1,614,268, $1,664,374 and $1,706,843respectively.

F-29

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**Regulatory Matters**

Laws and regulations governing the Medicare programand health care generally are complex and subject to interpretation. Prospectand its affiliates believe that they are in compliance with all applicable lawsand regulations and are not aware of any pending or threatened investigationsinvolving allegations of potential wrongdoing. While no such regulatoryinquiries have been made, compliance with such laws and regulations can besubject to future government review and interpretation as well as significantregulatory action including fines, penalties, and exclusion from the Medicareand Medicaid programs.

The Company’s affiliatedphysician organizations must comply with a minimum working capital, TangibleNet Equity (TNE), cash to claims ratio and claims payment requirementsprescribed by the California Department of Managed Health Care. TNE is definedas net assets less intangibles and amounts due from affiliates, plussubordinated obligations. At September 30, 2006, the affiliated physicianorganizations were in compliance with those regulatory requirements.

**NASD Inquiry**

On February 3, 2004,the Company received a notice of inquiry from the National Association ofSecurities Dealers, Inc. (NASD), concerning trading in its common stockthat took place around the time that it announced the first closing of aprivate placement of its Series A Preferred Stock. The Company respondedto an NASD 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, Prospectinitiated arbitration proceedings against St. Jude Medical Center (“St. Jude”)and PacifiCare of California (“PacifiCare”) for failure by St. Jude to providean accurate 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.

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.

F-30

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During Prospect’s fourth quarter of fiscal 2005,following rulings by the California Court of Appeals which upheld theArbitrator awards in favor of Prospect, but ruled that Prospect was responsibleto St. Jude for approximately $71,000 of arbitration costs, the partiesconcluded a settlement agreement as to all disputed matters. That settlementagreement, dated July 7, 2005, stated that, upon Prospect paying the$71,000 to St. Jude (which we did), all portions of the prior litigation wouldhave been satisfied, the parties would refrain from any further proceedings,and the parties would file the required stipulation with Superior Court,stipulating to the satisfaction of all prior judgments and the end ofproceedings on the matter. On September 13, 2005, the Superior Courtentered its order confirming these stipulations; following which, Prospectreversed the remaining legal reserve, effective in the fourth quarter ended September 30,2005.

*Other Matters  **We*and our affiliatedphysician organizations are parties to other legal actions arising in theordinary course of business. We believe that liability, if any, under theseclaims will not have a material adverse effect on our consolidated financialposition, results of operations, or cash flows.

**9.****                 DefinedContribution**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 changed from matching 25% of the first4% contributed to 100% of the first 3% and 50% of the next 2% contributed on orafter January 1, 2006. The total expense under the plan was $49,099 in2004, $102,498 in 2005 and $251,679 in 2006.

**10.**          IncurredBut Not Reported Claims Reserves

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

| ** **                                            | ** ** | **Year ended September 30** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                            | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| IBNR as of  beginning of year                         |       | $                                          | 10,557,426 | ** ** | **$** | **13,323,622** | ** ** | **$** | **11,532,328** | ** ** |
| Health care claim  expenses incurred during the year: |       |                                       |       |   |   |   |   |
| Related to current year                               |       | 44,699,711                                 | ** ** | **46,030,847** | ** ** | **50,587,185** | ** ** |
| Related to prior year                                 |       | (2,327,044                                 | )          | **(855,164** | **)** | **(854,595** | **)** |
| Total incurred                                        |       | 42,372,667                                 | ** ** | **45,175,683** | ** ** | **49,732,590** | ** ** |
| Health care  claims paid during the year:             |       |                                       |       |   |   |   |   |
| Related to current year                               |       | (33,295,082                                | )          | **(35,266,828** | **)** | **(39,488,526** | **)** |
| Related to prior year                                 |       | (7,268,752                                 | )          | **(11,700,149** | **)** | **(11,242,787** | **)** |
| Total paid                                            |       | (40,563,834                                | )          | **(46,966,977** | **)** | **(50,731,313** | **)** |
| IBNR acquired  during the year                        |       | 957,363                                    | ** ** | **—** | ** ** | **866,395** | ** ** |
| IBNR as of end of year                                |       | $                                          | 13,323,622 | ** ** | **$** | **11,532,328** | ** ** | **$** | **11,400,000** | ** ** |

 

F-31

----

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

| ** **                      | ** ** | **Year ended September 30** | ** ** |
|---------------------------------|------------|--------------------------------------------|------------|
| ** **                      | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| Capitation  expense             |       | $                                          | 48,053,154 |   | $ | 45,967,875 | ** ** | **$** | **44,553,992** | ** ** |
| Fee-for-service  claims expense |       | 42,372,667                                 |       | 45,175,683 | ** ** | **49,732,590** | ** ** |
| Other physician  compensation   |       | 4,495,641                                  |       | 4,524,284 | ** ** | **2,151,526** | ** ** |
| Other cost of  revenues         |       | 1,053,579                                  |       | 703,355 | ** ** | **746,093** | ** ** |
| Total cost of revenues          |       | $                                          | 95,975,041 |   | $ | 96,371,197 | ** ** | **$** | **97,184,201** | ** ** |

 

**11.**          JointVenture

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 the joint venture partnerfor managing those Medicaid enrollees specifically assigned to AMVI. Costsincurred by the Company in managing the joint venture are included in generaland administrative expenses in the accompanying consolidated financialstatements.

Summarizedunaudited financial information for the unconsolidated joint venture at September 30,2004, 2005 and 2006 and for each of the years then ended is as follows:

| ** **                                   | ** ** | **2004**  | ** ** | **2005** | ** ** | **2006**      | ** ** |
|----------------------------------------------|------------|-----------|------------|----------|------------|---------------|------------|
| Cash                                         |       | $         | 1,308,587  |     | $          | 823,306       | ** ** | **$** | **800,197** | ** ** |
| Receivables                                  |       | 514,524   |       | 914,113  | ** ** | **4,294,542** | ** ** |
| Total assets                                 |       | $         | 1,823,111  |     | $          | 1,737,419     | ** ** | **$** | **5,094,739** | ** ** |
| Accrued medical claims                       |       | $         | 659,807    |     | $          | 575,671       | ** ** | **$** | **2,420,031** | ** ** |
| Other payables                               |       | 1,200,000 |       | 900,000  | ** ** | **2,315,314** | ** ** |
| Other partner’s  capital                |       | 424,170   |       | 260,748  | ** ** | **358,394**   | ** ** |
| Prospect’s  capital                     |       | (460,866  | )          | 1,000    | ** ** | **1,000**     | ** ** |
| Total liabilities and partners’ capital |       | $         | 1,823,111  |     | $          | 1,737,419     | ** ** | **$** | **5,094,739** | ** ** |
| Revenues                                     |       | $         | 8,801,565  |     | $          | 8,836,729     | ** ** | **$** | **16,558,218** | ** ** |
| Income (loss) before income taxes            |       | $         | 344,972    |     | $          | (101,403      | )          | **$** | **846,489** | ** ** |
| Prospect’s equity income                |       | $         | 206,634    |     | $          | 87,516        | ** ** | **$** | **1,400,492** | ** ** |
| Management fees  earned by Prospect          |       | $         | 841,153    |     | $          | 806,788       | ** ** | **$** | **851,838** | ** ** |

 

F-32

----

**12.**          QuarterlyResults of Operations (Unaudited)

The following is a summaryof the quarterly results of operations for the years ended September 30,2005 and 2006 in thousands, except per share data:

| ** **                          | ** ** | **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 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 |   |   |

 

| ** **                           | ** ** | **For the quarter ended** | ** ** |
|--------------------------------------|------------|------------------------------------------|------------|
| ** **                           | ** ** | **December 31,  2005**              | ** ** | **March 31,  2006** | ** ** | **June 30,  2006** | ** ** | **September 30,  2006** | ** ** |
| Total revenues                       |       |                                     | $          | 33,465 |   |   |   | $ | 34,572 |   |   | $ | 34,818 |   |   | $ | 32,941 |   |   |
| Gross margin                         |       |                                     | 8,979      |   |   |   | 10,608 |   |   | 9,410 |   |   | 9,615 |   |   |
| Income before  income taxes          |       |                                     | 1,849      |   |   |   | 2,059 |   |   | 2,057 |   |   | 2,135 |   |   |
| Net income before  minority interest |       |                                     | 1,104      |   |   |   | 1,234 |   |   | 1,313 |   |   | 1,256 |   |   |
| Net income                           |       |                                     | $          | 1,103 |   |   |   | $ | 1,229 |   |   | $ | 1,304 |   |   | $ | 1,254 |   |   |
| Net earnings per  common share:      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                |       |                                     | $          | 0.16 |   |   |   | $ | 0.18 |   |   | $ | 0.19 |   |   | $ | 0.18 |   |   |
| Diluted                              |       |                                     | $          | 0.14 |   |   |   | $ | 0.15 |   |   | $ | 0.16 |   |   | $ | 0.15 |   |   |

 

As more fully discussed inNote 1, during the fourth quarter of fiscal 2005 and 2006, the Companyrecorded approximately $4 million increase in capitation revenue and$1.5 million reduction in capitation revenue, respectively, under theMedicare risk-adjustment payment system related to services rendered in therespective fiscal years. Also, in the fourth quarter of fiscal 2006, theCompany recorded $1.3 million in risk pool revenue compared to $0.7 million inthe fourth quarter of fiscal 2005. Additionally, in the 2005 fourth quarter, theCompany recorded physician and employee bonuses totaling approximately $2.8million, recouped approximately $0.5 million of previously expensed transactionexpenses upon the closing of its investment in Brotman Medical Center, andrecorded approximately $0.6 million resulting from the favorableconclusion of a longstanding legal matter. The Company did not awarddiscretionary physician bonuses in fiscal 2006.

F-33

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**REPORT OF INDEPENDENTREGISTERED PUBLIC ACCOUNTING FIRM**

Wehave audited the consolidated financial statements of Prospect MedicalHoldings, Inc. as of September 30, 2005 and 2006, and for each of thethree years in the period ended September 30, 2006, and have issued ourreport thereon dated December 22, 2006 (included elsewhere in this Form10-K). Our audits also included the accompanying financial statement schedule.This schedule is the responsibility of the Company’s management. Ourresponsibility is to express an opinion based on our audits. In our opinion,the financial statement schedule referred to above, when considered in relationto the basic financial statements taken as a whole, presents fairly in allmaterial respects the information set forth therein
|                         | /s/ ERNST &  yOUNG LLP |   |
|-------------------------|---------------------------------|--------|
| Los Angeles, California |                            |
| December 22, 2006  |                            |

 

F-34

----

**PROSPECT MEDICAL HOLDINGS, INC.SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS**

| ** **                       | ** ** | **Balance at the  Beginning of the  Year** | ** ** | **Charges to  Operations** | ** ** | **Deductions** | ** ** | **Balance at the  End of the  Year** | ** ** |
|----------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------|------------|----------------|------------|----------------------------------------------------------|------------|
| 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 |   |   |
| 2006                             |       |                                                           |       |                            |       |           |       |                                                     |       |   |   |   |   |   |   |   |   |
| Allowance for Doubtful  Accounts |       |                                                           | $          | 802,000                         |       |           |       | $                                                        | 106,000    |   |   |   | $ | 399,000 |   |   |   | $ | 509,000 |   |   |

 

F-35

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**EXHIBITINDEX**
| 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)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |

----

 
|        |   | 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 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)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |

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|        |   | 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)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 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)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |

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| 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)          |
| 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)                                                                                                                |

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| 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)                                                                                                                                                                                                                          |
| 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)                                                                                                                                                                      |

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| 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)                                                             |

 

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| 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.                                                                                                                                                                                                                                           |

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| 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)                                                 |

 

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| 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)       |
| 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)       |

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| 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)                                                                                                                                                                                                                                                                         |
| 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)                                                                                                                                                                                                                                                 |

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| 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 |
| 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)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |

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| 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 |   | Form of Limited Consent,  Omnibus Amendment No. 3 and Joinder Agreement to the Loan Documents,  dated as of November 1, 2005, 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 Independent  Registered Public Accounting Firm(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)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |

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| 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)  |

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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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