UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the fiscal year ended September 30, 2010

Commission File Number 1-32203

PROSPECT MEDICAL HOLDINGS, INC.


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

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

Securities registered pursuant to Section 12(b) of the Act: Common Stock, par value $0.01 per share

Securities registered pursuant to Section 12(g) of the Act: None

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

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. o Yes ý No

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o Yes ý No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):


Large accelerated filer o		Accelerated filer o		Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting company ý

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

The aggregate market value of common stock held by non-affiliates of the registrant as of March 31, 2010 (the last business day of our most recently completed second fiscal quarter) was approximately $66,812,323 based upon the closing price for shares of our common stock as reported by NASDAQ (the exchange upon which our common stock was traded at the time) on such date.

As of December 17, 2010, 100 shares of the registrant's common stock were outstanding, all of which were owned by Ivy Intermediate Holding, Inc. There is no public trading market for the registrant's common stock.

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Form 10-K


PART I
Item 1.	Business	4
Item 1A.	Risk Factors	39
Item 1B.	Unresolved Staff Comments	63
Item 2.	Properties	64
Item 3.	Legal Proceedings	66
Item 4.	Removed and Reserved	66
PART II
Item 5.	Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	67
Item 6.	Selected Financial Data	67
Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations	68
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	99
Item 8.	Financial Statements and Supplementary Data	99
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	99
Item 9A.	Controls and Procedures	99
Item 9B.	Other Information	101
PART III
Item 10.	Directors, Executive Officers, and Corporate Governance	102
Item 11.	Executive Compensation	105
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	109
Item 13.	Certain Relationships and Related Transactions, and Director Independence	110
Item 14.	Principal Accountant Fees and Services	112
PART IV
Item 15.	Exhibits and Financial Statement Schedules	113
Signatures		122

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain statements in this Annual Report on Form 10-K constitute "forward-looking statements" (rather than historical facts) as defined in the Private Securities Litigation Reform Act of 1995 or by the Securities and Exchange Commission (the"SEC") in its rules, regulations and releases, including Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements in this Annual Report, including under the captions "Business," "Risk Factors," and "Management's Discussion and Analysis of Financial Condition and Results of Operations," other than statements of historical fact, are forward-looking statements for purposes of these provisions, including statements of our current views with respect to our business strategy, business plan, our future financial results, and other future events. In some cases, forward-looking statements can be identified by the use of terminology such as "may," "will," "expects," "plans," "anticipates," "estimates," "potential" or "could" or the negative thereof or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements contained herein are reasonable, there can be no assurance that such expectations or any of the forward-looking statements will prove to be correct, and actual results could differ materially from those projected or assumed in the forward-looking statements.

All forward-looking statements involve inherent risks and uncertainties, and there are or will be important factors that could cause actual results to differ materially from those indicated in these statements. We believe that these factors include, but are not limited to, those factors set forth in this Annual Report under the captions "Business," "Risk Factors," and "Management's Discussion and Analysis of Financial Condition and Results of Operations," all of which you should review carefully. If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary materially from what we anticipate. Please consider our forward-looking statements in light of those risks as you read this Annual Report. We undertake no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.

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PART I

Item 1. Business.

Overview

We provide quality, coordinated healthcare and physician services in Southern California. We own and operate five hospitals, with a total of approximately 759 licensed beds, and currently maintain approximately 746 on-staff physicians, including specialists who cover approximately 35 medical and surgical specialties. Our hospitals are located in high density population areas within Los Angeles County and maintain leading market positions in the areas they serve. We also manage the provision of physician services through ten Medical Groups that consist of physician networks with approximately 8,300 primary care and specialty physicians. Our Medical Groups provide physician services to approximately 177,000 enrollees. Based on our enrollment, our combined Medical Groups represent one of the largest in Southern California and has contracts with nearly all the major (non-Kaiser) HMOs operating in the region. We believe the coordination of our hospitals and Medical Groups will create an efficient healthcare delivery system that positions us to drive growth and profitability.

We operate both our hospitals and Medical Groups by applying highly disciplined, data-driven management to the provision of quality care. Through this in-depth and data-driven approach to analysis and application of various operational and financial metrics, we have been able to achieve a highly-efficient cost structure which enables us to adjust our operations to provide services that generate higher margins and revenue growth. Our management's expertise in executing our operating model has enabled us to increase profitability across a diverse mix of payors and the flexibility to adapt to economic and regulatory changes. Our operating model also allows us to be well-positioned for the future, as we believe that the most cost-efficient providers will be the ones who benefit in this rapidly changing economic and regulatory environment.

We have grown through a series of strategic acquisitions:

•: in June 2007, we acquired the ProMed Entities, which, at the time of the acquisition, collectively had approximately 82,000 HMO enrollees;
•: in August 2007, we acquired Alta, which owned and operated four community-based hospitals in Los Angeles County with a combined 339 licensed beds served by approximately 315 on-staff physicians. In connection with the Alta acquisition, Sam Lee, Alta's president, joined our board of directors and the management team and was later appointed Chief Executive Officer in March 2008. The acquisition of Alta transformed our Company from a business exclusively providing Medical Group management services to a business capable of providing coordinated hospital and physician management services; and
•: in April 2009, we increased our approximately 33% ownership stake in Brotman, a 420 licensed bed hospital located in Culver City, California, to approximately 72%. That ownership stake was increased to approximately 78% in November 2010.
•: on December 15, 2010, we completed the merger with entities affiliated with Leonard Green & Partners, L.P. ("LGP") (the "Merger"). Completion of the merger makes the final step in the transformation into a privately held company.

We have improved our operating margin and profitability through the following actions:

•: managing staffing levels according to patient volumes and acuity levels of care required;
•: optimizing resource allocation by utilizing our case management program, which assists in improving clinical care and cost containment;

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•: negotiating favorable payor contracts and reductions in uncompensated care and payor claims denial;
•: expanding and improving profitable services offered by our hospitals;
•: enhancing claims management functions and negotiating more favorable provider contracts for our Medical Groups;
•: divesting non-core assets; and
•: restructuring our senior management team and adding experienced professionals in the areas of finance, operations, claims management, business development and compliance.

We believe that our acquisitions and the successful implementation of our operating model by our management team have both strengthened our infrastructure and positioned us for continued revenue growth and profitability.

Our principal executive offices are located at 10780 Santa Monica Blvd., Suite 400, Los Angeles, CA 90025. Our telephone number is (310) 943-4500. Our web site address is www.prospectmedicalholdings.com. A copy of this filing is posted on our web site. However, our web site and the information contained on our web site or connected to our web site are not incorporated by reference into this Annual Report on Form 10-K.

The organizational structure of our business is set forth on the next page.

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ORGANIZATIONAL STRUCTURE OF OUR BUSINESS

History and Development of Our Business, Including Our December 2010 Merger

Our business effectively commenced in 1996, when we began to implement our growth strategy through a series of acquisitions and affiliations. Between 1996 and 2005, PMG acquired fourteen physician organizations. These acquisitions provided us with a substantial concentration of HMO enrollees in our three Southern California service areas—North and Central Orange County, West Los Angeles and the Antelope Valley region of Los Angeles County. In 2007 we completed two major acquisitions, described below, which resulted in the addition of HMO enrollees in San Bernardino County and in the establishment of our Hospital Services segment.

On June 1, 2007, PMG completed the acquisition of the ProMed Entities, for consideration of $48,000,000, consisting of $41,040,000 of cash and 1,543,237 shares of PMH common stock, valued at $6,960,000, or $4.51 per share. As a result of the ProMed Acquisition, PHCA became a wholly-owned subsidiary of PMH and PVMG and UMG became wholly-owned subsidiaries of PMG. At the time of the acquisition, PVMG and UMG had approximately 80,000 HMO enrollees.

On August 8, 2007, we acquired Alta, and we repaid approximately $41,500,000 of Alta's existing debt. Total merger consideration, exclusive of the Alta debt repaid, consisting of approximately $103,000,000, was paid one-half ($51,300,000) in cash and one-half in stock (valued, for transaction purposes only, at $5.00 per share of our common stock). The equity portion of the merger

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consideration consisted of 1,887,136 shares of common stock and 1,672,880 shares of Series B Preferred Stock. The Series B Preferred Stock was non-convertible until such time as the stockholders voted to approve its convertibility. Such approval was received at our annual meeting of stockholders held on August 13, 2008. As a result, each share of Series B Preferred Stock automatically became convertible into five shares of common stock at a conversion price of $5.00 per share of common stock. Following such stockholder approval, the holders of all the outstanding shares of Series B Preferred Stock elected to convert their preferred shares into common stock.

Also on August 8, 2007, in connection with the closing of the Alta acquisition, Bank of America, N.A. (the "Lender") agented $155,000,000 of financing for us in the form of term loans totaling $145,000,000 and a $10,000,000 revolving line of credit facility, $3,000,000 of which was drawn at closing. The term loans were used to refinance approximately $41,500,000 of existing Alta debt, refinance approximately $48,000,000 of our existing debt that had previously been provided by the Lender in connection with our acquisition of ProMed, and pay the cash portion of the Alta purchase price.

On August 1, 2008, we completed the sale of all of the issued and outstanding stock of Sierra Medical Management, Inc., Sierra Primary Care Medical Group, Antelope Valley Medical Associates, Inc. and Pegasus Medical Group, Inc., (the "AV Entities") for total pre-tax cash consideration of $8,000,000 and entered into a non-competition agreement in the Antelope Valley region of Los Angeles County for the benefit of the buyer.

On August 31, 2005, we initially acquired an approximately 33% ownership interest in Brotman. Although Brotman faced financial and operational challenges, we viewed the investment as having a potential benefit to our Medical Group business. Following our initial investment, Brotman continued to incur substantial losses. In September 2007, following consultation with outside advisors and our new management team, which was experienced in hospital management and turnarounds, Brotman determined that it would be in its best interest to file for bankruptcy protection, which it did in October 2007. Concurrent with the filing, we entered into an amendment to our existing consulting services agreement with Brotman, which provided for an increased level of services and responsibility by our new management team.

On April 14, 2009, Brotman emerged from bankruptcy. Pursuant to the terms of the bankruptcy plan, we made additional investments in Brotman totaling $2,500,000, increasing our ownership to approximately 72%. Effective November 15, 2010, Brotman completed a $3,750,000 rights offering, wherein we participated in the amount of approximately $3,065,000, increasing our ownership to approximately 78%.

On August 16, 2010, we entered into an Agreement and Plan of Merger (the "Ivy Merger Agreement") with Ivy Holdings Inc. ("Ivy Holdings") and Ivy Merger Sub Corp. ("Merger Sub"), an indirect, wholly owned subsidiary of Ivy Holdings. On December 15, 2010, at a special meeting of our stockholders, the adoption of the Ivy Merger Agreement was approved by the affirmative vote of a majority of our common stock outstanding as of the record date for the special meeting. In accordance with the Ivy Merger Agreement and the Delaware General Corporation Law, Merger Sub subsequently merged with and into us on December 15, 2010 and we became an indirect, wholly-owned subsidiary of Ivy Holdings (the "Ivy Merger"). As a result of the Ivy Merger, our common stock ceased trading on the NASDAQ Global Market and will be delisted.

Ivy Holdings was formed by, and prior to the Ivy Merger was solely owned by, Green Equity Investors V, L.P., a Delaware limited partnership, and Green Equity Investors Side V, L.P., a Delaware limited partnership (the "LGP Funds"). The LGP Funds are affiliates of Leonard Green & Partners, L.P., a private equity fund ("Leonard Green").

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Immediately prior to the Ivy Merger, a group of our significant stockholders and management employees comprised of Samuel S. Lee (Chairman of the Board of Directors and Chief Executive Officer), Mike Heather (Chief Financial Officer), David R. Topper (President of our Alta Hospital System, LLC subsidiary) and Dr. Jeereddi A. Prasad (a director and President of our ProMed Health Services subsidiary), contributed to Ivy Holdings a total of 6,227,824 shares of our common stock in exchange for 529,365 shares of Ivy Holdings common stock. As a result, Messrs. Lee, Topper and Heather and Dr. Prasad beneficially owned approximately 20.2%, 14.9%, 1.6% and 1.2%, respectively, of the outstanding common stock of Ivy Holdings immediately following the effective time of the Ivy Merger (excluding any stock options that may be granted pursuant to a management equity incentive plan that Ivy Holdings may adopt following the completion of the Ivy Merger).

Upon completion of the Ivy Merger, each outstanding share of our common stock was converted into the right to receive $8.50 in cash per share, without interest and less any applicable withholding taxes, except for shares held by stockholders who perfect appraisal rights in accordance with Delaware law and except for shares owned by Ivy Holdings (including shares contributed to Ivy Holdings immediately prior to the completion of the Ivy Merger by Samuel S. Lee, Mike Heather, David R. Topper, Dr. Jeereddi A. Prasad and certain of our employees), Merger Sub, any other subsidiary of Ivy Holdings, or by us or any of our subsidiaries.

In connection with the Ivy Merger, on December 10, 2010, we formed a wholly owned subsidiary named Prospect Green Management, LLC, which will be used solely to pay management compensation to Leonard Green for its advisory services.

Our Strategy

Our objective is to operate as an entrepreneurial, efficient healthcare delivery system by delivering both hospital and physician services.

Enhance Operating Efficiencies

We seek to use our operating efficiencies to provide an advantage by enabling us to profitably service patients that other providers cannot serve profitably. We monitor our cost trends, operating performance and the regulatory environment in our existing markets to drive operating efficiencies, such as the optimization of staffing and utilization levels. These efficiencies allow us to strengthen our financial performance while improving the services we provide to our patients, physicians and health plan partners, as well as provide us greater flexibility to adapt to regulatory changes.

Cross-Fertilize Revenues among Our Hospitals and Medical Group Networks

We seek to generate organic growth primarily through cross-fertilization between our Medical Group and Hospital Services segments. Specifically, we have undertaken the following initiatives:

•

utilizing our existing community hospitals to facilitate growth to Brotman;

•

consolidating the back-office operations and management of our existing Medical Groups to reduce administrative costs and enhance partnering with HMOs and physicians; and

•

integrating Medical Group and Hospital Services operations to:

•: utilize our existing hospital-physician relationships to increase enrollment at our Medical Groups;
•: use our existing Medical Group enrollment to drive business to our hospital facilities;
•: leverage our existing Medical Groups to enhance payor diversification for our hospitals; and
•: expand HMO contracts by offering a combined hospital-physician provider solution.

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Additionally, we plan to expand our physician networks into areas where we have hospitals and seek hospital acquisition opportunities in areas where we have physician networks. The HMOs with which we contract have increasingly expressed their desires for their medical group partners to provide a combined hospital-physician solution.

Complete the Transformation of Brotman

Following our acquisition of a controlling stake in Brotman, we began implementing our operating model to drive efficiencies, as well as add new payors, improve reimbursement from existing payors and recruit new physicians to the medical staff. We will continue the implementation of our cost efficiency initiatives, to improve Brotman's operating results. We will also continue to recruit physicians for our surgical and cardiology groups as well as in primary care, which we anticipate will create opportunities for both inpatient and outpatient growth. In addition, we are evaluating the expansion of Brotman's emergency room services to better serve its strategic geographic location and facilitate admissions into the hospital.

Grow Through Strategic Acquisitions

We intend to continue growing through select strategic acquisitions of hospitals. We will seek hospital acquisition candidates that we believe are not currently achieving their potential in attractive service areas where our operating model can be applied. Additionally, we expect the number of potential acquisition candidates to increase given the fragmented ownership within the hospital market and the increasing number of underperforming hospitals struggling with inefficient operations and high cost structures.

Our Market

We operate our business in Southern California where we believe market dynamics will favorably impact our growth. There is a shortage of hospital beds in Los Angeles County, with fewer than 100 hospitals to serve approximately 10,000,000 people across 4,000 square miles. High hospital construction costs in Southern California have prevented meaningful increases in bed supply commensurate with demand.

Additionally, we expect demographic trends to further increase the supply-demand imbalance for hospital services. California anticipates unprecedented growth in its senior population as the baby boom generation ages and life expectancy continues to increase. Because of these demographic trends and the shortage of hospital beds in our local markets, we believe we are well-positioned to benefit from an increased demand for our services.

Closures of competitor hospitals have further added to the hospital bed shortage. Also, the Southern California hospital market is highly fragmented, with numerous different ownership entities. We believe that the fragmented ownership and decreasing number of hospitals in our market will help facilitate our acquisition strategy, as competitor hospitals become available for acquisition.

Description of Our Business—Hospital Services Segment

Overview

The hospital services sector is comprised of at least three sub-sectors that do not generally compete with each other because they largely serve three distinct patient populations:

•: Tertiary Care Hospitals: Tertiary care hospitals are generally owned by the larger philanthropic organizations and for-profit hospital companies which tend to be well funded and utilize state of the art facilities to treat commercially insured patients and higher acuity care patients.

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•: Community Hospitals: Community hospitals are both for-profit and not-for-profit and operate in generally older properties, use generally less state-of-the-art equipment, and are equipped to care for patients of lower acuity. Efficient hospitals in this group are able to provide care profitably because of their significantly lower cost structures.
•: Public Hospitals: Public hospitals are generally owned by government entities that are set up to treat uninsured, indigent patients with a full range of acuity needs.

Both government and managed care payors are under pressure to reduce the cost of health coverage. One means of doing this is to match patients to the facility best suited to delivering the quality of care required in the most cost-efficient setting. Because of the focused, cost efficient structures of community hospitals, both patients and payors can benefit economically from utilizing community hospitals where feasible. In the managed care context, patient co-pays in many instances increase as the cost structure of the hospital increases, thereby providing an incentive to the patient, as well as the payor, to utilize focused cost efficient community hospitals. Further, government payors generally pay tertiary care hospitals higher per diem amounts for care under Medicare and Medi-Cal than the per diem amounts paid to community hospitals. Companies operating community-based hospitals are positioned to benefit from this market dynamic as focused quality, cost efficient providers.

Our Hospitals

We own and operate five hospitals in Los Angeles County, with a total of approximately 759 licensed beds served by 746 on-staff physicians at September 30, 2010. We acquired four community hospitals in Hollywood, Los Angeles, Norwalk and Van Nuys in connection with our acquisition of Alta, all accredited by the Joint Commission (formerly the Joint Commission on Accreditation of Healthcare Organizations). Our fifth hospital is Brotman Medical Center, located in Culver City, which is currently accredited by the Center for Medicare and Medicaid Services ("CMS"), and in the process of seeking an accreditation by Det Norske Veritas ("DNV") Healthcare, Inc.

Our three community hospitals in Hollywood, Los Angeles and Norwalk offer a comprehensive range of medical and surgical services, including general acute care hospital services, pediatrics, obstetrics and gynecology, pediatric sub-acute care, general surgery, medical-surgical services, orthopedic surgery, and diagnostic, outpatient, skilled nursing and urgent care services. Our psychiatric hospital in Van Nuys provides acute inpatient and outpatient psychiatric services on a voluntary basis. Brotman offers a comprehensive range of inpatient and outpatient services, including general surgery, orthopedic, spine and neurosurgery, cardiology, diagnostic outpatient, rehabilitation, psychiatric and detox services. In addition, Brotman has an active emergency room that plays an integral part in providing emergency services to the West Los Angeles area.

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The table below gives a brief overview of our hospitals and the locations they serve:

Name/Location	Primary Service	Number of Beds

Hollywood Community Hospital Hollywood, CA 100% owned	Medical/Surgical	100 licensed beds/100 staffed beds
Los Angeles Community Hospital Los Angeles, CA 100% owned	Medical/Surgical	130 licensed beds/121 staffed beds
Norwalk Community Hospital Norwalk, CA 100% owned	Medical/Surgical	50 licensed beds/50 staffed beds
Van Nuys Community Hospital Van Nuys, CA 100% owned	Psychiatric	59 licensed beds/57 staffed beds
Brotman Medical Center Culver City, CA 78% owned (72% as of September 30, 2010)	Medical/Surgical	420 licensed beds/220 staffed beds

Selected Operating Statistics

The table below sets forth selected hospital operating statistics for the years ended September 30, 2010 and 2009.

	Year Ended September 30,

	2010		2009(8)
Licensed beds as of the end of the period(1)		759		759
Admissions(2)		23,405		18,573
Adjusted admissions(3)		26,447		20,098
Emergency room visits(4)		38,592		25,616
Surgeries(5)		4,871		4,146
Patient days(6)		149,864		124,004
Acute care average length of stay in days(7)		6.4		6.2

(1): Licensed beds are beds for which a hospital has obtained approval to operate from the applicable state licensing agency.
(2): Admissions are patients admitted to our hospitals for inpatient treatment. This statistic is used by our management, investors and other readers of our financial statements as a measure of inpatient volume.
(3): Adjusted admissions are total admissions adjusted for outpatient volume. Adjusted admissions are computed by multiplying admissions (inpatient volume) by the sum of gross inpatient charges and gross outpatient charges and then dividing the resulting amount by gross inpatient charges. This statistic is used by our management, investors and other readers of our financial statements as a measure of inpatient and outpatient volume.

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(4): The number of emergency room visits is an important operational measure that is used by our management, investors and other readers of our financial statements to gauge our patient volume. Much of our inpatient volume results from a patient's initial encounter with our hospitals through an emergency room visit.
(5): The number of surgeries includes both inpatient and outpatient surgeries. This statistic is used by our management, investors and other readers of our financial statements as one component of overall patient volume and business trends.
(6): Patient days are the total number of days that patients are admitted in our hospitals. This statistic is used by our management, investors and other readers of our financial statements as a measure of inpatient volume.
(7): Acute care average length of stay in days represents the average number of days admitted patients stay in our hospitals. This statistic is used by our management, investors and other readers of our financial statements as a measure of our utilization of hospital resources.
(8): The fiscal year ended September 30, 2009 included only 169 days of Brotman operating statistics, commencing April 14, 2009, when the Company acquired a majority stake in Brotman.

Our Hospital Operating Model

Our hospital operating model is physician-centric, recognizing that a physician-friendly environment is key to recruiting physicians. We also strive to provide convenience in scheduling and collaborative patient case management in order to assist in the treatment of the patient and in the physician's time management. We have, for example, developed an admissions process that enables the physician's office to make a hospital admission with a single telephone call to our admissions coordinator. We also provide admissions through our emergency room and urgent care centers to help better evaluate medical necessity.

Our hospital physicians are not employed by us. However, some physicians provide services in our hospitals under contracts which generally describe a term of service, provide and establish the duties and obligations of such physicians, require the maintenance of certain performance criteria and fix compensation for such services. Any licensed physician may apply to be admitted to the medical staff of any of our hospitals in accordance with established credentialing criteria.

We have also developed transfer processes with other area hospitals to receive patients that are more appropriately treated in one of our hospitals. Hospitals with which we have such transfer relationships include community hospitals that do not accept Medi-Cal patients and tertiary care hospitals with high cost structures that consider certain non-tertiary-level care patients to be unprofitable. Correspondingly, our hospitals will transfer patients to another hospital with which we have a transfer relationship when the patient's individual circumstances warrant.

Hospital Revenues and Reimbursement

We record gross patient service charges on a patient-by-patient basis in the period in which services are rendered. Patient accounts are billed after the patient is discharged. When a patient's account is billed, our accounting system calculates the reimbursement that we expect to receive based on the type of payor and the contractual terms of such payor. We record the difference between gross patient service charges and expected reimbursement as contractual adjustments.

At the end of each month, we estimate expected reimbursement for unbilled accounts. Estimated reimbursement amounts are calculated on a payor-specific basis and are recorded based on the best

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information available to us at the time regarding applicable laws, rules, regulations and contract terms. We continually review our contractual adjustment estimation process to consider and incorporate updates to laws, rules and regulations, as well as changes to managed care contract terms that result from negotiations and renewals.

Hospital revenues depend upon inpatient occupancy levels, the ancillary services and therapy programs ordered by physicians and provided to patients, the volume of outpatient procedures and the charges or negotiated payment rates for such services. Charges and reimbursement rates for inpatient services vary significantly depending on the type of service and geographic location of the hospital. Our hospitals receive revenues for patient services from a variety of sources, including the federal Medicare program, California's Medi-Cal program, managed care payors (including PPOs and HMOs), indemnity-based health insurance companies and self-pay patients. The basis for payments involving inpatients is prospectively set Diagnostic Related Group ("DRG") rates for Medicare, negotiated per diem rates for Medi-Cal and percentage of charge or negotiated rates for the other payors. The basis for payments for outpatients is prospectively set rate-per-service based on the Ambulatory Payment Classification ("APC") assigned for Medicare, a fixed rate by procedure for Medi-Cal and percentage of charges or negotiated rates for other payors. Our hospitals are also eligible for State of California Disproportionate Share payments based on a prospective payment system for hospitals that serve large populations of low-income patients.

Our hospitals receive payment for patient services from the federal government, primarily under the Medicare program, the California Medi-Cal program, managed care plans (including PPOs and HMOs), indemnity-based health insurance plans, as well as directly from patients ("self-pay"). All of our hospitals are certified as providers of Medicare and Medi-Cal services. Amounts received under the Medicare and Medi-Cal programs are generally significantly less than a hospital's customary charges for the services provided. Since a substantial portion of our revenue comes from patients under Medicare and Medi-Cal programs, our ability to operate our business successfully in the future will depend, in large measure, on our ability to adapt to changes in these programs.

The nation's current economic crisis may have a negative impact on reimbursement for our hospitals. A recent American Hospital Association report on the economic crisis indicates that the credit crunch is making it difficult and expensive for hospitals to finance facility and technology needs. The majority of hospitals are experiencing decreased admissions and elective procedures. In addition, rising unemployment is leading to increased uncompensated care. California budget shortfalls may result in decreases in hospital Medi-Cal reimbursement.

Medicare

Medicare is a federal program that provides medical insurance benefits to persons age 65 and over, some disabled persons, and persons with end-stage renal disease. Under the Medicare program, we are paid for inpatient and outpatient services performed by our hospitals. Payments for inpatient acute services are generally made pursuant to a prospective payment system, commonly known as "PPS." Under PPS, our hospitals are paid a predetermined amount for each hospital discharge based on the patient's diagnosis.

Specifically, each discharge is assigned to a diagnosis related group, commonly known as a "DRG," based upon the patient's condition and treatment during the relevant inpatient stay. Each DRG is assigned a cost weight based on its severity. The DRG weight is then applied to a national average rate to arrive at the payment. The national average rate is adjusted for labor cost by a predetermined geographic adjustment factor assigned to the geographic area in which the hospital is located. In addition to the DRG payment, hospitals may qualify for an "outlier" payment when the relevant patient's treatment costs are extraordinarily high and exceed a specified regulatory threshold.

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The national average rates are adjusted by an update factor on October 1 of each year, the beginning of the federal fiscal year. The index used to adjust the DRG rates, known as the "market basket index," gives consideration to the inflation experienced by hospitals in purchasing goods and services. Under the Medicare Prescription Drug, Improvement and Modernization Act of 2003 ("MMA"), DRG payment rates were increased by the full "market basket index," for the federal fiscal years 2008, 2009 and 2010 or 3.3%, 3.6% and 2.1%, respectively. The Deficit Reduction Act of 2005 imposes a 2% reduction to the market basket index beginning in the federal fiscal year 2007, and thereafter, if patient quality data is not submitted. We intend to and have complied with this data submission requirement. Future legislation may decrease the rate of increase for DRG payments, but we are not able to predict the amount of any reduction or the effect that any reduction will have on us.

In an effort to encourage hospitals to improve quality of care, the Medicare program has taken steps to reduce or withhold payments to hospitals for treatment given to patients whose conditions were caused by serious medical error. Under rules that became effective October 1, 2008, Medicare will no longer pay hospitals for the higher costs of care resulting from eight complications, including falls, objects left inside patients during surgery, pressure ulcers and three types of hospital-acquired infections. California hospitals are required to report certain adverse events to a state agency charged with publicizing the events, as well as the results of any ensuing investigation conducted by the agency. We believe that our hospital quality of care programs will address such issues, but we are unable to predict the future impact of these developments on our business.

Medi-Cal

Medi-Cal is a federal/state-funded program, administered by the California Department of Health Services (the "State") which provides medical benefits to individuals that qualify. Our hospitals participate in the Medi-Cal system and are paid a negotiated per diem rate. There can be no assurances that revisions in the Medi-Cal program will not have a material adverse effect on our results of operations.

Pursuant to the terms of the Medi-Cal contracts between the State and each of our hospitals, a significant portion of our hospital business is subject to termination of contracts and subcontracts at the election of the government. The contract between the State and Los Angeles Community Hospital and Norwalk Community Hospital was entered into on September 14, 2000 and most recently amended effective as of February 4, 2010. The agreement may not be terminated without cause prior to July 10, 2012 and after that date it may be terminated without cause, provided that 120 days notice of termination is given. The contract between the State and Hollywood Community Hospital and Van Nuys Community Hospital was entered into on September 14, 2000 and most recently amended and restated on November 30, 2009. The agreement may not be terminated without cause prior to July 10, 2012 and after that date it may be terminated without cause, provided that 120 days notice of termination is given. The contract between the State and Brotman was entered into on September 1, 2005 and most recently amended on June 1, 2009. The agreement may not be terminated without cause prior to July 1, 2010 and after that date it may be terminated without cause, provided that 120 days notice of termination is given. California budgetary shortfalls may result in our inability to renew Medi-Cal contracts at existing rates. Thereafter, the contracts are renewed by negotiation between the parties. We can provide no assurance whether these contracts will be renewed upon their expiration.

Disproportionate Share Payments

Hospitals that treat a high percentage of low-income patients may receive additional Disproportionate Share ("DSH") payment adjustment from Medicare and Medi-Cal. We receive both of these adjustments. The Medicare adjustment is based on the hospital's DSH patient percentage, which is the sum of the number of patient days for patients entitled to both Medicare Part A and Supplemental Security Income benefits, divided by the total number of Medicare Part A patient days

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and a second factor that is a ratio of Medi-Cal eligible days to total DRG days. For fiscal 2010, total Medicare DSH payments received were approximately $29,600,000 compared to approximately $27,700,000 for fiscal 2009. The Medi-Cal adjustment is based either on the Hospital's Medi-Cal utilization or its low income utilization percentage. Our hospitals qualify because their Medi-Cal utilization was greater than one standard deviation above 42% of the hospitals' total patient days. For fiscal 2010, total Medi-Cal DSH payments received by our hospitals were approximately $15,500,000 compared to approximately $12,000,000 for fiscal 2009.

Medicare Bad Debt Reimbursement

Under Medicare, the costs attributable to the deductible and coinsurance amounts which remain unpaid by the Medicare beneficiary can be added to the Medicare share of allowable costs as cost reports are filed. Hospitals generally receive interim pass-through payments during the cost report year which were determined by the fiscal intermediary from the prior cost report filing.

Bad debts must meet the following criteria to be allowable:

•: the debt must be related to covered services and derived from deductible and coinsurance amounts;
•: the provider must be able to establish that reasonable collection efforts were made;
•: the debt was actually uncollectible when claimed as worthless; and
•: sound business judgment established that there was no likelihood of recovery at any time in the future.

The amounts uncollectible from specific beneficiaries are to be charged off as bad debts in the accounting period in which the accounts are deemed to be worthless. In some cases, an amount previously written off as a bad debt and allocated to the program may be recovered in a subsequent accounting period. In these cases, the recoveries must be used to reduce the cost of beneficiary services for the period in which the collection is made. In determining reasonable costs for hospitals, the amount of bad debts otherwise treated allowable costs is reduced by 30%. Under this program, our hospitals incurred an aggregate of approximately $5,079,000 and $4,568,000, which are subject to the 30% reduction, for fiscal 2010 and 2009, respectively. Amounts incurred by a hospital as reimbursement for bad debts are subject to audit and recoupment by the fiscal intermediary. Bad debt reimbursement has been a focus of fiscal intermediary audit/recoupment efforts in the past.

Annual Cost Reports

Hospitals participating in the Medicare and some Medi-Cal programs are required to meet specified financial reporting requirements. Federal and state regulations require submission of annual cost reports identifying medical costs and expenses associated with the services provided by each hospital to Medicare beneficiaries and Medi-Cal recipients. Annual cost reports required under the Medicare and Medi-Cal programs are subject to routine governmental audits. These audits may result in adjustments to the amounts ultimately determined to be due to us under these reimbursement programs. Finalization of these audits often takes several years. We can appeal any final determination made in connection with an audit. DRG outlier payments and other cost report abuses have been and continue to be the subject of audit and adjustment by the Centers for Medicare and Medicaid Services ("CMS").

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improper payments in the Medicare FFS program. In addition, in section 302 to the Tax Relief and Health Care Act of 2006 ("TRHCA"), Congress required DHHS to make the RAC program permanent and nationwide by no later than January 1, 2010. The RAC program does not include payments for Medicare Advantage or the Medicare prescription drug benefit.

The permanent RAC program began in California in July 2009, with auditors reviewing payments made to California healthcare providers to assure correct payment. Payments deemed incorrect will be adjusted at the time of audit. These adjustments can be appealed following the guidelines of the program. As of September 30, 2010, several hospitals have been scheduled for audits in fiscal year 2011.

Our hospitals are subject to audit along with other California hospitals during this upcoming year. Our hospitals have taken steps to assure on-going coding and billing accuracy, which we anticipate will help ensure successful RAC audits.

Inpatient Psychiatric

As of September 30, 2010, we operated one 70-bed, inpatient psychiatric unit paid under the IPF PPS method at Brotman and one 59 licensed bed, inpatient psychiatric unit paid on the acute PPS method at Van Nuys. Effective for reporting periods after January 1, 2005, CMS replaced the cost-based system with a PPS for inpatient hospital services furnished in freestanding psychiatric hospitals and PPS exempt psychiatric units of general, acute care hospitals and critical access hospitals ("IPF PPS"). IPF PPS is a per diem prospective payment system with adjustments to account for certain patient and facility characteristics. IPF PPS contains an "outlier" policy for extraordinarily costly cases and an adjustment to a facility's base payment if it maintains a full-service emergency department. Under this program, Brotman received an aggregate of approximately $7,606,000 and $6,520,000 for fiscal 2010 and 2009, respectively. Under the acute MS-DRG, Van Nuys received an aggregate of approximately $9,559,000 and $8,168,000 for fiscal 2010 and 2009, respectively.

Competition

All five of our hospitals are located in Los Angeles County and each hospital serves its own local community.

Within the Los Angeles Community Hospital ("LACH") service area, three urban hospitals are considered competitors of LACH. They are Mission Hospital of Huntington Park, a 127 licensed bed acute care hospital, Monterey Park Hospital, a 101 licensed bed acute care facility, and East Lost Angeles Doctors Hospital, which is licensed for 127 acute care beds and 30 skilled nursing beds.

The Norwalk Community Hospital service area has two main competitors, Coast Plaza Doctors Hospital, located in Norwalk, and Presbyterian Intercommunity Hospital, which is located in Whittier. Coast Plaza Doctors Hospital is licensed for 105 beds, of which 7 are skilled nursing beds. Presbyterian Intercommunity Hospital is licensed for 402 beds, of which 24 are licensed as skilled nursing beds.

In the surrounding service area of Hollywood Community Hospital, there are two main competitors, Olympia Medical Center, an acute care hospital licensed for 204 beds and Hollywood Presbyterian Medical Center, a 434 acute care licensed bed hospital.

Brotman, located in Culver City, serves the Culver City market, as well as parts of West Los Angeles. Its closest competitor, Century City Hospital, closed in the fall of 2008 which provided immediate benefit to Brotman as a number of registered nurses were hired from the hospital. Brotman's nearest competitors are UCLA Medical Center, Cedar Sinai Medical Center and Olympia Medical Center, which are located approximately seven miles, five miles and four miles, respectively, from Brotman.

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Van Nuys Community Hospital is the only psychiatric hospital in the area. There are two competing acute care facilities that offer acute psychiatric services. Mission Community Hospital in Panorama City is licensed for 60 acute psychiatric beds and Pacifica Hospital of the Valley, located in Sun Valley, is licensed for 38 acute psychiatric beds.

We believe that each of our hospitals is able to compete within its respective service areas based upon three primary factors:

•: Competitive Cost Structure. We have historically been successful in increasing operating revenue and developing improved service delivery capabilities. We have been able to achieve a highly-efficient cost structure which allows us to maintain profitability across all payors. Our cost structure enables us to service patients that many other providers cannot serve profitably. We seek to achieve efficiencies through higher margin revenue growth and continual process improvements.
•: Quality of Service. Our operating model has allowed our hospitals to develop a reputation for delivering quality care and easy access to the communities in which they serve. We have strengthened the patient care we provide by retaining and recruiting experienced physicians. Our medical staffs typically practice at several hospitals concurrently, including some major tertiary care facilities located within the same metropolitan areas as our hospitals.
•: Leverageable Platform. Our hospital operations are, over time, expected to provide synergies between our Medical Group business and our Hospital Services segment, allowing us to offer quality, coordinated, healthcare and physician services.

Description of Our Business—Medical Group Segment

Overview

Our affiliated group of Medical Groups is one of the largest providers of physician services for HMO enrollees in Southern California, managing the provision of healthcare services for approximately 131,700 commercial, 23,100 Medi-Cal and 22,700 Medicare lives. Our Medical Group network of approximately 8,300 independent physicians is concentrated in Orange, Los Angeles and San Bernardino Counties.

Our Medical Groups are networks of independent physicians who collectively contract with HMOs under a capitated payment arrangement. Under the capitated model, an HMO pays our Medical Groups a per-member-per-month ("PMPM") rate, or a "capitation" payment, and then assigns our Medical Groups the responsibility for providing the physician services required by those patients. In certain areas, HMOs find it more efficient to outsource the responsibility for providing physician services through Medical Groups. The relationship between HMOs and Medical Groups is a well-established model in the markets we serve and is designed to motivate physicians to practice preventative medicine and reduce unnecessary procedures. Medical Groups allow independent physicians to participate in contracts with HMOs and obtain patients, while allowing HMOs to more efficiently contract for physician services and outsource certain administrative functions associated with those activities.

We provide the following management and administrative support services to our affiliated physician organizations:

•: negotiation of contracts with physicians and HMOs;
•: physician recruiting and credentialing;
•: human resources;
•: claims administration;
•: provider relations;

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•: member services;
•: medical management, including utilization management and quality assurance; and
•: data collection and management information systems.

We employ a variety of methodologies to mitigate the financial risk associated with the capitation model, including passing a portion of our payment through to the physician in a "sub-capitated" payment, pre-negotiating contracts with other providers, requiring prior authorization for services, and other techniques to appropriately manage utilization. All of our primary care physicians and a portion of our specialist physicians receive sub-capitation payments, with capitation representing approximately 50% of our medical costs. The remaining 50% of our medical costs consist of pre-authorized procedures referred to our contracted providers at discounted fee-for-service rates and emergency room services provided by non-contracted providers.

Our Affiliated Physician Organizations

Our two management subsidiaries, Prospect Medical Systems, Inc. ("PMS") and ProMed Healthcare Administrators ("PHCA"), currently provide management services to ten affiliated physician organizations, which include PMG, Nuestra Familia Medical Group, Inc. ("Nuestra"), eight other affiliated physician organizations that PMG owns or controls, and one affiliated physician organization (AMVI/Prospect Health Network) that is an unconsolidated joint venture in which PMG owns a 50% interest. PMG, which was our first affiliated physician organization, has acquired the ownership interest in all of our other affiliated physician organizations, except Nuestra.

Physician organizations, by California law, may only be owned by physicians. We have designated Arthur Lipper, M.D., the President of PMG, to be the owner of all of the capital stock of PMG and Nuestra. As such he indirectly controls PMG's ownership interest in each of our other affiliated physician organizations. Dr. Lipper is also the President of all of the affiliated physician organizations that PMG owns (except Pomona Valley Medical Group, and Upland Medical Group, where he is a Vice-President), he is a Vice President of Nuestra, and he is one of the two general partners of AMVI/Prospect Health Network.

We control the ownership of each of our affiliated physician organizations through assignable option agreements that we have entered into through our management subsidiary, PMS, with Dr. Lipper and PMG, and with Dr. Lipper and Nuestra. See "Assignable Option Agreements," below. For financial reporting purposes, we are deemed to control PMG under U.S. Generally Accepted Accounting Principles (see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies—Consolidation of Financial Statements") and are therefore required to consolidate the financial statements of PMG with those of our management subsidiaries.

Our affiliated physician organizations consist of affiliated Medical Groups which contract with physicians (primary care and specialist) and other ancillary providers, to provide all of their physician services.

Each of our affiliated physician organizations enters into contracts with HMOs to provide physician services to enrollees of the HMOs. Most of our HMO agreements have an initial term of two years renewing automatically for successive one-year terms. Increased capitation rates under the HMO agreements are usually negotiated at the end of the term of such HMO agreements, typically taking the form of new agreements or amendments for additional two-year terms.

The HMO agreements generally provide for a termination by the HMOs for cause at any time, although we have never experienced a for-cause termination. The HMO agreements generally allow either the HMOs or the affiliated physician organizations to terminate the HMO agreements without cause within a four to six month period immediately preceding the expiration of the term of the agreement.

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As of September 30, 2010, our affiliated physician organizations had contracts with approximately 8,300 independent physicians.

The physicians of the affiliated physician organizations are exclusively in control of and responsible for all aspects of the practice of medicine, subject to specialist referral guidelines developed by multi-specialty medical committees composed of our contracted physicians and chaired by one of our medical directors.

Information about our ten affiliated physician organizations is listed in the tables below. Except where noted, each organization is a medical corporation owned either directly or through PMG by a single shareholder, currently, Arthur Lipper, M.D.

	As of September 30, 2010

Affiliated Physician Organizations	Primary Care Physicians			Specialists			Enrollees		Area of Operations
Prospect Medical Group, Inc.		389			4,016			26,174	Orange, Los Angeles & Riverside Counties
Prospect Health Source Medical Group, Inc.		81			2,230			14,975	West Los Angeles
Nuestra Familia Medical Group, Inc.(1)		78			1,225			3,452	East Los Angeles
AMVI/Prospect Health Network(2)		310			2,191			13,066	Orange County
Prospect Professional Care Medical Group		263			2,861			15,031	East Los Angeles & North Orange County
Prospect NWOC Medical Group, Inc.		114			1,756			4,693	North Orange County
StarCare Medical Group, Inc.		189			2,418			16,140	North Orange County
Genesis HealthCare of Southern California		232			2,127			10,851	Los Angeles and North Orange County
Pomona Valley Medical Group		133			222			51,687	San Bernardino County
Upland Medical Group		91			166			11,113	San Bernardino County
Managed Medical Groups(3)		50			168			10,292	Los Angeles County

		1,930			19,380			177,474
Less: Physicians counted at multiple Medical Groups		(906	)		(12,139	)		—

Total		1,024			7,241			177,474

(1): Approximately 62.16% owned by Arthur Lipper, M.D. through a separate assignable option agreement.
(2): 50% owned joint venture partnership with AMVI/IMC Health Network, originally formed to service Medi-Cal, Healthy Families and OneCare members under the CalOptima contract. Included in the total enrollment were approximately 3,000 enrollees that we manage for our own economic benefit, and approximately 10,100 enrollees that we manage for the economic benefit of our partner, for which we earn management fee income.
(3): Represent management agreements entered into on May 1, 2010 with an unaffiliated medical group to manage approximately 10,500 HMO enrollees for monthly management fees ranging from 7.5% to 12.5% of revenues (as defined).

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Revenue Concentration Statistics of our Medical Groups
for the Fiscal Years Ended September 30, 2010 and 2009

As of September 30, 2010, our Medical Groups had contracts with approximately 15 HMOs, from which our revenue was primarily derived. The contracts between our affiliated physician organizations and the HMOs provide for the provision of medical services by the affiliated physician organization to the HMO enrollees in consideration for the prepayment of the fixed monthly capitation amount per enrollee.

For the fiscal years ended September 2010 and 2009, our Medical Groups recognized capitation revenue of approximately $186,674,000 and $193,543,000, respectively. During each of those periods, the five largest HMOs of our affiliated physician organizations, Plan A, Plan B, Plan C, Plan D and Plan E, accounted for approximately 72% of total capitation revenue.

As of November 1, 2010, the latest date for which such data was compiled, our affiliated physician organizations were listed by Cattaneo & Stroud as having a combined market share (based on number of HMO enrollees served) of approximately 6% in Orange County (83,620) enrollees compared to 1,370,950 total enrollees in Orange County), approximately 0.7% in Los Angeles County (31,053 enrollees compared to 4,707,500 total enrollees in Los Angeles County), and approximately 6.2% in San Bernardino County (62,800 enrollees compared to 1,009,500 total enrollees in San Bernardino County).

Assignable Option Agreements

The assignable option agreements are an essential element of our "single shareholder model." The assignable option agreements between our management subsidiary, PMS, and PMG and Nuestra provide PMS the right, at will and on an unlimited basis, to designate a successor physician to purchase our capital stock of each of PMG and Nuestra for nominal consideration ($1,000) and thereby determine the ownership of PMG and our majority interest in Nuestra. The assignable option agreements terminate or expire coterminous with the management services agreements between PMS and PMG or PMS and Nuestra, as applicable. The management services agreement with PMG has a thirty-year term with successive automatic ten-year renewal terms. The management services agreement with Nuestra has a twenty-year term with successive ten-year renewal terms unless either party elects to terminate prior to a renewal. There is no limitation on who we may name as a successor shareholder except that any successor shareholder must be duly licensed as a physician in the State of California or otherwise be permitted by law to be a shareholder of a professional corporation.

As a result of the assignable option agreements and our control of PMS, we have control over the ownership of PMG and Nuestra. Because PMG is the owner of all or a significant amount of the capital stock of all of the other affiliated physician organizations, control over the ownership of PMG and Nuestra ensures that we can control the ownership of each of our affiliated physician organizations.

Arthur Lipper, M.D. is currently the sole shareholder, sole director and President of PMG. He is also the President of each of our other affiliated physician organizations, except for AMVI/Prospect Health Network, Nuestra Familia Medical Group, Pomona Valley Medical Group and Upland Medical Group. As such, Dr. Lipper has a fiduciary duty to protect the interests of each entity and its shareholders.

Management Services Agreements

Upon completion of every Medical Group acquisition, one of our management subsidiaries enters into a long-term management services agreement with the newly-acquired physician organization. Our management subsidiaries provide management services to our affiliated Medical Groups under management services agreements that transfer control of all non-medical components of the business of

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the affiliated physician organizations to our management subsidiaries to the full extent permissible under federal and state law.

Under the management services agreements, we, through our management subsidiaries, provide management functions only. Under these agreements, each affiliated physician organization delegates to us the non-physician support activities that are required by the affiliated physician organizations in the practice of medicine. The management services agreements require us to provide suitable facilities, fixtures and equipment and non-physician support personnel to each affiliated physician organization. The primary services that we provide under management services agreements include the following:

•: utilization management and quality assurance;
•: medical management;
•: physician contracting;
•: physician credentialing;
•: HMO contracting;
•: claims administration;
•: provider relations;
•: management information systems;
•: patient eligibility and services;
•: member services; and
•: physician recruiting.

In return for these management and administrative support services we receive a management fee. Our current standard management fee is 15% of each organization's gross revenues, which we receive from each of our affiliated physician organizations, with the exception of AMVI/Prospect Health Network (an amount equal to the sum of $5.25 per CalOptima Medi-Cal enrollee per month, $3.15 per CalOptima Healthy Families enrollee, and 6.5% of the premium per CalOptima OneCare enrollee per month).

In addition to these management fees, we receive an incentive bonus based on the net profit or loss of each wholly-owned affiliated physician organization. Generally, we are allocated a 50% residual interest in all profits after the first 8% of the profits or a 50% residual interest in the net losses, after deduction for costs to the management subsidiary and physician compensation.

From time to time, supplemental management fees have been awarded by the physician organizations to the management companies to compensate for, among other things, increased costs associated with specific initiatives for the benefit of the physician organizations.

Because of the ownership of a controlling financial interest by PMG or Dr. Lipper in all of our affiliated physician organizations, other than AMVI/Prospect Health Network, we have the ability to adjust our management fees (other than for AMVI/Prospect Health Network) should we determine that an adjustment is appropriate and warranted, based on increased costs associated with managing the affiliated physicians organizations. In the case of AMVI/Prospect Health Network, because PMG's ownership interest is a 50% interest, in the event we determine that an adjustment of the management fee for AMVI/Prospect Health Network is appropriate, an adjustment would require negotiation with the joint venture partner.

Notwithstanding our ability to control the management fee adjustment process, we are limited by laws affecting management fees of healthcare management service companies. Such laws require that our management fees reflect fair market value for the services being rendered, giving consideration

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however to the costs of providing the services. Such laws also limit our ability to increase our management fees more frequently than once a year.

The management services agreements with our affiliated physician organizations that are 100% owned by PMG each have a thirty-year term and renew automatically for successive ten-year terms unless either party elects to terminate them 90 days prior to the end of their term. The management services agreements with those affiliated physician organizations in which we have less than a 100% interest have different terms. Our contract with Nuestra is for only twenty years; however, because Dr. Lipper as the nominee shareholder under an assignable option agreement is an approximately 62% shareholder, any renewal or termination must be approved by Dr. Lipper. Similarly, our joint venture with AMVI is year-to-year, but because PMG is a 50% owner of that joint venture, it cannot be terminated without approval of the board of directors, of which PMG controls the appointment of 50% of the members. The management services agreements are terminable by the unilateral action of the particular physician organization prior to their normal expiration if we materially breach our obligations under the agreements or become subject to bankruptcy-related events, and we are unable to cure a material breach within sixty days of the occurrence. All management fees of consolidated entities are eliminated in our consolidated financial statements.

Risk Management

We control the medical expense or medical risk of our affiliated physician organizations. We use sub-capitation as our primary technique to control this risk. Sub-capitation is where an organization that is paid under capitated contracts with an HMO in turn contracts with other providers on a capitated basis for a portion of the original capitated premium. Historically, approximately half of the medical costs of our affiliated physician organizations are sub-capitated.

The medical costs of our affiliated physician organizations which are not sub-capitated are controlled in various ways. For those specialties for which we cannot, or do not choose to obtain a sub-capitated contract, we negotiate discounted fee-for-service contracts. Further, by contract, our affiliated physician organizations generally do not assume responsibility for the costs of providing medical services ("medical costs") that occur outside of their service area, which has been defined as a 30-mile radius around the office of the HMO enrollee's primary care physician. All non-emergent care requires prior authorization, in order to limit unnecessary procedures and to direct the HMO enrollee requiring care to the physicians contracted with our affiliated physician organizations, and to the most cost effective facility. Our affiliated physician organizations utilize board certified pulmonologists and internists, trained in intensive care to maintain appropriate utilization, reducing unnecessary consultations and facilitating the patient's treatment and discharge. We also review medical costs by Medical Group and by specialty and compare those costs to the trend of patient utilization of medical services by specialty. In those instances where the patient utilization is trending very low, we determine whether it would be less expensive for our affiliated physician organizations to pay their providers on a discounted fee-for-service basis rather than on a capitated basis.

In addition, our affiliated physician organizations' agreements with HMOs and hospitals contain risk-sharing arrangements under which the affiliated physician organizations can earn additional compensation by coordinating the provision of quality, cost-effective healthcare to enrollees, but, in certain very limited cases, they may also be required to assume a portion of any loss sustained from these arrangements. Risk-sharing arrangements are based upon the cost of hospital services or other services for which our physician organizations are not capitated. The terms of the particular risk-sharing arrangement allocate responsibility to the respective parties when the cost of services exceeds a budget, which results in a "deficit," and permit the parties to share in any amounts remaining in the budget, known as a "surplus," which occurs when actual cost is less than the budgeted amount. The amount of non-capitated and hospital costs in any period could be affected by factors beyond our control, such as changes in treatment protocols, new technologies and inflation. To the extent that such non-capitated

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and hospital costs are higher than anticipated, revenue paid to our affiliated physician organizations may not be sufficient to cover the risk-sharing deficits they are responsible for paying, which could reduce our revenues and profitability. It is our experience that "deficit" amounts for hospital costs are applied to offset any future "surplus" amount we would otherwise be entitled to receive. We have historically not been required to reimburse the HMOs for most hospital cost deficit amounts. Most of our contracts with HMOs specifically provide that we will not have to reimburse the HMO for hospital cost deficit amounts.

HMOs may insist on withholding negotiated amounts from the affiliated physician organizations' professional capitation payments, which the HMOs are permitted to retain, in order to cover the affiliated physician organizations' share of any risk-sharing deficits. Whenever possible, we seek to contractually reduce or eliminate our affiliated physician organizations' liability for risk-sharing deficits.

Provider Agreements

The physicians of our affiliated physician organizations are exclusively in control of, and responsible for all aspects of, the practice of medicine, and are subject to specialist referral guidelines developed by multi-specialty medical committees composed of our contracted physicians and chaired by one of our medical directors. Each affiliated physician organization enters into the following types of contracts for the provision of physician and ancillary health services:

Primary Care Physician Agreement. A primary care physician agreement provides for primary care physicians contracting with independent physician associations to be responsible for both the provision of primary care services to enrollees and for the referral of enrollees to specialists affiliated with the independent physician association, when appropriate. Primary care physicians receive monthly sub-capitation for the provision of primary care services to enrollees assigned to them.

Specialist Agreement. A specialist agreement provides for a specialty care physician contracting with the independent physician association to receive either sub-capitated payments or discounted fee-for-service payments for the provision of specialty services to those enrollees referred to them by the independent physician association's primary care physician.

Ancillary Provider Agreement. An ancillary provider agreement provides for ancillary service providers—generally non-physician providers such as physical therapists, laboratories, etc.—to contract with an independent physician association to receive either monthly sub-capitated, discounted fee-for service or case rate payments for the provision of service to enrollees on an as-needed basis.

Competition

The medical group industry is highly competitive and is subject to continuing changes with respect to the manner in which services are provided and how providers are selected and paid. We are subject to significant competition with respect to physicians affiliating with our physician organizations. Generally, both we and our affiliated physician organizations compete with any entity that enters into contracts with HMOs for the provision of prepaid healthcare services, including:

•: other companies that provide management services to healthcare providers but do not own the affiliated physician organization;
•: hospitals that affiliate with one or more physician organizations;
•: HMOs that contract directly with physicians; and
•: other physician organizations.

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We believe that we offer competitive services in the Southern California managed care market based upon our historical stability, our competitive compensation relative to other organizations, and our quality of service.

There is competition for patients and primary care physicians in every market in which our affiliated physician organizations operate. The number of significant competitors varies in each region. The following summary of information about our competitors and their estimated enrollment in various markets is based on an industry report updated through November 10, 2010. Enrollment numbers that follow differ from updated enrollment numbers of our affiliated entities provided elsewhere in this filing, due to differing dates of presentation.

Based on these reports, total HMO enrollment in Los Angeles County was approximately 4,707,500, of which we had approximately 32,000 enrollees, or approximately 0.7%. Our five largest competitors in Los Angeles County are Kaiser Foundation, Healthcare Partners Medical Group, Heritage Provider Network, La Vida Medical Group, and Facey Medical Foundation. HMO enrollment in Orange County was estimated at approximately 1,370,950, of which Prospect had approximately 83,600 enrollees, or approximately 6%. Our five largest competitors in Orange County are Kaiser Foundation, St. Joseph Heritage Healthcare, Monarch Healthcare, Greater Newport Physicians Medical Group, and CHOC Physicians Network. HMO enrollment in San Bernardino County was estimated at approximately 1,009,500 of which Prospect had approximately 62,800 enrollees, or approximately 6%. Our five largest competitors in San Bernardino County are Kaiser Foundation, Beaver Medical Group, Choice Medical Group, PrimeCare of San Bernardino and LaSalle Medical Associates. As such, we believe that the combined enrollment of our affiliated physician organizations is the eighth largest in California.

Some of our competitors are larger than us, have greater resources and may have longer-established relationships with buyers of their services, giving them greater value in contracting with physicians and HMOs. Such competition may make it difficult to enter into affiliations with physician organizations on acceptable terms and to sustain profitable operations.

Health Care Regulation

General Regulatory Overview

Both our hospitals and affiliated physician organizations are subject to numerous federal and state statutes and regulations that are applicable to the management and provision of health care services and to business generally, as summarized below. The healthcare industry is required to comply with extensive government regulation at the federal, state, and local levels. Under these regulations, hospitals must meet requirements to be certified as hospitals and qualified to participate in government programs, including the Medicare and Medi-Cal programs. These requirements relate to the adequacy of medical care, equipment, personnel, operating policies and procedures, maintenance of adequate records, hospital use, rate-setting, compliance with building codes, and environmental protection laws. There are also extensive regulations governing a hospital's participation in these government programs. If we fail to comply with applicable laws and regulations, we can be subject to criminal penalties and civil sanctions, our hospitals can lose their licenses and we could lose our ability to participate in these government programs. In addition, government regulations may change. If that happens, we may have to make changes in our facilities, equipment, personnel, and services so that our hospitals remain certified as hospitals and qualified to participate in these programs. We believe that our hospitals and affiliated physician organizations are in substantial compliance with current federal, state, and local regulations and standards.

In addition to the regulations referenced above, our affiliated physician organization operations may also be affected by changes in ethical guidelines and operating standards of professional and trade associations such as the American Medical Association. Changes in existing ethical guidelines or

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professional organization standards, adverse judicial or administrative interpretations of such guidelines and standards, or enactment of new legislation could require us to make costly changes to our business that would reduce our profitability. Changes in health care legislation or government regulation may restrict our existing operations, limit the expansion of our business or impose additional compliance requirements and costs, any of which could have a material adverse effect on our business, financial condition, results of operations and the trading price of our debt.

Corporate Practice of Medicine and Professional Licensing

In California, lay entities are generally prohibited from exercising control over the medical or the business aspects of a professional practice, and may be prohibited from sharing the profits of a professional practice. The California Medical Board has taken the position that certain physician practice management agreements that confer too much control over a physician practice violate the prohibition against corporate practice of medicine. The California Medical Board has also taken the position in at least one case that an assignable option agreement, whereby a lay management company can assign to a nominee physician the right to purchase all of the shares of the managed medical group for a nominal price, violates the corporate practice of medicine prohibition. While there is no express provision in the California statutes prohibiting a lay entity from holding an option to purchase stock in a medical corporation, lay entities are prohibited from owning such stock and one court, in an unpublished opinion, has determined that such stock may not be beneficially owned by a lay entity.

State law also imposes licensing requirements on individual physicians and on some facilities operated by physicians. Federal and state laws regulate HMOs and other managed care organizations with which physician organizations may have contracts. Some states also require licensing of third-party administrators and collection agencies. This may affect our operations in states in which we may seek to do business in the future. Our ability to operate profitably will depend, in part, upon our ability and the ability of our affiliated physician organizations to obtain and maintain all necessary licenses and other approvals and operate in compliance with applicable health care laws and regulations, including any new laws and regulations or new interpretations of existing laws and regulations.

Anti-Kickback

Medicare and Medi-Cal anti-kickback and anti-fraud and abuse amendments codified under Section 1128B(b) of the Social Security Act (the "Anti-kickback Statute") prohibit certain business practices and relationships that might affect the provision and cost of health care services payable under the Medicare and Medi-Cal programs and other government programs, including the payment or receipt of remuneration for the referral of patients whose care will be paid for by such programs. Sanctions for violating the Anti-kickback Statute include criminal and civil penalties, as well as fines and possible exclusion from government programs, such as Medicare and Medi-Cal. Many states have statutes similar to the federal Anti-kickback Statute, except that the state statutes usually apply to referrals for services reimbursed by all third-party payors, not just federal programs. In addition, it is a violation of the federal Civil Monetary Penalties Law to offer or transfer anything of value to Medicare or Medi-Cal beneficiaries that is likely to influence their decision to obtain covered goods or services from one provider of service over another. The federal government has also issued regulations that describe some of the conduct and business relationships that are permissible under the Anti-kickback Statute. These regulations are often referred to as the "Safe Harbor" regulations. The fact that certain conduct or a given business arrangement does not meet a Safe Harbor does not necessarily render the conduct or business arrangement illegal under the Anti-kickback Statute. Rather, such conduct and business arrangements risk increased scrutiny by government enforcement authorities and should be reviewed on a case-by-case basis.

There are several aspects of our hospitals' relationships with third parties and our relationships with physicians to which the Anti-kickback Statute may be relevant. The government may construe

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some of the marketing and managed care contracting activities that we historically performed as arranging for the referral of patients to the physicians with whom we had a management agreement. The government may also construe some of the financial arrangements that our hospitals have historically had with physicians, marketers and other referral sources as payment for the referral or arranging for the referral of patients to our hospitals. As a result of our internal compliance review process, we have, from time to time, identified contract relationships we believed posed a risk to the Company, and in such cases, we have changed the payments, modified the terms or terminated these contracts. We believe our business activities are not in violation of the Anti-kickback Statute. Further, we believe that the business operations of our affiliated physician organizations do not involve the offer, payment, solicitation or receipt of remuneration to induce referrals of patients, because compensation arrangements between the physician organizations and the primary care physicians who make referrals are designed to discourage referrals to the extent they are medically unnecessary. These physicians are paid either on a sub-capitation or fee-for-service basis and do not receive any financial benefit from making referrals.

Noncompliance with, or violation of, the Anti-kickback Statute can result in exclusion from the Medicare and Medi-Cal programs and civil and criminal penalties. California also has a similar anti-kickback prohibition with similar penalties. Although we believe our activities to be in compliance, if we were found to be in violation of the anti-kickback legislation, we could suffer civil penalties, criminal fines, imprisonment or possible exclusion from participation in the reimbursement programs, which could reduce our revenues, increase our costs and decrease our profitability.

Self-Referral

Section 1877 of the Social Security Act (commonly referred to as the "Stark law") generally restricts referrals by physicians of Medicare patients to entities with which the physician or an immediate family member has a financial relationship, unless one of several exceptions applies. The referral prohibition applies to a number of statutorily defined "designated health services," such as clinical laboratory, physical therapy, radiology, and inpatient and outpatient hospital services. The exceptions to the referral prohibition cover a broad range of common financial relationships. These statutory, and the subsequent regulatory, exceptions are available to protect certain permitted employment relationships, leases, group practice arrangements, medical directorships, and other common relationships between physicians and providers of designated health services, such as hospitals. A violation of the Stark law may result in a denial of payment, required refunds to patients and the Medicare program, civil monetary penalties of up to $15,000 for each violation, civil monetary penalties of up to $100,000 for "sham" arrangements, civil monetary penalties of up to $10,000 for each day that an entity fails to report required information, and exclusion from participation in the Medicare and Medi-Cal programs and other federal programs. In addition, California has its own self-referral laws which are similar in many ways to the Stark law, but which differ from the federal law in that they apply not just to Medicare patients, but to all categories of patients and they impose disclosure requirements. No payment from any source is permitted for services performed pursuant to referrals which are prohibited by California's self-referral law. Our hospitals' and Medical Groups' participation in and development of financial relationships with physicians could be adversely affected by the Stark law or similar state enactments.

The self-referral prohibition applies to our services, and we believe our relationships comply with the law. We believe our business arrangements do not involve the referral of patients to entities with whom referring physicians have an ownership interest or compensation arrangement within the meaning of federal and state self-referral laws, because referrals are made directly to other providers rather than to entities in which referring physicians have an ownership interest or compensation arrangement. We further believe our financial arrangements with physicians fall within exceptions to state and federal self-referral laws, including exceptions for ownership or compensation arrangements with managed care

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organizations and for physician incentive plans that limit referrals. In addition, we believe that the methods we use to acquire existing physician organizations and to recruit new physicians do not violate such laws and regulations. Nevertheless, it is possible that the government or a court could construe some of the financial arrangements that our hospitals or Medical Groups have historically had with physicians or may have in the future as non-compliant with state or federal self-referral statutes. If we were found to have violated the self-referral laws, we could be subject to denial of reimbursement, forfeiture of amounts collected in violation of the law, civil monetary penalties, and exclusion from the Medicare and Medi-Cal programs, which could reduce our revenues, increase our costs and decrease our profitability.

False Claims Act

The federal False Claims Act ("FCA") prohibits providers from knowingly submitting false claims for payment to the federal government. This law has been used not only by the federal government, but also by individuals who bring an action on behalf of the government under the law's "qui tam" or "whistleblower" provisions. When a private party brings a qui tam action under the federal FCA, the defendant may not become aware of the lawsuit until the government makes a determination whether it will intervene and take a lead in the litigation.

Civil liability under the federal FCA can be up to three times the actual damages sustained by the government plus civil penalties for each separate false claim. There are many potential bases for liability under the federal FCA, including claims submitted pursuant to a referral found to violate the anti-kickback or self-referral statutes. Although liability under the federal FCA arises when an entity knowingly submits a false claim for reimbursement to the federal government, the federal FCA defines the term "knowingly" broadly. Although simple negligence generally will not give rise to liability under the federal FCA, submitting a claim with reckless disregard for its truth or falsity can constitute "knowingly" submitting a false claim. Recently, the federal FCA was further expanded to cover the improper retention of an overpayment when President Obama signed into law the Fraud Enforcement and Recovery Act of 2009.

The State of California has enacted false claims legislation. These California false claims statutes are generally modeled on the federal FCA, with similar damages, penalties, and qui tam enforcement provisions. For example, the California False Claims Act prohibits "knowingly" submitting false claims for payment to California and its agencies, such as the Medi-Cal program. Violations are subject to damages and civil monetary penalties. Similar to the federal statute, the California False Claims Act allows private parties to sue on behalf of the state as qui tam (i.e., whistleblower) plaintiffs, and authorizes qui tam plaintiffs to share in any proceeds recovered as a result of the lawsuit. California's False Claims Act also includes provisions intended to discourage employers from retaliating against employees for initiating, testifying or assisting in qui tam lawsuits, or otherwise furnishing information to government or law enforcement authorities. An increasing number of healthcare false claims cases seek recoveries under both federal and state law. Provisions in the Deficit Reduction Act of 2005 ("DRA") that went into effect on January 1, 2007 give states significant financial incentives to enact false claims laws modeled on the federal FCA. Additionally, the DRA requires every entity that receives annual payments of at least $5,000,000 from a state Medi-Cal plan to establish written policies for its employees that provide detailed information about federal and state false claims statutes and the whistleblower protections that exist under those laws. Both provisions of the DRA are expected to result in increased false claims litigation against health care providers. We believe our hospitals have fully complied with the written policy requirements. Compliance with the written policy requirement is a condition of payment by Medi-Cal, and failure to comply could give rise to claims for recoupment of Medi-Cal payments, damages and other sanctions.

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Fraud and Abuse

Existing federal laws governing Medi-Cal, Medicare and other federal health care programs, as well as similar state laws, impose on us a variety of fraud and abuse prohibitions. These laws are interpreted broadly and enforced aggressively by multiple government agencies, including the Office of Inspector General of the Department of Health and Human Services, the Department of Justice and various state authorities. In addition, in the DRA, Congress created a new Medicaid Integrity Program to enhance federal and state efforts to detect Medi-Cal fraud, waste and abuse and provide financial incentives for states to enact their own false claims acts as an additional enforcement tool against Medi-Cal fraud and abuse. Violations of these laws are punishable by substantial penalties, including monetary fines, civil penalties, criminal sanctions, exclusion from participation in government-sponsored health care programs, and forfeiture of amounts collected in violation of such laws, any of which could have an adverse effect on our business and results of operations.

Emergency Medical Treatment and Active Labor Act

All of our hospital facilities are subject to the Emergency Medical Treatment and Active Labor Act ("EMTALA"). This federal law requires any hospital that participates in the Medicare program to conduct an appropriate medical screening examination of every person who presents to the hospital's emergency department for treatment and, if the patient is suffering from an emergency medical condition, to either stabilize that condition or make an appropriate transfer of the patient to a facility that can handle the condition. The obligation to screen and stabilize emergency medical conditions exists regardless of a patient's ability to pay for treatment. All hospitals with specialized capabilities are also required to accept appropriate transfers of patients in need of such specialized services if the transferring hospital cannot provide the services required by the patient. There are severe penalties under EMTALA if a hospital fails to screen or appropriately stabilize or transfer a patient or if the hospital delays appropriate treatment in order to first inquire about the patient's ability to pay, or if the hospital fails to accept an appropriate transfer of a patient from another hospital for specialized services. Penalties for violations of EMTALA include civil monetary penalties and exclusion from participation in the Medicare program. In addition, an injured patient, the patient's family or a medical facility that suffers a financial loss as a direct result of another hospital's violation of the law can bring a civil suit against that other hospital.

During 2003, CMS published a final rule clarifying a hospital's duties under EMTALA. In the final rule, CMS clarified when a patient is considered to be on a hospital's property for purposes of treating the person pursuant to EMTALA. CMS stated that off-campus facilities such as specialty clinics, surgery centers and other facilities that lack emergency departments should not be subject to EMTALA, but that these locations must have a plan explaining how the location should proceed in an emergency situation such as transferring the patient to the closest hospital with an emergency department. CMS further clarified that hospital-owned ambulances could transport a patient to the closest emergency department instead of to the hospital that owns the ambulance. However, under certain circumstances, when a patient is in a ground or air ambulance owned by one of our hospitals for purposes of examination and treatment for a medical condition at that hospital, EMTALA requires that the patient be screened for, and as needed, treated for an emergency medical condition at least until the patient's condition has been stabilized. CMS's rules did not specify "on-call" physician requirements for an emergency department, but provided a subjective standard stating that "on-call" hospital schedules should meet the hospital's and community's needs. Although we believe that our hospitals comply with EMTALA, we cannot predict whether CMS will implement new requirements in the future and whether our hospitals will comply with any new requirements.

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Annual Cost Reports

In 2003, Congress passed legislation to enhance and support Medicare's current efforts in identifying and correcting improper payments. In section 306 of the Medicare Modernization Act ("MMA"), Congress directed the Department of Health and Human Services ("DHHS") to conduct a three-year demonstration program using Recovery Audit Contractors ("RAC") to detect and correct improper payments in the Medicare FFS program. In addition, in section 302 to the Tax Relief and Health Care Act of 2006 ("TRHCA"), Congress required DHHS to make the RAC program permanent and nationwide by no later than January 1, 2010. The RAC program does not detect or correct payments for Medicare Advantage or the Medicare prescription drug benefit.

The permanent RAC program began in California in July 2009, with the auditors reviewing payments made to California healthcare providers to assure correct payment. Payments deemed incorrect will be adjusted at the time of audit. These adjustments can be appealed following the guidelines of the program. As of September 30, 2010, several of our hospitals have been scheduled for audits in fiscal year 2011.

Health Care Facility Licensing, Certification and Accreditation Requirements

All of our hospitals are subject to compliance with various federal, state and local statutes and regulations. Our hospitals must also comply with the conditions of participation and licensing requirements of federal, state and local health agencies, as well as the requirements of municipal building codes, health codes and local fire departments. Various other licenses and permits also are required in order to dispense narcotics, operate pharmacies, handle radioactive materials and operate certain equipment. We believe our health care facilities hold all required governmental approvals, licenses and permits material to the operation of our business.

Hospitals are subject to periodic inspection by federal, state, and local authorities to determine their compliance with applicable regulations and requirements necessary for licensing and certification. All of our hospitals are licensed under appropriate state laws and are qualified to participate in Medicare and Medi-Cal programs. In addition, our Alta hospitals are accredited by the Joint Commission, and Brotman Hospital is accredited by the Centers for Medicare and Medicaid Services ("CMS"), and is in the process of seeking accreditation by DNV Healthcare, Inc. Both accreditations indicate that a hospital satisfies the applicable health and administrative standards to participate in Medicare and Medi-Cal programs. If any of our facilities were to lose its accreditation or otherwise lose its certification under the Medicare and Medi-Cal programs, the hospital may be unable to receive reimbursement from the Medicare and Medi-Cal program and other payors. We believe that our hospitals are in substantial compliance with current applicable federal, state, local and independent review body regulations and standards. The requirements for licensure, certification and accreditation

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are subject to change and, in order to remain qualified, it may become necessary for us to make changes in our facilities, equipment, personnel and services in the future, which could have a material adverse impact on operations.

Recovery Audit Contractors

In 2003, Congress enacted section 306 of the MMA, which directed the Department of Health and Human Services to conduct a three year demonstration program using Recovery Audit Contractors ("RACs") to identify overpayments and underpayments in the Medicare Fee-For-Service program, as a means of fighting fraud, waste and abuse in the Medicare program. The demonstration project operated in New York, Massachusetts, Florida, South Carolina and California and ended on March 27, 2008. In 2006, Congress enacted the Tax Relief and Health Care Act of 2006, which established a permanent and national RAC program that became effective on January 1, 2010. The RACs review hospitals, physician practices, nursing homes, home health agencies, durable medical suppliers and any other provider or supplier that bills Medicare Parts A and B. The RACs will review claims on a post-payment basis and conduct both automated (no medical record needed) and complex (medical record required) reviews for claims paid after October 1, 2007. CMS and the RAC contractors are currently in the process of phasing in the program. Reviews by the RACs may result in a determination that there have been overpayments by Medicare to facility and recoupment by Medicare of such overpayment amounts, plus interest and potential penalties. As of September 30, 2010 several of our hospitals have been scheduled for audits in fiscal year 2011.

Never Events and Hospital Acquired Conditions

In 2002, the National Quality Form published "Serious Reportable Events in Healthcare: A Consensus Report" that identified 27 adverse events that were "serious, largely preventable and of concern to both the public and healthcare providers." This list (and subsequent revisions) became known as "never events." Historically, Medicare did not distinguish between costs that resulted from patient treatment as opposed to costs that resulted from an adverse event that occurred in the hospital. Section 5001(c) of the Deficit Reduction Act of 2005 required CMS to identify conditions that were high cost or volume or both, resulted in assignment to a DRG that had a higher payment when present as a secondary diagnosis, and that could have reasonably been prevented. As a result, CMS has developed a list of hospital acquired conditions (such as foreign object retained after surgery, Stage III and IV pressure ulcers and catheter-associated urinary tract infections) that are denied higher Medicare payments. In addition, CMS has developed a list of non-covered services that relate to adverse events (e.g., surgery on the wrong body part or correct procedure on the wrong patient) for which the hospital will not be reimbursed. The hospital will be at risk for decreased reimbursement if certain adverse events or hospital acquired conditions occur.

California Reporting of Adverse Events and Immediate Jeopardy Penalties

California is one of many states that have adopted strict reporting requirements for adverse events in general acute-care hospitals (and psychiatric and special hospitals) and initiated penalties for failure to report and for deficiencies identified as situations where the "noncompliance caused or was likely to cause serious harm or death to the patient" (known as "immediate jeopardy" deficiencies). Health and Safety Code section 1279.1 mandates that a health facility report an adverse event (as delineated in the statute) to the Department of Public Health within five days of the date the adverse event is detected or within one day if the issue is an ongoing or emergent threat to a patient, personnel or visitors' welfare, health or safety. Failure to report an adverse event may result in fines of up to $100 per day for each day the event is not reported. If the Department of Public Health issues a deficiency that constitutes immediate jeopardy, the hospital will be responsible for submitting a plan of correction and the Department of Public Health may assess an administrative penalty. Effective January 1, 2009,

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Health and Safety Code Section 1280.1(d) provides that the amount of the administrative penalty for immediate jeopardy shall be up to $50,000 for the first administrative penalty, up to $75,000 for the second subsequent immediate jeopardy violation and up to $100,000 for the third and every subsequent violation. The statute further provides that an administrative penalty issued after three years from the date of the last immediate jeopardy shall be considered a first administrative penalty as long as the hospital has not received additional immediate jeopardy violations and is determined to be in substantial compliance with all state and federal licensing laws and regulations. The hospital will be at risk for administrative penalties if adverse events occur. The hospital will also be at risk for further oversight from state and federal regulators.

Utilization Review Compliance and Hospital Governance

Federal law contains numerous provisions designed to ensure that services rendered by hospitals to Medicare and Medi-Cal patients meet professionally recognized standards, are medically necessary and that claims for reimbursement are properly filed. These provisions include a requirement that a sampling of admissions of Medicare and Medi-Cal patients must be reviewed by peer review organizations, which review the appropriateness of Medicare and Medi-Cal patient admissions and discharges, the quality of care provided, the validity of DRG classifications and the appropriateness of cases of extraordinary length of stay or cost. Peer review organizations may deny payment for services provided, or assess fines and also have the authority to recommend to the DHHS that a provider which is in substantial noncompliance with the standards of the peer review organization be excluded from participation in the Medicare program. Utilization review is also a requirement of most non-governmental managed care organizations.

Medical and surgical services and practices are extensively supervised by committees of staff doctors at each of our hospitals, are overseen by each facility's local governing board, the members of which primarily are community members and physicians, and are reviewed by our clinical quality personnel. The local hospital governing board also helps maintain standards for quality care, develop long-range plans, establish, review and enforce practices and procedures, and approve the credentials and disciplining of medical staff members.

California Seismic Standards

California's Alfred E. Alquist Hospital Facilities Seismic Safety Act (the "Alquist Act") requires that the California Building Standards Commission adopt earthquake performance categories, seismic evaluation procedures, standards and timeframes for upgrading certain facilities, and seismic retrofit building standards. These regulations require hospitals to meet seismic performance standards to ensure that they are capable of providing medical services to the public after an earthquake or other disaster. The Building Standards Commission completed its adoption of evaluation criteria and retrofit standards in 1998. The Alquist Act requires that within three years after the Building Standards Commission had adopted evaluation criteria and retrofit standards:

•: Hospitals in California must conduct seismic evaluations and submit these evaluations to the Office of Statewide Health Planning and Development ("OSHPD"), Facilities Development Division for its review and approval;
•: Hospitals in California must identify the most critical nonstructural systems that represent the greatest risk of failure during an earthquake and submit timetables for upgrading these systems to the OSHPD, Facilities Development Division for its review and approval; and
•: Hospitals in California must prepare a plan and compliance schedule for each regulated building demonstrating the steps a hospital will take to bring the hospital buildings into substantial compliance with the regulations and standards.

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We were required to conduct engineering studies at our hospitals to determine whether and to what extent modifications to the hospital facilities will be required. We believe that our hospitals satisfy all current requirements; however, we may be required to make significant capital expenditures in the future to comply with the seismic standards, which could impact our earnings.

OSHPD is currently implementing a new voluntary program to re-evaluate the seismic risk of hospital buildings classified as Structural Performance Category ("SPC-1"). These buildings are considered hazardous and at risk of collapse in the event of an earthquake and must be retrofitted, replaced or removed from providing acute care services by January 1, 2013. OSHPD is using HAZUS, a state-of-the-art methodology, to reassess the seismic risk of SPC-1 buildings and those that are determined to pose a low seismic risk may be reclassified to SPC-2. The SPC-2 buildings would have until January 1, 2030 to comply with the structural seismic safety standards. Any buildings that are denied reclassification will remain in the SPC-1 category, and must meet seismic compliance standards by January 1, 2013, unless further extensions are granted. Participation in the HAZUS program is optional for hospital owners wishing to have their SPC-1 building(s) re-evaluated. We have applied for a HAZUS re-evaluation of the seismic risk for Hollywood Community Hospital, Los Angeles Community Hospital, Norwalk Community Hospital and Brotman. Our Van Nuys Community Hospital is exempt from the seismic retrofitting guidelines because psychiatric hospitals are exempt from seismic retrofitting. The current status of the re-evaluation is as follows:

•: Hollywood Community Hospital was denied reclassification, and remains in the SPC-1 category;
•: Norwalk Community Hospital was granted the reclassification, and moved into the SPC-2 category;
•: Los Angeles Community Hospital was granted SPC-2 status for one of the three buildings and still awaits reclassification decisions on the other two buildings which currently remain in the SPC-1 category;
•: Brotman was denied reclassification and structural analysis is being performed to determine upgrade requirements; and
•: Los Angeles Community Hospital is waiting reclassification decision and currently remain in the SPC-1 category; and
•: Brotman has also qualified for SB 306 extension to 2020 which means it will not have to meet SPC-2 and NPC-3 by 2013. However, if Brotman does not meet SPC-2 and NPC-3 category by 2013, it must retrofit the building to meet SPC-5 and NPC-5 by 2020.

Furthermore, the Alquist Act permits OSHPD to grant an extension to acute care hospitals that lack the financial capacity to meet the January 1, 2013 retrofit deadline, and instead, requires them to replace those buildings by January 1, 2020. Brotman has been approved for this extension.

Pursuant to the Alquist Act, hospital buildings not in compliance by their applicable deadlines may be subject to loss of licensure. Unless the noncompliant hospital places its license in voluntary suspense, the Department of Public Health may suspend or refuse to renew the license of a hospital that has received a notice of violation. However, the license may be reinstated or renewed upon presentation to the Department of Public Health of a written notice of compliance.

Hospital Conversion Legislation

California has adopted legislation regarding the sale or other disposition of hospitals operated by not-for-profit entities. The California attorney general has demonstrated an interest in these transactions under its general obligations to protect charitable assets. These legislative and administrative efforts primarily focus on the appropriate valuation of the assets divested and the use of the proceeds of the sale by the not-for-profit seller. These reviews and, in some instances, approval

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processes can add additional time to the closing of a not-for-profit hospital acquisition. Future actions by state legislators or attorneys general may seriously delay or even prevent our ability to acquire certain hospitals.

Environmental Regulation

Our hospitals and certain affiliated physician organizations generate medical waste that must be disposed of in compliance with federal, state and local environmental laws, rules and regulations. Our operations, as well as our purchases and sales of hospitals, are also subject to compliance with various other environmental laws, rules and regulations. Such compliance costs are not significant and we do not anticipate that such compliance costs will be significant in the future.

HIPAA Transaction, Privacy and Security Requirements

Federal regulations issued pursuant to the Health Insurance Portability and Accountability Act ("HIPAA") contain, among other measures, provisions that require us to implement very significant and potentially expensive new computer systems, employee training programs and business procedures. The federal regulations are intended to protect the privacy of healthcare information and encourage electronic commerce in the healthcare industry. Our hospitals and affiliated physician organizations are covered entities subject to these regulations. As a business associate of such entities and contracted health plans, we are also subject to many HIPAA requirements pursuant to a business associate contract required between covered entities and their business associates and now, because of Health Information Technology for Economic and Clinical Health Act (the "HITECH Act"), directly under HIPAA. HITECH amended HIPAA, which previously applied only to "covered entities" (i.e., healthcare providers, insurers, and clearinghouses), to now apply directly to business associates, who previously were subject only to contractual liability to covered entities under business associate agreements. As a result, business associates will have to institute the same formalized HIPAA compliance programs that covered entities must, including detailed written policies, training programs, dedicated personnel, and board oversight. We are also subject to California's privacy laws regarding privacy of medical information.

Among other things, HIPAA requires healthcare facilities to use standard data formats and code sets established by DHHS when electronically transmitting information in connection with several transactions, including health claims and equivalent encounter information, healthcare payment and remittance advice and health claim status. We have implemented or upgraded computer system utilizing a third party vendor, as appropriate, at our facilities and at our corporate headquarters to comply with the new transaction and code set regulations and have tested these systems with our payors.

HIPAA also requires DHHS to issue regulations establishing standard unique health identifiers for individuals, employers, health plans and healthcare providers to be used in connection with the standard electronic transactions. All healthcare providers, including our facilities, were required to obtain a new National Provider Identifier to be used in standard transactions instead of other numerical identifiers beginning no later than May 23, 2007. Our facilities have fully implemented use of the Employer Identification Number as the standard unique health identifier for employers without experiencing any payment delays during the transition.

HIPAA regulations also require our facilities to comply with standards to protect the confidentiality, availability and integrity of patient health information, by establishing and maintaining reasonable and appropriate administrative, technical and physical safeguards to ensure the integrity, confidentiality and availability of electronic health and related financial information. The security standards were designed to protect electronic information against reasonably anticipated threats or hazards to the security or integrity of the information and to protect the information against unauthorized use or disclosure. The security standards require our facilities to implement business

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procedures and training programs, though the regulations do not mandate use of a specific technology. We have performed comprehensive security risk assessments and are currently in the remediation process for the systems/devices that have been identified as having the highest levels of vulnerability. This will be an ongoing process as we update, upgrade, or purchase new systems technology.

DHHS has also established standards for the privacy of individually identifiable health information. These privacy standards apply to all health plans, all healthcare clearinghouses and healthcare providers, such as our facilities, that transmit health information in an electronic form in connection with standard transactions, and apply to individually identifiable information held or disclosed by a covered entity in any form. These standards now also apply to us in our capacity as a business associate of such covered entities. These standards impose extensive administrative requirements on us and our facilities and require compliance with rules governing the use and disclosure of this health information, and they require our facilities to impose these rules, by contract, on any business associate to whom we disclose such information in order for them to perform functions on our facilities' behalf. In addition, our facilities will continue to remain subject to California's privacy laws that are in many instances more restrictive than the privacy regulations issued under HIPAA. California's privacy laws could impose additional penalties.

The restrictions under HIPAA and California's privacy laws have over the years been strengthened and penalties for their breach increased. HITECH greatly enhanced HIPAA's patient privacy and security obligations. HITECH and HIPAA require correspondingly intensive compliance efforts by providers and suppliers, including self-disclosures of breaches to federal officials and a fining system. "Snooping" by covered entity personnel constitutes a breach of HIPAA. These anti-snooping provisions present operational challenges to healthcare providers, including us. HITECH also amends HIPAA to create new enforcement provisions and expanded civil and criminal penalties. The net effect of these amendments is to make HIPAA a more encompassing regulatory scheme for patient privacy. California legislation enacted effective January 1, 2009 mirrors the HIPAA changes enacted by HITECH. The California legislation has more stringent anti-snooping provisions than those enacted by HITECH, contains mandatory breach notice rules applicable to us and enhances penalties for noncompliance. Compliance with these standards requires significant commitment and action by us.

Antitrust

Federal and state antitrust laws prohibit agreements in restraint of trade, price-fixing, division of markets, the exercise of monopoly power and other practices that are considered to be anti-competitive. We must structure and operate our business activities and select and implement our Medical Group and hospital acquisitions in a manner which conforms with antitrust laws. If any of our current or newly acquired Medical Groups were determined to be competitors with one another, it is possible that their common management by us could be claimed to lead to sharing of pricing information or coordinated price negotiations that could be prohibited under antitrust laws. Government authorities have also challenged Medical Groups under the antitrust laws if the Medical Groups negotiate prices on behalf of their physician members with PPOs or insurance companies on a non-capitated (e.g. fee-for-service) basis. If one or more of our Medical Groups were to negotiate PPO prices in such a manner, they could be subject to an antitrust challenge. While we believe that we are in material compliance with federal and state antitrust laws, if we were found to be in violation of these laws, we could be subject to significant financial penalties, possible divestiture of certain assets and a possible injunction that could disrupt our business operations or require a restructuring of our physician relationships.

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Health Plan Licensing and Regulation

The California Department of Managed Health Care ("DMHC") is responsible for licensing and regulating health plans in California under the Knox-Keene Health Care Service Plan Act of 1975 (the "Knox-Keene Act").

Our affiliated physician organizations contract with HMOs to provide physician and certain ancillary services to the HMO enrollees. The Knox-Keene Act imposes numerous requirements on health plans regarding the provision of care to health plan enrollees. HMOs, in turn, require their contracted physician organizations to comply with those requirements where applicable. Health plans also require their contracted physician organizations to ensure compliance with applicable Knox-Keene Act requirements on the part of the organizations' sub-contracted physicians. Thus, our physician organizations are indirectly subject to many of the requirements of the Knox-Keene Act. While health plans are bound by the provisions of the Knox-Keene Act directly, our physician organizations are indirectly bound by many of these same provisions as embodied in their contracts with the health plans.

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

In addition to state regulations, HMOs which contract with the Medicare program under Medicare Advantage, as well as their subcontracting Medical Groups, such as ours, are subject to extensive federal regulations. These regulations govern many aspects of our Medical Groups' operations, including but not limited to, marketing to and enrollment of Medicare beneficiaries into Medicare Advantage plans, reporting requirements, claims payment, disclosure requirements, and physician compensation. Failure to comply with these regulations could result in the imposition of civil monetary penalties or other sanctions.

Financial Solvency Regulations

The DMHC has instituted financial solvency regulations mandated by California Senate Bill 260. The regulations are intended to provide a formal mechanism for monitoring the financial solvency of capitated physician groups. Management believes that our affiliated physician organizations that are subject to these regulations will be able to comply with them. However, these regulations could limit our ability to use our cash resources, including our ability to make future acquisitions.

Under the regulations, our affiliated physician organizations are required to comply with specific 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 qualified receivables, divided by the organization's total unpaid claims liability). The regulations require a cash-to-claims ratio of 0.75.
•: Submit periodic reports to the DMHC containing various data and attestations regarding performance and financial solvency, including IBNR (incurred but not reported) calculations and documentation, and attestations as to whether or not the organization was in compliance with Knox-Keene Act requirements related to claims payment timeliness, had maintained positive tangible net equity and had maintained positive working capital.

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Further, under these regulations, the DMHC will make public some of the information contained in the reports, including, but not limited to, whether or not a particular physician organization met each of the criteria.

In the event we are not able to meet certain of the financial solvency requirements, and fail to meet subsequent corrective action plans, we could be subject to sanction, or limitations on, or removal of, our ability to do business in California.

Our cash-to-claims ratio on September 30, 2010, was 2.8.

Government Investigations

The government increasingly examines arrangements between health care providers and potential referral sources to ensure that they are not designed to exchange remuneration for patient referrals, do not violate self-referral laws and do not involve billing fraud. Investigators are increasingly willing to look behind formalities of business transactions to determine the underlying purpose of payments. Enforcement actions have increased and are highly publicized.

In addition to investigations and enforcement actions initiated by governmental agencies, we could become the subject of an action brought under the False Claims Act by a private individual on behalf of the government. Actions under the False Claims Act, commonly known as "whistleblower" lawsuits, are generally filed under seal to allow the government adequate time to investigate and determine whether it will intervene in the action, and defendant health care providers may have no knowledge of such actions until the government has completed its investigation and the seal is lifted.

To our knowledge, we, and our affiliated physician organizations, are not currently the subject of any investigation or action under the False Claims Act. Any such future investigation or action could result in sanctions and unfavorable publicity that could reduce potential revenues and profitability.

Health Care Reform

The U.S. health care industry continues to attract much legislative interest and public attention. In recent years, an increasing number of legislative proposals have been introduced or proposed in Congress and in some state legislatures that would effect major changes in the health care system. Proposals that have been considered include changes in Medicare, Medi-Cal and other programs, cost controls on hospitals and mandatory health insurance coverage for employees. The costs of implementing some of these proposals would be financed, in part, by reduction of payments to health care providers under Medicare, Medi-Cal, and other government programs. We cannot predict the course of future health care legislation or other changes in the administration or interpretation of governmental health care programs. However, future legislation, interpretations, or other changes to the health care system could reduce our revenues and profitability.

Regulatory Compliance Program

It is our policy to conduct our business with integrity and in compliance with the law. We have a Code of Conduct which applies to all directors, officers, employees and consultants, and a confidential disclosure program to enhance the statement of ethical responsibility expected of our employees and business associates who work in the accounting, financial reporting, and asset management areas of our company.

Our hospitals have in place and continue to enhance a company-wide compliance program which focuses on all areas of regulatory compliance including billing, reimbursement and cost reporting practices. This regulatory compliance program is intended to help ensure that high standards of conduct are maintained in the operation of our business and that policies and procedures are implemented so that employees act in full compliance with all applicable laws, regulations and company

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policies. Specific written policies, procedures, training and educational materials and programs, as well as auditing and monitoring activities have been prepared and implemented to address the functional and operational aspects of our business. Included within these functional areas are materials and activities for business sub-units, including laboratory, radiology, pharmacy, emergency, surgery, observation, home health, skilled nursing, and clinics. Specific areas identified through regulatory interpretation and enforcement activities have also been addressed in our program. Claims preparation and submission, including coding, billing, and cost reports, comprise the bulk of these areas. Financial arrangements with physicians and other referral sources, including compliance with anti-kickback and Stark laws, emergency department treatment and transfer requirements, and other patient disposition issues are also the focus of policy and training, standardized documentation requirements, and review and audit. Another focus of the program is the interpretation and implementation of the HIPAA standards for privacy and security.

Under the regulatory compliance program, every employee, certain contractors involved in patient care, and coding and billing, receive initial and periodic legal compliance and ethics training. In addition, we regularly monitor our ongoing compliance efforts and develop and implement policies and procedures designed to foster compliance with the law. The compliance program also includes a mechanism for employees to report, without fear of retaliation, any suspected legal or ethical violations to their supervisors, designated compliance officers in our hospitals, our compliance hotline or directly to our corporate compliance office. There can be no assurances, however, that our regulatory compliance program will prevent us from being subject to any public or private regulatory actions, claims or investigations.

Insurance

We maintain general liability, umbrella liability, property, crime, fiduciary, corporate counsel, automobile and workers' compensation insurance, directors and officers insurance and employment practices liability insurance. Our annual policy limits are $1,000,000 per occurrence and $3,000,000 in the aggregate for general liability coverage, $5,880,000 for property coverage and $8,000,000 for business interruption coverage with total insured value of $13,880,000, $2,000,000 for crime coverage, $2,000,000 for fiduciary coverage, $2,000,000 for corporate counsel coverage, $1,000,000 for automobile coverage, the amounts required by state law for workers' compensation, $5,000,000 for employment practices liability and $8,000,000 in the aggregate for directors and officers liability, and Side A DIC Coverage in the amount of $7,000,000. The umbrella policy limits of $3,000,000 operate as excess limits over the underlying general liability and automobile liability coverage.

As a result of the merger agreement with Ivy Holdings Inc. and Ivy Merger Sub Corp., the Directors & Officers liability, employment practices liability, side A and fiduciary liability policies will be placed into run-off coverage effective at the close of the transaction. The run-off policy period will be six years from the close of transaction, and a new set of policy aggregate limits will be provided. New policies for Directors & Officers liability, employment practices liability, side A and fiduciary liability coverage will be in effect for the new entity effective on the transaction date close. The new policies will be issued with limits of $8,000,000 Directors & Officers liability, $5,000,000 employment practices, $7,000,000 side A and $2,000,000 fiduciary liability coverage.

Our affiliated physician organizations, Prospect Professional Care Medical Group, Inc., AMVI/Prospect Health Network, Nuestra Familia Medical Group, Inc., Prospect Health Source Medical Group, Inc., Prospect NWOC Medical Group, Inc., StarCare Medical Group, Inc., Genesis HealthCare of Southern California, Inc., A Medical Group, Prospect Medical Group, Inc., Pomona Valley Medical Group, Inc. and Upland Medical Group, a Professional Medical Corporation maintain managed care errors and omissions insurance (professional liability) in a minimum coverage amount of $2,000,000 per claim and $5,000,000 in the aggregate. The individual physicians who contract with the Affiliates carry their own medical malpractice insurance. Under the Hospital Services segment, Alta purchases

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professional and general liability insurance to cover medical malpractice claims under a claims-made policy.

Our Alta hospitals maintain professional liability, general liability, property, automobile and workers' compensation insurance. The Alta/Prospect workers' compensation coverage for October 1, 2009 through September 30, 2010 did not have an aggregate loss limit. The current workers' compensation policy for the period of October 1, 2010 through September 30, 2011 does not have an aggregate loss limit. The policy limits are $10,000,000 per occurrence and in the aggregate for the professional and general liability, $38,376,528 for property coverage, $10,356,000 for contents, $2,000,000 for accounts receivable coverage and $20,000,000 for business interruption coverage, with a total insured value of $70,732,528. In addition to the policy, coverage includes $1,000,000 for automobile coverage and amounts required by law for workers' compensation. The excess liability policy for Alta operates as excess coverage over the underlying primary automobile liability coverage.

Brotman Medical Center maintains professional liability, general liability, property, automobile, storage tank liability and workers' compensation insurance. In 2010 and 2009, Brotman had a commercial occurrence-based insurance policy for workers' compensation claims. In 2005, the policy had a $250,000 deductible per accident with an annual aggregate loss limitation of $1,625,000. The 2007 policy had a $250,000 loss limitation per accident with an annual aggregate loss limitation of $1,562,000. The professional and general liability limits carried are $1,000,000/$3,000,000 for the primary policy and $9,000,000/$9,000,000 excess/umbrella coverage. Primary automobile liability coverage is $1,000,000, and storage tank liability coverage is $1,000,000 each incident/$2,000,000 in the aggregate. Property insurance limits are set at $84,373,937 for buildings, $30,981,223 for the contents and $40,480,102 for business income. The umbrella policy provides excess limits over the primary professional and general liability, automobile and employer's liability policies.

Our insurance, and the insurance of our affiliated physician organizations, contain customary exclusions and exceptions from coverage. Additionally, we are at risk for our self-insured retention ("deductible") on certain policies such as $10,000 for our Prospect property policy, $50,000 for our Alta property policy, and $75,000 for the managed care errors and omissions insurance. Directors & Officers liability and employment practices liability policies have a $150,000 self-insured retention and the hospital's professional/general liability policy has a $1,000,000 self-insured retention. Brotman has a commercial claims-made insurance policy for malpractice claims in excess of $100,000 per claim with no annual aggregate. The general liability coverage is occurrence coverage with a $100,000 per occurrence retention and an annual aggregate of $12,000,000. Brotman offers self-insured HMO and PPO plans to employees. Employee health benefits are administered by a local claims processor based on plan coverage and eligibility guidelines determined by Brotman and collective bargaining agreements. A commercial insurance policy covers losses in excess of $200,000 per occurrence.

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

Employees

Hospital Services Segment

General. Our hospitals are staffed by licensed physicians who have been admitted to the medical staffs of individual hospitals. Under state laws and other licensing standards, hospital medical staffs are generally self-governing organizations subject to ultimate oversight by the hospital's local governing board. Members of the medical staffs of our hospitals also often serve on the medical staffs of hospitals not owned by us. Members of our medical staffs are free to terminate their affiliation with our hospitals or admit their patients to competing hospitals at any time. Although we operate some

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physician practices and, where permitted by law, employ some physicians, the overwhelming majority of the physicians who practice at our hospitals are not our employees. Nurses, therapists, lab technicians, facility maintenance workers and the administrative staffs of hospitals, however, normally are our employees. We are subject to federal minimum wage and hour laws and various state labor laws, and maintain a number of different employee benefit plans.

Although we will continue our efforts to successfully attract and retain key employees, qualified physicians and other healthcare professionals, the loss of some or all of our key employees or the inability to attract or retain sufficient numbers of qualified physicians and other healthcare professionals could have a material adverse effect on our business, financial condition, results of operations or cash flows.

Union Activity and Labor Relations. At September 30, 2010, our Hospital Services operation had a total of 1,806 employees, which included 923 employees at our four Alta hospitals and 799 employees at Brotman. Of that amount, approximately 5.42% and 78% of the total employee headcount at our Alta and Brotman hospitals, respectively, are subject to collective bargaining agreements. On or about May 9, 2008 we entered into a new collective bargaining agreement with the SEIU to replace the expired collective bargaining agreement at Hollywood Community Hospital, which is one of the hospitals under the consolidated group of Alta Hospitals System, LLC. The collective bargaining agreement covers a small number of Hollywood Community Hospital's employees, and expires on May 9, 2011. We do not anticipate that the agreement we reached in 2008 will have a material adverse effect on the results of our Hospital Services operations. Brotman has two unions—the SEIU and CNA—covering approximately 78.0% of the hospital's employees. After months of good faith negotiations, Brotman recently entered into two new tentative collective bargaining agreements with the SEIU and CNA.

Corporate and Medical Group Segment

At September 30, 2010, we and our Medical Group subsidiaries had a total of 277 employees. The employees are not subject to any collective bargaining agreements. We believe that employee relations are good.

Item 1A. Risk Factors

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

Medicare, Medi-Cal, other government-sponsored programs and private third-party payor cost containment efforts and reductions in reimbursement rates could reduce our hospital revenue and our cash flow.

For the fiscal year ended September 30, 2010, our hospitals derived approximately 80% of their revenue from the Medicare and Medi-Cal programs. Changes in recent years in the Medicare and Medi-Cal programs, including both fee-for-service and managed care programs, have resulted in limitations on reimbursement and, in some cases, reduced levels of reimbursement for healthcare services. Payments from federal and state government programs are subject to statutory and regulatory changes, administrative rulings, interpretations and determinations, requirements for utilization review, and federal and state funding restrictions, all of which could materially increase or decrease revenue, as well as affect the cost of providing service to patients and the timing of payments to facilities. Future federal and state legislation may further reduce the payments we receive for our services.

The State of California has incurred budget deficits in the past few years. As a result, the State has enacted legislation designed to reduce its Medi-Cal expenditures. In 2008 and 2009, the State reduced and/or froze Medi-Cal reimbursement for numerous services, including hospital outpatient services, hospital sub-acute services, and distinct-part nursing services. In addition, payments to hospitals for

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inpatient services not furnished under Medi-Cal contracts were reduced. The inpatient reductions do not currently affect our hospitals because our hospitals have contracts with the State to provide Medi-Cal inpatient services, but these reductions could affect our hospitals if any of our contracts are terminated. All of these limitations are being challenged in court by the California Hospital Association. The outcome of this litigation is uncertain. A temporary injunction has been issued prohibiting certain of the limitations enacted in 2008 pursuant to Assembly Bill 1183 from being implemented for services on and after April 6, 2009, and a second temporary injunction has been issued prohibiting certain other limitations enacted in 2009 pursuant to Assembly Bill X45 from being implemented on or after February 24, 2010 due to the state's failure to comply with federal Medicaid law. The cases are still pending and the preliminary injunctions are still in place. If the courts ultimately find that the rate reductions were lawful, the Company may be obligated to return to the State the additional amounts paid under the injunction and future Medi-Cal reimbursement could be reduced.

Additionally, the State of California has recently enacted legislation affecting reimbursement for inpatient hospital services under Medi-Cal which (a) provides that, effective July 1, 2010, Medi-Cal payment rates shall be no higher than the rates in effect on January 1, 2010, (b) requires the California Department of Health Care Services to develop a prospective payment system based on diagnosis-related groups by June 30, 2014, and (c) requires that the payments made to hospitals for services furnished on and after July 1, 2010 will be reconciled to the amount computed to be due for such services under the new prospective payment system once that system is developed. These changes could have a significant adverse effect on our hospitals' Medi-Cal revenue.

Furthermore, the State of California has considered, and/or is considering, various proposals designed to reduce its healthcare-related expenditures. Many of these proposals threaten to reduce our hospital revenue. The State of California has considered numerous proposals reducing Medi-Cal payments directly to private hospitals in the form of Disproportionate Share Hospital ("DSH") payments or distressed hospital supplemental payments. In addition, the State of California has considered other proposals that may impact our hospitals' revenue, including reductions in coverage and reimbursement relating to prescription drugs, AIDS services, family planning services and mental health community-based services, breast and cervical screening, non-emergency services for individuals without documentation status, dialysis and non-digestive nutrition services. The State of California has also considered the reduction of funding for counties to pay local hospitals for uncompensated care, the elimination of funding to Institutions of Mental Disease for ancillary health services not covered under the federal Medicaid program and restricting eligibility for or coverage under the Medi-Cal and Healthy Families programs or eliminating the Healthy Families program altogether. These proposals would increase the number of uninsured individuals or amount of non-covered services, potentially adversely affecting the revenue of our hospitals. The recent California budget included reductions in funding for the Medi-Cal mental health managed care program, which could potentially reduce revenues for our hospital in Van Nuys. California continues to explore further reforms to payments to Medi-Cal managed care plans in light of California's ongoing budget crises.

We are unable to predict the effect of future state or federal healthcare funding policy changes on our operations. If the rates paid by governmental payors are reduced, if the scope of services covered by governmental payors is limited, or if we, or one of our hospitals, are excluded from participation in the Medicare or Medi-Cal program or any other government healthcare program, there could be a material adverse effect on our business, financial condition, results of operations and cash flows.

Employers have also passed more healthcare benefit costs on to employees to reduce the employers' health insurance expense. This trend has caused the self-pay/deductible component of healthcare services to become more common. This payor shifting increases collection costs and reduces overall collections.

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During the past several years, major purchasers of healthcare, such as federal and state governments, insurance companies and employers, have undertaken initiatives to revise payment methodologies and monitor healthcare costs. As part of their efforts to contain healthcare costs, purchasers increasingly are demanding discounted fee structures or the assumption by healthcare providers of all or a portion of the financial risk through prepaid capitation arrangements, often in exchange for exclusive or preferred participation in their benefit plans. We expect efforts to impose greater discounts and more stringent cost controls by government and other payors to continue, thereby reducing the payments we receive for our services. In addition, these payors have instituted policies and procedures to substantially reduce or limit the use of inpatient services. The trends may result in a reduction from our historical levels in per patient revenue received by our hospitals and affiliated physician organizations.

In our hospital segment, the continued growth of uninsured and underinsured patients or further deterioration in the collectability of the accounts of such patients could harm our results of operations.

Like others in the hospital industry, we have experienced large provisions for bad debts, totaling $29,900,000 or 10.7% of total net patient revenue for fiscal 2010, due to a growth in self-pay volume. Although we continue to seek ways of improving collection efforts and implementing appropriate payment plans for our services, if we experience growth in self-pay volume and revenue, our results of operations could be adversely affected. Further, our ability to improve collections for self-pay and other patients may be limited by statutory, regulatory and investigatory initiatives, including private lawsuits directed at hospital charges and collection practices for uninsured and underinsured patients. The principal collection risks for our accounts receivable include uninsured patient accounts and to patient accounts for which the primary insurance carrier has paid the amounts covered by the applicable agreement but patient responsibility amounts (e.g., deductibles, co-payments and other amounts not covered by insurance) remain outstanding. The amount of our provision for doubtful accounts is based upon our assessment of historical cash collections and accounts receivable write-offs, expected net collections, business and economic conditions, trends in federal, state and private employer healthcare coverage and other collection indicators. If we continue to experience significant levels of uninsured and underinsured patients, and bad debt expenses, our results of operations could be negatively impacted.

Because our hospitals are obligated to provide care in certain circumstances regardless of whether we will get paid for providing such care, if the number of uninsured patients treated at our hospitals increases, our results of operations may be harmed.

In accordance with our Code of Business Conduct and Ethics, as well as EMTALA, we provide a medical screening examination to any individual who comes to our hospitals while in active labor and/or seeking medical treatment (whether or not such individual is eligible for insurance benefits and regardless of their ability to pay) to determine if such individual has an emergency medical condition. If it is determined that such person has an emergency medical condition, we provide further medical examination and treatment as is required in order to stabilize the patient's medical condition, within the facility's capability, or arrange for transfer of such individual to another medical facility in accordance with applicable law and the treating hospital's written procedures. If the number of indigent and charity care patients with emergency medical conditions we treat increases significantly, our results of operations may be negatively impacted.

Decreases in the number of HMO enrollees using our Medical Group networks could reduce our profitability and inhibit future growth.

During recent periods, the number of HMO enrollees using our physician networks has declined (exclusive of increases resulting from our managed contracts), and management currently anticipates that this trend will continue. The profitability and growth of our business depends largely on the

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number of HMO members who use our physician networks. We seek to maintain and increase the number of HMO enrollees using our physician networks by partnering with HMOs with which our affiliated physician organizations have contracts. If we are not successful, we may not be able to maintain or achieve profitability. For the years ended September 30, 2010 and 2009, our Medical Group segment saw a decrease in the number of HMO enrollees, using our physician networks of approximately 10,300 and 12,000, respectively. Estimated revenue reductions associated with the enrollment decreases for those periods were approximately $3,200,000 and $4,200,000, respectively. These fiscal year estimates assume that enrollment decreased ratably during the indicated periods and, as such, represent approximately 50% of the lost revenue that will be experienced in subsequent periods, when the enrollment decline is in effect for the whole period.

Substantially all of our Medical Group segment revenues are generated from contracts with a limited number of HMOs, and if we were to lose HMO contracts or to renew HMO contracts on less favorable terms, our revenues and profitability could be significantly reduced.

With the consolidation of HMOs, there are a limited number of HMOs doing business in California, which magnifies the risk of loss of any one HMO contract. The potential for risk is also magnified because HMO contracts often have only a one-year term, may be terminated with cause upon short notice, and, upon renewal, are subject to annual negotiation of capitation rates, covered benefits and other terms and conditions.

We are particularly at risk with respect to the potential loss or renewal on less favorable terms of contracts that we have with five of these HMOs due to the concentration of revenue with these HMOs—Plan A, Plan B, Plan C, Plan D, and Plan E. For the fiscal year ended September 30, 2010, contracts with our five largest HMOs accounted for approximately 67% of our enrollment and approximately $144,599,000, or 72% of our total capitation revenue. The loss of contracts with any one of these HMOs could significantly reduce our revenues and profitability.

We have one-year automatically renewable contracts with most contracted HMOs, including our largest HMO customers discussed above, whereby such contracts are automatically renewed, unless either party provides the other party with four to six months' notice (prior to the expiration of the term) of such party's intent not to renew. Under limited circumstances, the HMOs may immediately terminate the contracts for cause; otherwise, termination for cause requires one to three months' prior written notice with an opportunity to cure. There can be no assurance that we will be able to renew any of these contracts or, if renewed, that they will contain terms favorable to us.

In our Medical Group segment, risk-sharing arrangements that our Medical Groups have with HMOs and hospitals could result in their costs exceeding the corresponding revenues, which could reduce or eliminate any shared risk profitability.

Most of our affiliated physician organizations' agreements with HMOs and hospitals contain risk-sharing arrangements under which the affiliated physician organizations can earn additional compensation by coordinating the provision of quality, cost-effective healthcare to enrollees, but they may also be required to assume a portion of any loss sustained from these arrangements, thereby reducing our net income. Risk-sharing arrangements are based upon the cost of hospital services or other services for which our physician organizations are not capitated. The terms of the particular risk-sharing arrangement allocate responsibility to the respective parties when the cost of services exceeds the related revenue, which results in a "deficit," or permit the parties to share in any "surplus" amounts when actual costs are less than the related revenue. The amount of non-capitated and hospital costs in any period could be affected by factors beyond our control, such as changes in treatment protocols, new technologies, longer lengths of stay by the patient and inflation. To the extent that such non-capitated and hospital costs are higher than anticipated, revenue may not be sufficient to cover the risk-sharing deficits they are responsible for, which could reduce our revenues and profitability. It is our

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experience that "deficit" amounts for hospital costs are applied to offset any future "surplus" amount we would otherwise be entitled to receive. We have historically not been required to reimburse the HMOs for any hospital cost deficit amounts. Most of our contracts with HMOs specifically provide that we will not have to reimburse the HMO for hospital cost deficit amounts.

HMOs often insist on withholding negotiated amounts from professional capitation payments, which the HMOs are permitted to retain, in order to cover our share of any risk-sharing deficits; and hospitals may demand cash settlements of risk-sharing deficits as a "quid pro quo" for joining in these arrangements. Net risk-pool deficits were approximately $3,808,000 and $6,217,000, for the fiscal years ended September 30, 2010 and 2009, respectively.

To date, we have not suffered significant losses due to hospital risk arrangements other than offsets (for deficit amounts) against any future surpluses we otherwise would have received. Whenever possible, we seek to contractually reduce or eliminate our affiliated physician organizations' liability for risk-sharing deficits. Notwithstanding the foregoing, risk-sharing deficits could have a significant impact on our future profitability.

The operating results of our Medical Group segment could be adversely affected if our actual healthcare claims exceed our reserves.

At certain times in our history, we have not had adequate cash resources to retire one hundred percent of our incurred but not reported ("IBNR") medical claims. As of September 30, 2010 and 2009, we had sufficient cash to fully retire our estimated accrued medical claims and other healthcare costs payable of approximately $14,852,000 and $16,824,000, respectively.

Historically, we have been able to satisfy our claims payment obligations each month out of cash flows from operations and existing cash reserves. However, in the event that our revenues are substantially reduced due to a loss of a significant HMO contract or other factors, our cash flow may not be sufficient to pay off claims on a timely basis, or at all. If we are unable to pay claims timely we may be subject to HMO de-delegation wherein the HMO would take away our claims processing functions and perform the functions on our behalf, charging us a fee per enrollee, a requirement by the HMO to comply with a corrective action plan, and/or termination of the HMO contract, which could have a material adverse effect on our operations and results of operations.

We estimate the amount of our reserves for submitted claims and IBNR claims primarily using standard actuarial methodologies based upon historical data. The estimates for submitted claims and IBNR claims liabilities are made on an accrual basis, are continually reviewed and are adjusted in current operations as required. Given the uncertainties inherent in such estimates, the reserves could materially understate or overstate our actual liability for claims payable. Any increases to these prior estimates could adversely affect our results of operations in future periods.

In our Medical Group segment, we may be exposed to liability or fail to estimate IBNR claims accurately if we cannot process any increased volume of claims accurately and timely.

We have regulatory risk for the timely processing and payment of claims. If we are unable to handle increased claims volume, or if we are unable to pay claims timely we may become subject to an HMO corrective action plan or de-delegation until the problem is corrected, and/or termination of the HMO agreement, which could have a material adverse effect on our operations and profitability. In addition, if our claims processing system is unable to process claims accurately, the data we use for our IBNR estimates could be incomplete and our ability to accurately estimate claims liabilities and establish adequate reserves could be adversely affected.

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The profitability of our Medical Group segment may be reduced or eliminated if we are not able to manage our healthcare costs effectively.

Our success depends in large part on our effective management of healthcare costs incurred by our affiliated physician organizations and controlling utilization of specialty and ancillary care, and by contracting with our independent physicians at competitive prices.

We attempt to control the healthcare costs of our HMO enrollees through capitated and discounted fee-for-service contracts, by emphasizing preventive care, entering into risk-sharing agreements with HMOs at hospitals that have favorable rate and utilization structures, and requiring prior authorization for specialist physician referrals. If we cannot maintain or improve our management of healthcare costs, our business, results of operations, financial condition, and ability to satisfy our obligations could be adversely affected.

Under all current HMO contracts, our affiliated physician organizations accept the financial risk for the provision of primary care and specialty physician services, and some ancillary healthcare services. If we are unable to negotiate favorable contract rates with providers of these services, or if our affiliated physician organizations are unable to effectively control the utilization of these services, our profitability would be negatively impacted. Our ability to manage healthcare costs is also diminished to the extent that we are unable to sub-capitate the specialists in our service areas at competitive rates. To the extent that our HMO enrollees require more frequent or extensive care, our operating margins may be reduced and the revenues derived from our capitation contracts may be insufficient to cover the costs of the services provided.

The revenue and profitability of our Medical Group segment could be significantly reduced and could also fluctuate significantly from period to period under Medicare's Risk Adjusted payment methodology.

In calendar 2004, CMS began a four-year phase-in of a revised compensation model for Medicare beneficiaries enrolled in Medicare Advantage plans. Previously, monthly capitation revenue was based primarily on age, sex and location.

The CMS revised payment model seeks to compensate Medicare managed care organizations based on the health status of each individual enrollee. Health plans/Medical Groups with enrollees that can be proven to require more care will receive higher compensation, and those with enrollees requiring less care will receive less. This is referred to by CMS as "Risk Adjustment."

Increased numbers of office visits by members, and submission of encounter data is required in order to receive incremental revenue, or not lose revenue for any given member. This requires a great deal of continuous effort on our part, and cooperation on the part of our contracted physicians and HMO enrollees. We have not always been able to gain this cooperation from the contracted physicians and enrollees, or devote the resources necessary to obtain incremental Risk Adjustment revenue, or avoid having previously received revenue taken back from us.

Additionally, because of the time required by CMS to process all of the submitted encounter data from all participating entities, we typically do not find out until the latter part of the calendar year what adjustments will be made to our Medicare revenue for the prior year, at which time those adjustments to revenue, which have historically been significant, are recorded.

In fiscal 2010 and 2009, we received approximately $4,000,000 and $4,300,000, respectively, in incremental Risk Adjustment revenue, which was recorded in the respective fiscal fourth quarter. This adjustment became known, and was recorded, in the fiscal fourth quarter, even though the majority of the adjustment related to earlier periods.

Given the deadlines for submitting data to CMS, and CMS's processing time in order to calculate these Risk Adjustment revenue changes, we have no way of reliably estimating the impact of Risk

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Adjustment until such time as those adjustments are made known by CMS. As such, retroactive Risk Adjustments will be recorded each year in the quarter they become known, notwithstanding that a significant portion of those adjustments will relate to earlier periods. These adjustments will continue to be significant and could be materially more or less than our estimates.

An increasing portion of our Medical Group revenue is "at risk" and difficult to project, which increases uncertainty regarding future revenues, cash flow projections, and profitability.

Historically, our Medical Group revenue has primarily consisted of contractually guaranteed capitation revenue from HMOs based on a fixed per-member-per-month rate. In recent years, new revenue sources including pay for performance, risk-sharing and risk adjustment have increased and will represent an increasingly significant portion of our total Medical Group revenue. These revenue sources and reimbursement methods are more difficult to project and have a much longer collection cycle. Pay for performance revenue is paid on an approximate one-year lag basis, and predicated on health plan funding being available as well as on the ability of the organization and its partner physicians to achieve certain criteria. These performance thresholds are typically in the areas of clinical measures, patient satisfaction, IT investment, encounter data submission and generic drug utilization. The ultimate receipt of pay for performance monies can vary with our relative performance in comparison to that of competitor medical groups and our ability to successfully modify physician behavior in these areas. Similarly, risk-sharing and risk adjustment revenues have more variability and volatility than capitated arrangements and can require a lengthy reconciliation and reimbursement process. As mentioned previously, incremental revenue generated by both sources involves not only our ability to control medical costs and influence provider and member behavior (i.e., office visits, encounter data submission, etc.), but also is contingent on certain other factors that are beyond our control.

Our profitability could be adversely affected by any changes that would reduce payments to HMOs under government-sponsored health care programs and recent changes affecting payments to non-contract hospitals under Medi-Cal Managed Care.

Although our affiliated physician organizations do not directly contract with CMS, during the fiscal years ended September 30, 2010 and 2009, our affiliated physician organizations received approximately $89,736,000 and $89,649,000 or 48% and 46%, respectively, of capitation revenues from HMOs related to contracts with Medicare, Medi-Cal and other government-sponsored health care programs. Consequently, any change in the regulations, policies, practices, interpretations or statutes adversely affecting payments made to HMOs under these government-sponsored health care programs could reduce our profitability. The recent California budget included reductions in funding for the Medi-Cal mental health managed care program, which could potentially reduce revenues for our hospital in Van Nuys. California continues to explore further reforms to payments to Medi-Cal managed care plans in light of California's ongoing budget crises.

The State of California enacted legislation in 2008 concerning the amount of payments to providers, including hospitals, for services furnished to Medi-Cal recipients enrolled in managed care plans with which the provider does not have a contract. Our hospitals furnish such services. Under the legislation, payments are limited to the regional average rate under Medi-Cal fee-for-service contracts for emergency services and 95% of this rate for post-stabilization services. These payment limits could adversely affect our hospitals' revenues.

If any of our hospitals lose their Joint Commission and CMS accreditation, such hospitals could become ineligible to receive reimbursement under Medicare or Medi-Cal.

Our hospitals are accredited, meaning that they are properly licensed under appropriate State laws and regulations, certified under the Medicare program and accredited by the Joint Commission

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(formerly known as the Joint Commission on Accreditation of Healthcare Organizations) and CMS Healthcare, Inc. The effect of maintaining accredited facilities is to allow such facilities to participate in the Medicare and Medi-Cal programs. We believe that all of our healthcare facilities are in material compliance with applicable federal, state, local and independent review body regulations and standards. However, should any of our healthcare facilities lose their accredited status and thereby lose certification under the Medicare or Medi-Cal programs, such facilities would be unable to receive reimbursement from either of those programs and our business could be harmed. Because the requirements for accreditation are subject to modification, it may be necessary for us to effect changes in our facilities, equipment, personnel and services in order to maintain accreditation. Such changes could be expensive and could harm our results of operations.

Controls designed to reduce inpatient services may reduce our hospital revenue.

Controls imposed by third party payors that are designed to reduce admissions and the average length of hospital stays, commonly referred to as "utilization management," have affected and are expected to continue to affect results for our hospital facilities. Utilization management reviews entail an evaluation of a patient's admission and course of treatment by healthcare payors. Inpatient utilization, average lengths of stay and occupancy rates continue to be negatively impacted by payor-required pre-admission authorization, utilization reviews and payor pressure to maximize outpatient and alternative healthcare delivery services for less acutely ill patients. Efforts to impose more stringent cost controls are expected to continue. Although we cannot predict the effect these changes will have on our operations, limitations on the scope of services for which we are reimbursed and/or downward pressure on reimbursement rates and fees as a result of increasing utilization management efforts by payors could have a material adverse effect on our business, financial position and results of operations.

Relocation of the Brotman emergency room facility in connection with the JHA option will require significant capital and may disrupt operations.

As part of the bankruptcy plan of reorganization for Brotman, replacement financing was secured from JHA West 16, LLC and JHA East 7, LLC, affiliates of the Los Angeles Jewish Home for the Aging (collectively, "JHA"), and exit financing was secured through Gemino Healthcare Finance, LLC ("Gemino"). The JHA transaction was comprised of two term debt components, a $16,000,000 tranche secured by assets on the west side of the Brotman campus commonly referred to as "Delmas West" and a $6,250,000 tranche on the main hospital pavilion on the east side of the property. The $16,000,000 tranche contains an option for JHA to acquire the Delmas West parcel, where JHA plans to construct a senior living facility, for a purchase price equal to the outstanding debt within 24 months of the effective date of the bankruptcy. In connection with JHA's exercise of its option to purchase the Delmas West parcel, Brotman will have to relocate its emergency room facilities and other related ancillary services to the main hospital pavilion on the east side of the property. Such relocation could take up to four years, could involve assistance from the City of Culver City in connection with the possible acquisition of a contiguous property, could cost an estimated $20,000,000 to $25,000,000, which might require additional debt, and could disrupt operations during periods of construction.

The JHA West loan is due on April 14, 2011. Brotman has had discussions with JHA regarding an extension of this loan, but has not yet reached any agreement with JHA regarding an extension. If Brotman is unable to extend or refinance this loan, it may default on such loan. Any default on the loan may have a material adverse effect on Brotman's business and financial condition, and may adversely affect its ability to continue its business as a going concern. Such default, may also have a material adverse effect on the consolidated financial position and results of the Company.

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Hospital operations are capital intensive and could prove to be a drain on cash.

Operating a hospital requires a significant continual investment in capital assets, particularly in hospital machinery and equipment. Due to obsolescence and heavy usage, hospital capital assets may require more frequent replacement, and at a higher cost relative to that in an independent physician association ("IPA"). With additional acquisitions of hospitals and expansion of our existing facilities, some of which are operating near capacity, the capital investment required to maintain hospital operations at an optimal level could be significant.

Additionally, according to the California Hospital Association, 1,022 hospitals statewide would have to be upgraded by the year 2013 to comply with seismic retrofitting guidelines established by legislation enacted in the 1990s. Hollywood Community Hospital is required to meet applicable compliance standards by January 1, 2013 and Norwalk Community Hospital is required to meet applicable compliance standards by January 1, 2030. We have applied for a HAZARDS U.S. ("HAZUS") re-evaluation of the seismic risk for Los Angeles Community Hospital and Brotman. Our Van Nuys Community Hospital is exempt from the seismic retrofitting guidelines because psychiatric hospitals are exempt from seismic retrofitting. (See "Business Description—Health Care Regulation—California Seismic Standards"). Further, Brotman's relocation of the emergency room facility in connection with JHA's exercise of the purchase option may negatively impact the HAZUS evaluation process as well as the related OSHPD approval since Brotman will build new facilities in a building that may have seismic issues prior to HAZUS approval which may complicate the requirements of the approval process. Any upgrading costs we incur in order to comply with seismic retrofitting guidelines for our hospitals may be significant.

If we do not continually enhance our hospitals with the most recent technological advances in diagnostic and surgical equipment, our ability to maintain and expand our markets will be adversely affected.

Technological advances are continually being made regarding computer-assisted tomography scanners, magnetic resonance imaging equipment, positron emission tomography scanners and other similar equipment. In order to effectively compete, we must continually assess our equipment needs and upgrade when technological advances occur. If our hospitals do not invest significantly and stay abreast of technological advances in the healthcare industry, patients may seek treatment from other providers and physicians may refer their patients to alternate sources.

If we are unable to identify suitable acquisition candidates or to negotiate or complete acquisitions on favorable terms, our prospects for growth could be limited. In addition, we may not realize the anticipated benefits of any acquisitions that we are able to complete.

Part of our business strategy is to grow through potential acquisitions in order to achieve economies of scale. Although we are regularly in discussions with potential acquisition candidates, it may be difficult to identify suitable acquisition candidates and to negotiate satisfactory terms with them. If we are unable to identify suitable acquisition candidates at favorable prices, our ability to grow by acquisition could be limited.

In addition, to the extent we are successful in identifying suitable acquisition candidates and making acquisitions, these acquisitions involve a number of risks, including:

•: we may find that the acquired company or assets do not further our business strategy, or that we overpaid for the company or assets, or that industry or economic conditions change, all of which may require a future impairment charge;
•: we may have difficulty integrating the operations and personnel of the acquired business and may have difficulty retaining the key personnel of the acquired business;

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•: we may have difficulty incorporating the acquired services with our existing services;
•: there may be customer confusion where our services overlap with those of entities that we acquire;
•: our ongoing business and management's attention may be disrupted or diverted by transition or integration issues and the complexity of managing geographically and culturally diverse locations;
•: we may have difficulty maintaining uniform standards, controls, procedures and policies across locations;
•: we may acquire companies that have material liabilities, including, among other things, for the failure to comply with healthcare laws and regulations;
•: the acquisition may result in litigation from terminated employees or third parties;
•: we may experience significant problems or liabilities associated with service quality, technology and legal contingencies;
•: we may spend considerable amounts of money (legal, accounting, diligence, etc.) in seeking an acquisition candidate and never complete the acquisition; and
•: acquisition candidate letters of intent may have large break-up fees that we could be liable for in the event we sign a letter of intent and do not complete the transaction.

In particular, our strategy for growth includes strategic acquisitions of hospitals. However, even if we are successful in completing further acquisitions, it may not be possible to integrate their operations into our operations or it may be difficult and time consuming to integrate the acquired hospitals' management services, information systems, billing and collection systems, finance department, medical records, and other key administrative functions, while at the same time managing a larger entity with a differing history, business model and culture. Management may be required to develop working relationships with providers and vendors with whom they have had no previous business experience. Management also may not be able to obtain the necessary economies of scale. Integration of acquired entities is vital for us to be able to operate effectively and to control variable (staffing) and fixed 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 realize the anticipated benefits of our acquisitions, including cost savings. There may be substantial unanticipated costs associated with acquisition and integration activities, any of which could result in significant one-time or on-going charges to earnings or otherwise adversely affect our operating results.

We may not be able to make future acquisitions without obtaining additional financing.

To finance any acquisitions, we may, from time to time, issue additional equity securities or incur additional debt. A greater amount of debt or additional equity financing could be required to the extent that our common stock fails to achieve or to maintain a market value sufficient to warrant its use in future acquisitions, or to the extent that acquisition targets are unwilling to accept common stock in exchange for their businesses. Our ability to incur additional debt will be restricted by our senior secured credit facility and the indenture governing the notes issued under the facility. Even if we were permitted to incur additional debt or determine to sell equity, we may not be able to obtain additional required capital on acceptable terms, if at all, which would limit our plans for growth. In addition, any capital we may be able to raise could result in increased leverage on our balance sheet, additional interest and financing expense, and decreased operating income.

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The acquisition of hospitals and subsequent integration with our Medical Group business may prove to be difficult and may outweigh the anticipated benefits of a hospital-Medical Group combination.

Our core business has historically been that of a healthcare management services company that manages independent physician associations providing healthcare services to HMO enrollees. In continuing to diversify acquisition targets beyond our Medical Group business, we will be facing a myriad of unique operational, financial and regulatory issues in a hospital environment that could prove to be a drain on existing resources, and be a significant distraction from other initiatives facing us. For instance, hospital revenue from Medicare, Medi-Cal and other third parties are tentative in nature and subject to audits by third-party fiscal intermediaries. In addition, acquiring, developing and integrating facilities may involve significant cash expenditures, expenses and unforeseen liabilities that could have a material adverse effect on our financial condition and results of operation. Finally, changing legislation on the funding and recognition of hospital revenues could negatively impact financial performance and cause earnings decreases. Moreover, in recent years Congress has enacted legislation regarding DSH payments revisiting the program's intent and methodologies for calculating payments to hospitals. There have recently been other initiatives proposed to reduce the overall funding of Medicare and Medi-Cal programs, coupled with increased regulation on the disbursement methodology for such funds. Unfavorable outcomes on such legislation could cause a reduction in revenues generated as compared to prior years.

Whenever we seek to make an acquisition of an entity that has an HMO contract, the HMO could potentially refuse to consent to the transfer of its contract, and this could effectively stop the acquisition or potentially deprive us of the revenues associated with that HMO contract if we choose to complete the acquisition without the HMO's consent.

Contracts with HMOs typically include provisions requiring the HMO to consent to the transfer of their contract before effecting any change in control of the healthcare provider party thereto. As a result, whenever we seek to make an acquisition, such acquisition may be conditioned upon the acquisition candidate's ability to obtain such consent from the HMOs with which it has contracted. Therefore, an acquisition could be delayed while an HMO seeks to determine whether it will consent to the transfer. While in our experience the HMOs limit their review to satisfying their regulatory responsibility to ensure that, following the acquisition, the post-acquisition entity will meet certain financial and operational thresholds, the language in many of the HMO agreements give the HMO the ability to decline to give their consent if they simply do not want to do business with the acquiring entity. If an HMO is unwilling for any reason to give its consent, this could deter us from completing the acquisition, or, if we complete an acquisition without obtaining an HMO's consent, we could lose the benefits associated with that HMO's contract.

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

Our success depends, in large part, on the skills, experience and efforts of our senior management team and on the efforts, ability and experience of key members of our local hospital management staffs, including our Chairman and Chief Executive Officer, Sam Lee, who is also Chief Executive Officer of Alta Hospitals System, LLC; our Chief Financial Officer, Mike Heather; our President of Alta Hospitals Subsidiary, David Topper; and Jeereddi Prasad, M.D., President of our ProMed Entities. In addition to these individuals, there are a number of other critical members of management whose loss would very negatively impact our operations. If for any reason we were to lose the services of any key member of management, we would need to find and recruit a qualified replacement quickly to avoid disrupting our business and reducing our profitability and revenue growth. We compete with other companies for executive talent, and it may not be possible for us to recruit a qualified candidate

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on a timely basis, or at all. The loss of the services of one or more members of our senior management team or of a significant portion of our local hospital management staffs could significantly weaken our management expertise and our ability to efficiently deliver healthcare services, which could harm our business.

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

We are highly dependent on the efforts, abilities and experience of our medical support personnel, including our nurses, pharmacists and lab technicians. We compete with other healthcare providers in recruiting and retaining qualified hospital management, nurses and other medical personnel. Hospitals are experiencing a severe ongoing shortage of nursing professionals, a trend which we expect to continue for some time. If the supply of qualified nurses declines in the markets in which our hospitals operate, it may require us to enhance wages and benefits to recruit and retain nurses and other medical support personnel or require us to hire expensive temporary personnel, and may result in increased labor expenses and lower operating margins at those hospitals. California has regulatory requirements to maintain specified nurse-staffing levels. To the extent we cannot meet those levels of staffing, the healthcare services that we provide in these markets may be reduced. In addition, to the extent that a significant portion of our employee base unionizes, or attempts to unionize, our labor costs could increase. We cannot predict the degree to which we will be affected by union activity or the future availability or cost of attracting and retaining talented medical support staff. If our general labor and related expenses increase, we may not be able to raise our rates correspondingly. Our failure to either recruit and retain qualified hospital management, nurses and other medical support personnel or control our labor costs could harm the results of our operations.

The performance of our hospital business segment depends on our ability to recruit and retain quality physicians.

Physicians generally direct the majority of hospital admissions, and the success of our hospitals depends, therefore, in part on the number and quality of the physicians on the medical staffs of our hospitals, the admitting practices of those physicians and maintaining good relations with those physicians. Physicians are often not employees of the hospitals at which they practice and, in many of the markets that we serve, most physicians have admitting privileges at other hospitals in addition to our hospitals. Such physicians may terminate their affiliation with our hospitals at any time. If we are unable to provide adequate support, personnel or technologically advanced equipment and hospital facilities that meet the needs of those physicians, they may be discouraged from referring patients to our facilities, admissions may decrease and our operating performance may decline.

Our revenues and profits could be diminished if we lose the services of key primary care physicians.

Substantially all of our Medical Group revenues are derived from our affiliated physician organizations. Key primary care physicians with large patient enrollment could retire, become disabled, terminate their provider contracts, get lured away by a competing IPA, or otherwise become unable or unwilling to continue practicing medicine or contracting with our affiliated physician organizations. Enrollees who have been served by such physicians could choose to enroll with competitors' physician organizations, reducing our revenues and profits. Moreover, we may not be able to attract new physicians into our affiliated physician organizations to replace the services of terminating physicians.

Physicians make hospital admitting decisions and decisions regarding the appropriate course of patient treatment, which, in turn, affect hospital revenue. Therefore, the success of our hospitals depends, in part, on the number and quality of the physicians on the medical staffs of our hospitals, the admitting practices of those physicians and our maintenance of good relations with those physicians. In

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many instances, physicians are not employees of our hospitals and, in a number of the markets that we serve, physicians have admitting privileges at other hospitals in addition to our hospitals. If we are unable to provide adequate support personnel or technologically advanced equipment and facilities that meet the needs of those physicians, they may be discouraged from referring patients to our facilities and our results of operations could be harmed.

Our ability to control labor and employee benefit costs could be hindered by continued acquisition activity.

As additional acquisitions are completed and our work force continues to grow, maintaining competitive salaries and employee benefits could prove to be cost prohibitive. The impact of inflation and the challenge of blending different benefit programs into our existing structure could lead to either a significant increase in compensation expense and reduced profitability, or a reduction in benefits with the potential outcomes of increased turnover and a reduced ability to attract quality employees.

We operate in a highly competitive market; increased competition could adversely affect our revenues.

A number of factors affect our HMO membership levels and patient census at our hospitals. The healthcare industry, including hospitals and Medical Groups, are highly competitive. In addition to the competition we face for acquisitions and physicians, we must also compete with other hospitals and healthcare providers for patients, which competition has continued to intensify in recent years. Our hospitals face competition from hospitals inside and outside of their primary service areas, including hospitals that operate newer facilities or provide more complex services. Patients in our primary service areas may travel to these other hospitals for a variety of reasons. These reasons include physician referrals or the need for services we do not offer. Patients who seek services from these other hospitals may subsequently shift their preferences to those hospitals for the services that we provide.

Some of the hospitals that compete with our hospitals are owned by government agencies or not-for-profit corporations. Tax-exempt competitors may have certain financial advantages not available to our facilities, such as endowments, charitable contributions, tax-exempt financing, and exemptions from sales, property and income taxes. In California some government hospitals are permitted by law to directly employ physicians while for-profit hospitals are prohibited from doing so. We also face increasing competition from physician-owned specialty hospitals and freestanding surgery, diagnostic and imaging centers for market share in high margin services and for quality physicians and personnel.

If competing healthcare providers are better able to attract patients, recruit and retain physicians, expand services or obtain favorable managed care and other contracts at their facilities, we may experience a decline in inpatient and outpatient volume levels. Our inability to compete effectively with other hospitals and other healthcare providers could cause local residents to use other hospitals. If our hospitals are not able to effectively attract patients, our business could be harmed.

In 2005, CMS began making public performance data relating to ten quality measures that hospitals submit in connection with their Medicare reimbursement. If any of our hospitals should achieve poor results (or results that are lower than our competitors) on these ten quality criteria, patient volumes could decline. In the future, other trends toward clinical transparency may have an unanticipated impact on our competitive position and patient volume.

The managed care industry is also highly competitive and is subject to continuing changes in the ways in which services are provided and providers are selected and paid. We are subject to significant competition with respect to physicians affiliating with our affiliated physician organizations. Some of our competitors have substantially greater financial, technical, managerial, marketing and other resources and experience than we do and, as a result, may compete more effectively than we can. Companies in other healthcare industry segments, some of which have financial and other resources greater than we do, may become competitors in providing similar services. We may not be able to

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continue to compete effectively in this industry. Additional competitors may enter our markets and this increased competition may have an adverse effect on our business, financial condition and results of operations.

Hospitals with union contracts could experience setbacks from unfavorable negotiations with union members.

Our Hollywood Community Hospital has a collective bargaining agreement with the Service Employees International Union ("SEIU") involving a small portion of the hospital staff. This agreement, which expires May 9, 2011, specifies employee benefits for those represented by the collective bargaining agreement, including compensation rates, hours of work, overtime, vacation, holiday, sick, and health and retirement benefits. In addition, Brotman has two unions—the SEIU and CNA—covering approximately 78% of the hospital employees. Unsuccessful negotiations between hospital officials and union representatives could have an unfavorable impact on day-to-day operations of that hospital and any increased costs that we are required to pay pursuant to a new collective bargaining agreement could materially and adversely affect our results of operations.

We may be required to obtain a Knox-Keene license or otherwise restructure our Medical Group segment if the assignable option agreement or our management services agreements with affiliated physician organizations are deemed invalid under California's prohibition against the corporate practice of medicine.

State laws specify who may practice medicine and limit the scope of relationships, including management agreements and stock purchase agreements, between medical practitioners and other parties. Under these laws, lay companies, like us and our subsidiaries, are prohibited from practicing medicine, exercising control over the medical and business aspects of a medical practice and owning stock in a medical corporation, and may be prohibited from sharing in the profits of a medical practice.

While we exercise control over the ownership of the stock in our affiliated Medical Groups through assignable option agreements, the options are not exercisable by us or by any non-professional organization, and neither we nor our subsidiaries directly own the stock in our affiliated Medical Groups. Rather, we have the right to designate the physician who will purchase the capital stock of our affiliated physician organizations. We and our subsidiaries do not employ physicians to provide medical services, exert control over medical decision-making or represent to the public that we offer medical services. Our subsidiaries have entered into management services agreements with our affiliated physician organizations pursuant to which the physician organizations reserve exclusive control and responsibility for all aspects of the practice of medicine and the delivery of medical services.

Nevertheless, it is possible that the California Medical Board, a different regulatory agency or a court could determine that the assignable option agreements, either independently or coupled with the management services agreements, confer impermissible control over the business and/or medical operations of the affiliated physician groups or their participating physicians, that the management fee results in profit sharing or that we are the beneficial owner of the Medical Groups' stock in violation of the corporate practice of medicine doctrine. If there were a determination that the assignable options and/or management services agreements constituted a corporate practice of medicine violation, these arrangements could be deemed invalid, potentially resulting in a loss of our Medical Group revenues and we, as well as the shareholder nominee, could be subject to criminal or civil penalties or an injunction for practicing medicine without a license or aiding and abetting the unlicensed practice of medicine. This could also force a restructuring of our Medical Group management arrangements, including possible revisions of the management services agreements, which might include a modification of the management fee or elimination of any portion of the fee tied to Medical Group profits, and/or establishing an alternative structure, such as obtaining a Knox-Keene license which would permit us to operate a physician network without being subject to the corporate practice of medicine prohibition.

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There can be no assurance that such a restructuring would be feasible, or that it could be accomplished within a reasonable time frame without a material adverse effect on our operations and financial results.

If our assignable option agreements with our physician shareholder nominee of our affiliated physician organizations are deemed invalid under California or federal law, are terminated as a result of changes in California law or application of Financial Accounting Standards Board policies, it would impact our consolidation of our affiliated physician organizations and total revenues.

Our financial statements are consolidated and include the accounts of the Company and all majority owned subsidiaries and controlled Medical Group entities, which control is effectuated through the existence of a call option under which we have the ability to require the holders of all of the voting common stock of the underlying entities to sell their shares at a fixed nominal price ($1,000) to another designated physician chosen by us. All adjustments considered necessary for a fair presentation of the results as of the date of, and for the interim periods presented, which consist solely of normal recurring adjustments, have been included. All significant inter-company balances and transactions have been eliminated in consolidation. In the event of a change in FASB interpretations, a determination by a regulatory agency or a court that the assignable option agreements or the Company's management relationships with its affiliated Medical Groups are not valid or if there were a change in California or federal law, we may be forced to no longer consolidate the revenues of our affiliated physician organizations. See "Business Description—Health Care Regulation—Corporate Practice of Medicine and Professional Licenses."

In the event our physician shareholder nominee under the assignable option agreements was to file a personal bankruptcy, we may need court approval to replace such physician nominee under such option agreements.

Under our assignable option agreements with our physician shareholder nominee, we can replace at any time our physician shareholder nominee for consideration of $1,000. In the event our physician shareholder nominee was to file a personal bankruptcy, we may need court approval to replace such physician nominee under the option agreements, which may require a significant amount of time, may require payment of an amount much greater than the normal consideration in the option agreements or may not be given by the bankruptcy court. To the extent we are unable to nominate the physician shareholder, we may lose a certain degree of control over our Medical Groups. In addition, in the event of the bankruptcy of the sole physician shareholder, our stockholders and creditors could experience delays in recovering the value of the IPA-related collateral held by such physician shareholder or could lose the value of these assets entirely.

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

Failure to comply with federal and state regulations could result in substantial penalties and changes in business operations. Companies that provide healthcare services are required to comply with many highly complex laws and regulations at the federal, state and local levels, including, but not limited to, those relating to the adequacy of medical care, billing for services, patient privacy, equipment, personnel, operating policies and procedures and maintenance of records. We, along with our hospitals and our affiliated physician organizations, are subject to numerous federal and state statutes and regulations that are applicable to healthcare organizations and businesses generally, including the corporate practice of medicine prohibition, federal and state anti-kickback laws and federal and state laws regarding the use and disclosure of patient health information. If our business operations are found to be in violation of any of the laws and regulations to which we are subject, we

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may be subject to the applicable penalty associated with the violation, including civil and criminal penalties, damages, fines, and increased legal expenses, we may be required to make costly changes to our business operations, and we may be excluded from government reimbursement programs. The laws and regulations that our hospitals and affiliated physician organizations are subject to are complex and subject to varying interpretations. Any action against our hospitals or affiliated physician organizations for violation of these laws or regulations, even if we successfully defended against it, could cause us to incur significant legal expenses 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 profitability and curtailing our growth. Although we believe that we are in compliance with all applicable laws and regulations, if we fail to comply with any such laws or regulations, we could suffer civil or criminal penalties, including the loss of licenses to operate our facilities. We could also become unable to participate in Medicare, Medi-Cal, and other federal and state healthcare programs that significantly contribute to our revenue.

Because many of the laws and regulations to which we are subject are relatively new or highly complex, in many cases we do not have the benefit of regulatory or judicial interpretation. In the future, it is possible that different interpretations or enforcement of such laws and regulations could require us to make changes in our facilities, equipment, personnel, services or capital expenditure programs.

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

Significant media and public attention has been focused on the hospital industry due to ongoing investigations related to referrals, cost reporting and billing practices, laboratory and home healthcare services and physician ownership of joint ventures involving hospitals. Both federal and state government agencies have announced heightened and coordinated civil and criminal enforcement efforts and the Office of the Inspector General of the U.S. Department of Health and Human Services and the U.S. Department of Justice have, from time to time, established enforcement initiatives that focus on specific areas of suspected fraud and abuse. Recent initiatives include a focus on hospital billing practices.

We closely monitor our billing and other hospital practices to maintain compliance with prevailing industry interpretations of applicable laws and regulations and we believe that our practices are consistent with current industry practices. However, government investigations could be initiated that are inconsistent with industry practices and prevailing interpretations of existing laws and regulations. In public statements, governmental authorities have taken positions on issues for which little official interpretation had been previously available. Some of those positions appear to be inconsistent with practices that have been common within the industry and, in some cases, have not yet been challenged. Moreover, some government investigations that were previously conducted under the civil provisions of federal law are now being conducted as criminal investigations under fraud and abuse laws.

We cannot predict whether we will be the subject of future governmental investigations or inquiries. Any determination that we have violated applicable laws or regulations or even a public announcement that we are being investigated for possible violations could harm our business.

The healthcare industry is subject to many laws and regulations designed to deter and prevent practices deemed by the government to be fraudulent or abusive.

Unless an exception applies, the portion of the Social Security Act commonly known as the "Stark law" prohibits physicians from referring Medicare or Medi-Cal patients to providers of enumerated "designated health services" with whom the physician or a member of the physician's immediate family has an ownership interest or compensation arrangement. Such referrals are deemed to be "self

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referrals" due to the physician's financial relationship with the entity providing the designated health services. Moreover, many states have adopted or are considering similar legislative proposals, some of which extend beyond the scope of the Stark law to prohibit the payment or receipt of remuneration for the prohibited referral of patients for designated healthcare services and physician self-referrals, regardless of the source of the payment for the patient's care.

Companies in the hospital industry are subject to Medicare and Medi-Cal anti-fraud and abuse provisions, known as the "anti-kickback statute." As a company in the hospital industry, we are subject to the anti-kickback statute, which prohibits some business practices and relationships related to items or services reimbursable under Medicare, Medi-Cal and other federal healthcare programs. For example, the anti-kickback statute prohibits hospitals from paying or receiving remuneration to induce or arrange for the referral of patients or purchase of items or services covered by a federal or state healthcare program. If regulatory authorities determine that any of our hospitals' arrangements violate the anti-kickback statute, we could be subject to liabilities under the Social Security Act, including:

•: criminal penalties
•: civil monetary penalties; and/or
•: exclusion from participation in Medicare, Medi-Cal or other federal healthcare programs, any of which could impair our ability to operate one or more of our hospitals profitably.

We systematically review all of our operations on an ongoing basis and believe that we are in compliance with the Stark law and similar state statutes. When evaluating strategic joint ventures or other collaborative relationships with physicians, we consider the scope and effect of these statutes and seek to structure the relationships in full compliance with their provisions. We also maintain a company-wide compliance program in order to monitor and promote our continued compliance with these and other statutory prohibitions and requirements. Nevertheless, if it is determined that certain of our practices or operations violate the Stark law or similar statutes, we could become subject to civil and criminal penalties, including exclusion from the Medicare or Medi-Cal programs and loss of government reimbursement. The imposition of any such penalties could harm our business.

We may be subjected to actions brought by the government under anti-fraud and abuse provisions or by individuals on the government's behalf under the False Claims Act's "qui tam" or whistleblower provisions.

Whistleblower provisions allow private individuals to bring actions on behalf of the government alleging that the defendant has defrauded the federal government. Defendants found to be liable under the False Claims Act may be required to pay three times the actual damages sustained by the government, plus mandatory civil penalties ranging between $5,500 and $11,000 for each separate false claim.

There are many potential bases for liability under the False Claims Act. Liability often arises when an entity knowingly submits a false claim for reimbursement to the federal government. The False Claims Act defines the term "knowingly" broadly. Although simple negligence will not give rise to liability under the False Claims Act, submitting a claim with reckless disregard for its truth or falsity constitutes a "knowing" submission under the False Claims Act and, therefore, will give rise to liability. In some cases, whistleblowers or the federal government have taken the position that providers, who allegedly have violated other statutes, such as the anti-kickback statute and the Stark law, have thereby submitted false claims under the False Claims Act. In addition, a number of states, including California, have adopted their own false claims provisions as well as their own whistleblower provisions whereby a private party may file a civil lawsuit in state court. See "Business Description—Health Care Regulations—False Claims Act".

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Although we intend and will endeavor to conduct our business in compliance with all applicable federal and state fraud and abuse laws, many of these laws are broadly worded and may be interpreted or applied in ways that cannot be predicted. Therefore, we cannot assure you that our arrangements or business practices will not be subject to government scrutiny or be found to be in compliance with applicable fraud and abuse laws.

We are required to comply with laws governing the transmission, security and privacy of health information that require significant compliance costs, and any failure to comply with these laws could result in material criminal and civil penalties.

HIPAA and California's patient privacy laws require us to comply with standards regarding the exchange of health information and the security and privacy of patient medical information within our company and with third parties, such as healthcare providers, business associates and our members. To the extent that state laws impose stricter privacy standards than HIPAA privacy regulations, HIPAA does not preempt the state standards and laws. The California Medical Information Act, and other California laws contain stringent privacy and security protections, many of which are not preempted by HIPAA, the HITECH Act, Title XIII, Div. A and Title IV, Div. B of the American Recovery and Reinvestment Act of 2009, Pub. L. No. 111-5, greatly enhanced HIPAA's patient privacy and security obligations.

Given the complexity of the HIPAA, HITECH Act and California privacy restrictions, the possibility that the regulations may change, and the fact that the regulations are subject to changing and potentially conflicting interpretation, our ability to comply with the HIPAA, HITECH Act and California privacy requirements is uncertain and the costs of compliance are significant. Furthermore, California's promulgation of stricter laws, and uncertainty regarding many aspects of California's requirements, make compliance more difficult. To the extent that we submit electronic healthcare claims and payment transactions that do not comply with the electronic data transmission standards established under HIPAA, payments to us may be delayed or denied. Additionally, the costs of complying with any changes to the HIPAA and California privacy restrictions may have a negative impact on our operations. We could be subject to criminal penalties and civil sanctions for failing to comply with the HIPAA and California privacy restrictions, which could result in the incurrence of significant monetary penalties. See "Business Description—Health Care Regulation—HIPAA Transaction, Privacy and Security Requirements."

We cannot predict the effect that health care reform and other changes in government programs may have on our business, financial condition, results of operations or cash flows.

The Patient Protection and Affordable Care Act as amended by the Health Care and Education Reconciliation Act of 2010 ("Health Care Reform Legislation") was signed into law in March 2010. In general, the Health Care Reform Legislation seeks to reduce health care costs and decrease over time the number of uninsured legal U.S. residents, by among other things, requiring employers to offer, and individuals to carry, health insurance or be subject to penalties. However, it is difficult to predict the full impact of the Health Care Reform Legislation due to the law's complexity and current lack of implementing regulations or interpretive guidance, as well as our inability to foresee how individuals and businesses will respond to the choices available to them under the law. Furthermore, many of the provisions of the Health Care Reform Legislation that expand insurance coverage will not become effective until 2014 or later. It is also possible that implementation of these and other provisions could be delayed or even blocked due to court challenges, and there may be efforts to repeal or amend the law. In addition, the Health Care Reform Legislation will result in increased legislative and regulatory changes in the State of California, which we are unable to predict at this time, in order for California to comply with new federal mandates, such as the requirement to establish health insurance exchanges and to participate in grants and other incentive opportunities.

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The Health Care Reform Legislation contains a number of provisions designed to significantly reduce Medicare and Medicaid program spending, including reductions in Medicare market basket updates and Medicare and Medicaid disproportionate share funding. A significant portion of both our patient volumes and, as a result, our revenues is derived from government health care programs, principally Medicare and Medi-Cal. Reductions to our reimbursement under the Medicare and Medi-Cal programs by the Health Care Reform Legislation could adversely affect our business and results of operations, to the extent such reductions are not offset by increased revenues from providing care to previously uninsured individuals.

Because of the many variables involved, we are unable to predict the net effect on us of the reductions in Medicare and Medi-Cal spending, the expected increases in revenues from providing care to previously uninsured individuals, and numerous other provisions in the law that may affect us. In addition to the Health Care Reform Legislation and any changes thereto, we remain subject to other legislative or regulatory changes that may take place at the federal or state level. See also "Future reforms in healthcare legislation and regulation could reduce our revenues and profitability," below.

Future reforms in healthcare legislation and regulation could reduce our revenues and profitability.

In addition to the Health Care Reform Legislation and any subsequent changes in such legislation, President Obama and Congress may consider other proposals for healthcare reform.

Additional changes to the public health care system or the Medi-Cal and/or Medicare programs may impact our profitability. For example, a significant percentage of our revenue is based on payments received from Medicare Advantage plans. As a result, any future changes to the Medicare Advantage program may significantly affect the amounts of payment we receive for services that our providers render. Changes to the current system also may increase our administrative costs, particularly during the transition from the current payment model to the new system. Any other changes to the payment system to hospitals, such as tying payment to patient quality of care or bundling payments to hospitals to cover the costs of treating patients during and immediately after their admission, may impact our receipt of payments.

In addition to the Health Care Reform Legislation, numerous other legislative initiatives have been introduced or proposed in recent years that would also result in major changes in the healthcare delivery system on a national or a state level. Among the other proposals that have been introduced are California healthcare coverage for the uninsured and price controls on hospitals. The State of California has also recently adopted AB 1383 which significantly changes the Medi-Cal reimbursement system for hospitals. AB 1383 provides for fee assessments on hospitals relating to Medicaid services performed over the period April 1, 2009 through December 31, 2010 that together with federal matching funds is used to fund supplemental payments to hospitals. It is possible that the State of California will propose legislation similar to AB 1383 that will take effect after December 31, 2010. Such a proposal, like AB 1383, could also include a fee or tax that together with federal matching funds could be used to fund supplemental payments to hospitals, and could result in lowered revenue at our hospital. Further, the State of California is considering various other changes to the Medi-Cal program including seeking a federal waiver to implement widespread changes that could have a significant adverse effect on our hospital's Medi-Cal revenue.

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services under the new prospective payment system once that system is developed. These changes could have a significant adverse effect on our hospitals' Medi-Cal revenue.

We cannot predict whether changes will be made to the Healthcare Reform legislation or any of the proposals listed above or any other proposals will be adopted and, if adopted, no assurances can be given that their implementation will not have a material adverse effect on our business, financial condition or results of operations. The costs of implementing some of these proposals could be financed, in part, by reductions in the payments made to healthcare providers under Medicare, Medi-Cal, and other government programs. Future legislation, regulations, interpretations, or other changes to the healthcare system could reduce our revenues and profitability.

Recently enacted legislation may require us to spend significant capital on an electronic health record system to benefit from Medicare financial incentives and avoid financial and other penalties.

President Obama's desire to encourage the adoption of new health information technology has resulted in the enactment under the Health Information Technology for Economic and Clinical Health Act (the "HITECH Act") of a system of incentives and disincentives for hospitals and non-hospital based physicians to purchase and use electronic health record technology. Beginning in fiscal year 2011 for hospitals and calendar year 2011 for non-hospital based physicians, the HITECH Act provides financial incentives for "meaningful" EHR users of "certified" electronic health record ("EHR") technology. To be a meaningful EHR user, hospitals and non-hospital based physicians must use certified EHR technology to meet use objectives and measures specified by the Centers for Medicare and Medicaid Services in the final rule implementing the meaningful use incentive program. Meeting the specified criteria for meaningful use may prove difficult for many providers even after they have installed certified EHR technology. Hospitals and non-hospital based physicians who become "meaningful" EHR users over the next two to three years will maximize their incentive payments under Medicare and Medicaid. Hospitals and non-hospital based physicians who are not meaningful EHR users before 2015 will have no opportunity to receive meaningful use incentive payments. The HITECH Act phases down incentive payments significantly starting in 2014, and no incentive payments will be made after 2016. Instead, from 2017-2020, Medicare hospitals and non-hospital based physicians who do not make meaningful use of EHR technology will be penalized a percentage of their Medicare reimbursements. It is possible that any participation in the Medicare and Medicaid programs after 2020 may require meaningful use of certified EHR technology. We have recently entered into contracts with third party vendors that are intended to provide us with the technology and services required to (i) comply with the HITECH Act, (ii) achieve meaningful use of EHR technology prior to 2013, and (iii) receive the HITECH Act's Medicare incentive payments. We will have to expend considerable money and administrative resources under this contract to implement EHR technology. We may be unable even after the implementation of the EHR technology to meet, either initially or on an on-going basis, the meaningful use criteria required to receive the HITECH Act's Medicare incentive payments, avoid future penalties and, perhaps, even to continue to participate in the Medicare and Medicaid programs. There can be no assurance that the Company will have sufficient financial and administrative resources and operational expertise and commitment to comply with the meaningful use criteria to benefit from the financial incentives and avoid financial and other penalties.

If our affiliated physician organizations are not able to satisfy California Department of Managed Health Care financial solvency requirements, we could become subject to sanctions and our ability to do business in this segment in California could be limited or terminated.

The California Department of Managed Health Care ("DMHC") has instituted financial solvency regulations. The regulations are intended to provide a formal mechanism for monitoring the financial solvency of capitated physician groups. Management believes that our affiliated physician organizations

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that are subject to these regulations will be able to comply with them. However, these regulations could limit our ability to use our cash resources to make future hospital acquisitions.

Under the regulations, our affiliated physician organizations are required to comply with specific 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 qualified receivables, divided by the organization's total unpaid claims liability.) The regulations currently require a cash-to-claims ratio of 0.75.
•: Submit periodic reports to the DMHC containing various data and attestations regarding performance and financial solvency, including IBNR (incurred but not reported) calculations and documentation, and attestations as to whether or not the organization was in compliance with the Knox-Keene Health Care Service Plan Act of 1975 (the "Knox-Keene Act") requirements related to claims payment timeliness, had maintained positive tangible net equity (i.e., at least $1.00), and had maintained positive working capital (i.e., at least $1.00).

In a case where an organization is not in compliance with any of the above criteria, the organization would be required to describe in the report submitted to the DMHC the reasons for non-compliance and actions to be taken to bring the organization into compliance. Further, under these regulations, the DMHC will make public some of the information contained in the reports, including, but not limited to, whether or not a particular physician organization met each of the criteria. In the event our affiliated physician organizations are not able to meet certain of the financial solvency requirements, and fail to meet subsequent corrective action plans, we could be subject to sanction, or limitations on, or removal of, our ability to do business in this segment in California. Our affiliated physician organizations had a cash-to-claims ratio at September 30, 2010 of 3.50, which was significantly in excess of the minimum DMHC requirement. We also significantly exceeded the DMHC's tangible net equity and minimum working capital requirements.

Because our business is currently limited to the Southern California area, any reduction in our revenues and profitability from local economic, regulatory, environmental and other developments would not be offset by operations in other geographic areas.

To date, we have developed our business within only one geographic area to take advantage of economies of scale. Due to this concentration of business in a single geographic area, we are exposed to potential losses resulting from economic, regulatory, environmental and competition changes in Southern California. A natural disaster or other catastrophic event could affect us more significantly than other companies with less geographic concentration. Specifically, mudslides, earthquakes, wildfires and other natural disasters occur frequently in California. Potential damage and disruption in our facilities or employees' homes located in California as a result of mudslides, earthquakes, wildfires or other natural disasters could be substantial. If we experience mudslides, earthquakes, wildfires or other natural disasters at any of our facilities or employees' homes, our reputation and results of operations could be harmed due to financial losses to repair or rebuild our facilities or disruption to our customers or employees that could hurt our ability to effectively provide our services. Should any adverse economic, regulatory, environmental or other developments occur in Southern California, our business, financial condition, results of operation or cash flows could be materially adversely affected.

We may be unable to expand into some geographic areas, or may be unable to do so without incurring significant additional costs.

We are likely to incur additional costs if we enter states or other counties in California where we do not currently operate. Our rate of expansion into other geographic areas may also be inhibited by:

•: our inability to develop a network of physicians, hospitals and other healthcare providers that meets our requirements, the requirements of the community and those of government regulators;
•: competition for physicians and patients;
•: the cost of providing healthcare services in those areas; and
•: demographics and population density.

Accordingly, we may be unsuccessful in entering other metropolitan areas, counties or states.

Our overall business results may suffer from the recent economic downturn.

Recently, the U.S. economy has weakened significantly. Tightening credit markets, depressed consumer spending and higher unemployment rates continue to pressure many industries. During economic downturns, governmental entities often experience budgetary constraints as a result of increased costs and lower than expected tax collections. These budgetary constraints may result in decreased spending for health and human service programs, including Medicare, Medi-Cal and similar programs, which represent significant payor sources for our hospitals and Medical Groups. Other risks we face from general economic weakness include potential declines in the population covered under managed care agreements, patient decisions to postpone or cancel elective and non-emergent healthcare procedures, potential increases in the uninsured and underinsured populations and further difficulties in our collecting patient co-payment and deductible receivables.

We must evaluate the effectiveness of our disclosure controls and internal control over financial reporting on a periodic basis and publicly disclose the results of these evaluations and related matters.

Our management is required to periodically evaluate the effectiveness of our disclosure controls and procedures and our internal control over financial reporting. We are also required to disclose in our periodic reports with the SEC any changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. The rules governing the standards that must be met for management to assess the effectiveness of our internal control over financial reporting are complex and require significant documentation, testing and possible remediation. Compliance with these rules has resulted in increased expenses and the devotion of significant management resources.

Our evaluation of our disclosure controls and procedures may reveal material weaknesses in our internal control over financial reporting. If we identify a material weakness, we would be required to conclude that our internal control over financial reporting is ineffective and disclose this conclusion, which could harm our business.

We are required to upgrade and modify our management information systems to accommodate growth in our business and changes in technology and to satisfy new government regulations. As we seek to implement these changes, we may experience complications, delays and increasing costs, which could disrupt our business and reduce our profitability.

We have developed sophisticated management information systems that process and monitor patient case management and utilization of physician, hospital and ancillary services, claims receipt and claims payments, patient eligibility and other operational data required by management. These systems

require ongoing modifications, improvements or replacements as we expand and as new technologies become available. We have a centralized business office ("CBO") currently located in Bellflower, California to meet the management information systems needs of our four Alta hospitals. Although Brotman currently outsources all of its information technology and management information systems needs, we currently plan to integrate Brotman into our CBO in the Spring of 2011. This transition may result in substantial cost and disrupt operations. Full integration of Brotman into our CBO may take up to 24 months, or it may not even be possible.

We may also be required to modify our management information systems in order to comply with new government regulations. For example, regulations adopted under HIPAA have required us to comply with new electronic healthcare transactions and conduct standards, uniform standards for data reporting, formatting and coding, and standards for ensuring the privacy of individually identifiable health information. This required us to make significant changes to our management information systems, at substantial cost. Similar modifications, improvements and replacements may be required in the future at additional substantial cost and could disrupt our operations during periods of implementation. Moreover, implementation of such systems is subject to the availability of information technology and skilled personnel to assist us in creating and implementing the systems. The complications, delays and cost of implementing these changes could disrupt our business and reduce our profitability. In addition, any system failure that causes an interruption in service or availability of our systems could adversely affect operations or delay the collection of revenues.

We and our hospitals and affiliated physician organizations may become subject to claims of medical malpractice or HMO bad-faith liability claims for which our insurance coverage may not be adequate. Such claims could materially increase our costs and reduce our profitability.

In the ordinary course of business, we may be subject to medical malpractice lawsuits and other legal actions arising from our operations. These actions may involve large claims and significant defense costs. In an effort to resolve one or more of these matters, we may choose to negotiate a settlement. Amounts we pay to settle any of these matters may be material. To mitigate a portion of this risk, we maintain professional malpractice liability, general liability insurance coverage and managed care errors and omissions insurance for these potential claims in amounts above our self-insured retention level that we believe to be appropriate for our operations. However, some of these claims could exceed the scope of the coverage in effect, or coverage of particular claims could be denied. It is possible that successful claims against us that are within the self-insured retention level amounts, when considered in the aggregate, could have an adverse effect on our results of operations, cash flows, financial condition or liquidity. Furthermore, insurance coverage in the future may not continue to be available at a cost allowing us to maintain adequate levels of insurance with acceptable self-insured retention level amounts. Also, one or more of our insurance carriers may become insolvent and unable to fulfill its obligation to defend, pay or reimburse us when that obligation becomes due. In addition, physicians using our hospitals may be unable to obtain insurance on acceptable terms. Our subsidiary hospitals are subject to medical malpractice lawsuits, general liability lawsuits and other legal actions. We believe, based on our past experience and actuarial estimates, that our insurance coverage is sufficient to cover claims arising from the operations of our subsidiary hospitals. However, if payments for claims and related expenses exceed our estimates or if payments are required to be made by us that are not covered by insurance, our business could be harmed.

If our goodwill and intangible assets become impaired, the impaired portion has to be written off, which will materially reduce the value of our assets and reduce our net income for the year in which the write-off occurs.

As of September 30, 2010, goodwill totaled approximately $153,250,000 and other intangible assets totaled approximately $42,159,000 for a combined total of $195,409,000, representing approximately

51% of our total assets. Of these amounts, approximately $24,373,000 was attributable to goodwill and approximately $2,784,000 was attributable to identifiable intangible assets recorded in connection with the Brotman Acquisition.

Under U.S. generally accepted accounting principles ("GAAP"), we are required to evaluate the carrying value of goodwill and indefinite life intangible assets for impairment at least on an annual basis, or more frequently if certain indicators are encountered. A two-step impairment test is used to identify potential goodwill impairment and to measure the amount of goodwill impairment loss to be recognized (if any). The first step of the goodwill impairment test, which is used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired, making the second step of the impairment test unnecessary.

A finding that the value of our goodwill and intangible assets has been impaired requires us to write off the impaired portion, which significantly reduces the value of our assets and reduces our net income for the year in which the write-off occurs.

Our hospital revenues and volume trends may be adversely affected by certain factors over which we have no control, including weather conditions, severity of annual flu seasons and other factors.

Our hospital revenues and volume trends are dependent on many factors, including physicians' clinical decisions and availability, payor programs shifting to a more outpatient-based environment, whether or not certain services are offered, seasonal and severe weather conditions, earthquakes, current local economic and demographic changes and the intensity and timing of yearly flu outbreaks. Any of these factors could have a material adverse effect on our revenues and volume trends, and none of these factors will be within the control of our management.

The financial statements of Brotman are being presented on a standalone basis and is expected to include a Going Concern emphasis paragraph

The audit opinion for those standalone financial statements reflects the fact that Brotman's auditors have concluded that there is substantial doubt about Brotman's ability to continue as a going concern, resulting from liquidity issues and the potential for the JHA debt to be called within twelve months from the date of issuance of those standalone financial statements. This uncertainty may negatively impact the carrying value of the Company's investment in Brotman and could result in the future impairment of Goodwill. No adjustments have been recorded in the consolidated financial statements from any losses that may result from this uncertainty.

We also face other risks that could adversely affect our business, financial condition or results of operations, which include:

•: any requirement to restate financial results in the event of inappropriate application of accounting principles;
•: a significant failure of our internal control over financial reporting;
•: failure of our prevention and control systems related to employee compliance with internal policies, including data security;
•: failure to protect our proprietary information;
•: failure of our corporate governance policies or procedures;
•: failure to meet covenants or requirements under our loan agreements which could impact our liquidity and ability to make future acquisitions,

•: the fact that Brotman has a history of losses and defaults under indebtedness owed to its creditors and its ability to return to profitability is subject to its management's ability to revise and implement the turnaround plans and to generate sufficient cash from operations to meet its obligations.;
•: Recently issued accounting standards, not required for adoption as of September 30, 2010, are currently being monitored and reviewed for any potential impacts to the Company; and
•: risks that the merger disrupts our current plans and operations and the potential difficulties in employee retention as a result of the transaction;
•: our ongoing business and management's attention may be disrupted or debated by transition or integration issues; and
•: the merger has and may result in litigation.

Item 1B. Unresolved Staff Comments.

None.

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Item 2. Properties.

We own or control through our subsidiaries, Alta Hospitals System, LLC and Prospect Hospital Advisory Services, Inc., the following real property:

Entity	Location	Description

Hollywood Community Hospital	6245 De Longpre Ave. Los Angeles, CA 90028 and 6228 Leland Way Los Angeles, CA 90028	Hospital with 100 licensed beds with 49,152 square feet of improvements situated on 1.88 acres of land.
Los Angeles Community Hospital	4081 East Olympic Blvd. Los Angeles, CA 90023	Hospital with 130 licensed beds with 64,024 square feet of improvements situated on 2.01 acres of land.
Los Angeles Community Hospital	4057/4059 East Olympic Blvd. Los Angeles, CA 90023	Hospital clinic with 5,520 square feet of improvements.
Norwalk Community Hospital	13222 Bloomfield Ave. Norwalk, CA 90650	Hospital with 50 licensed beds with 23,530 square feet of improvements situated on 1.88 acres of land.
Van Nuys Community Hospital	14433 Emelita St. Van Nuys, CA 91401	Psychiatric hospital with 59 licensed beds with 34,192 square feet of improvements situated on 1.86 acres of land.
Brotman Medical Center	3828 Delmas Terrace Culver City, CA 90232	Hospital Pavilion with 420 licensed beds with 44,301 square feet of improvements.
Brotman Medical Center	3847 Delmas Terrace Culver City, CA 90232	Hospital Tower with 14,497 square feet of improvements.
Brotman Medical Center	3828 Hughes Avenue Culver City, CA 90232	Outpatient and hospital support facilities with 39,000 square feet of improvements.
Brotman Medical Center	3817 Watseka Avenue Culver City, CA 90232	Plant operations building with 3,957 square feet of improvements.

In addition, we, or our affiliated physician organizations, currently lease space for administrative and medical offices, some of which is shared space, as follows:

Medical or Independent Practice Association Offices

Entity		Location		Purpose		Lease Term; Renewal		Current Monthly Rent

Prospect Medical Group(1)		Santa Ana, CA		Shares space with Prospect Medical Systems		5 years; 2010		$	47,518

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Administrative Offices

Entity	Location	Purpose	Lease Term; Renewal	Current Monthly Rent

Prospect Medical Holdings(3)	Los Angeles, CA	Shares office space with Alta Hospitals System LLC	7 years; 2015	$	27,114
Prospect Medical Holdings(5)	Culver City, CA	Office space	2 yrs, 4 mos; 2012	$	6,000
Prospect Medical Systems(2)	Santa Ana, CA	Shares space with Prospect Medical Group	3 years; 2013	$	33,293
Prospect Medical Systems(2)	Santa Ana, CA	Shares space with Prospect Medical Group	5 years; 2011	$	17,200
ProMed Health Care Administrators, Inc.	Ontario, CA	Office space shared with Pomona Valley Medical Group and Upland Medical Group	10 years; 2014	$	42,723
ProMed Health Care Administrators, Inc.	Ontario, CA	Storage Space	Month-to-month	$	1,210
Alta Hospitals System, LLC(3)	Los Angeles, CA	Shares office space with Prospect Medical Holdings	7 years; 2015	$	27,114
Alta Hospitals System, LLC(6)	Norwalk, CA	Office space	7 years; 2017	$	26,003
Alta Hospitals System, LLC(6)	Bellflower, CA	Office space	2011	$	13,352
Norwalk Community Hospital	Norwalk, CA	Medical office space	5 years; 2014	$	1,010
Hollywood Community Hospital	Hollywood, CA	Administrative office space	2 years; 2011	$	3,250
Brotman Medical Center	Culver City, CA	Medical office space	6 years; 2012	$	6,498
Brotman Medical Center(4),(6)	Culver City, CA	Office space	2011	$	9,097
Brotman Medical Center	Culver City, CA	Medical office space	10 years; 2019	$	9,295

(1): Prospect Medical Group includes all affiliated physician organizations that are wholly-owned subsidiaries of Prospect Medical Group.
(2): On June 30, 2010, Prospect Medical Systems executed an amended and restated office lease that provides for an additional three year lease term and a rent decrease to its current monthly rate of $33,293.

We leased additional space in July, 2006 adjacent to the Santa Ana facilities for approximately 12,015 square feet. The lease agreement term is for 60 months, through 2011, with starting monthly lease payments of approximately $20,400.
(3): On May 7, 2008, Alta Hospitals System, LLC executed a lease for approximately 7,154 square feet of office space that is shared with Prospect Medical Holdings. The lease agreement term is for 84 months through 2015 with starting monthly lease payments of approximately $25,039.
(4): Brotman recently extended its lease agreement with Washington Mutual Bank until February 28, 2011. Thereafter, this office will be consolidated with Alta as described in (6) below.
(5): Prospect Medical Holdings, Inc. executed a sublease agreement effective March 31, 2010 which replaced another sublease after its tenant vacated. The current sublease extends for the remainder of the original lease. The monthly sublease payments are approximately $3,589.
(6): On August 26, 2010, Alta Hospitals System, LLC executed a lease for approximately 14,691 square feet of office space. The space will house Alta's central business office ("CBO") and will replace the office lease in

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Bellflower, California, which will soon expire. Additionally, the Brotman CBO will be moved to this new space upon the expiration of its lease per (4) above.

We believe that this office space is sufficient for our operational needs for the foreseeable future, although we may need to acquire additional space to accommodate our plans for future growth, if successful.

Item 3. Legal Proceedings.

We and our affiliated physician organizations are parties to legal actions arising in the ordinary course of business. We believe that liability, if any, under these claims will not have a material adverse effect on our consolidated financial position or results of operations.

Item 4. Removed and Reserved.

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PART II

Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Common Stock. Beginning on September 30, 2009, our common stock, par value $0.01 per share, commenced listing on the NASDAQ Global Market under the symbol "PZZ" and we voluntarily ceased its trading on the NYSE Amex (formerly the American Stock Exchange) where it had begun trading on May 11, 2005. Following the Ivy Merger described under Item 1, our common stock is no longer listed on the NASDAQ Global Market.

The following table sets forth the quarterly high and low sales prices for our common stock for the last two completed fiscal years.

Date Range	High Sales Price		Low Sales Price

2009
First Quarter	$	3.00	$	1.00
Second Quarter	$	2.64	$	1.45
Third Quarter	$	5.00	$	1.23
Fourth Quarter	$	4.69	$	3.54
2010
First Quarter	$	4.50	$	2.80
Second Quarter	$	6.95	$	4.16
Third Quarter	$	7.64	$	4.02
Fourth Quarter	$	8.81	$	5.81

As of December 15, 2010, following the completion of the Ivy Merger, 100 shares of our common stock were outstanding, all of which are owned by Ivy Intermediate Holding Inc., which is a wholly owned subsidiary of Ivy Holdings Inc.

Dividends. We have not paid any cash dividends on our common stock in the past and do not plan to do so in the near future. Under our new credit facilities, we are allowed to make dividend payments, provided that the aggregate amount of such payments do not exceed 50% of our consolidated net income (as defined in the credit agreements) and so long as no default has occurred.

Equity Compensation Plan Information. See Part III, Item 12, Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters, for information regarding securities that were authorized for issuance under our equity compensation plans as of September 30, 2010. As a result of the Ivy Merger, we no longer have any securities authorized for issuance under our equity compensation plans..

Item 6. Selected Financial Data.

Not applicable.

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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Overview

Prior to the acquisition of Alta and Brotman, our organization was focused solely on providing management services to affiliated physician organizations that operate as Independent Physician Associations ("Medical Groups"). With the acquisition of Alta and Brotman, we now own and operate five hospitals in Southern California and our operations are organized into three reporting segments: Hospital Services, Medical Group and Corporate. The Hospital Services segment includes the results of operations and financial position of Brotman beginning April 14, 2009.

Hospital Services Segment

We own and operate five hospitals in Los Angeles County, all accredited by the Joint Commission (formerly the Joint Commission on Accreditation of Healthcare Organizations) or DNV Healthcare, Inc., with a total of 759 licensed beds served by 746 on-staff physicians at September 30, 2010. Alta owns (i) Alta Hollywood Hospitals, Inc., a California corporation, dba Hollywood Community Hospital and Van Nuys Community Hospital; and (ii) Alta Los Angeles Hospitals, Inc., a California corporation, dba Los Angeles Community Hospital and Norwalk Community Hospital. On April 14, 2009 (the "Acquisition Date"), the Company increased its existing approximately 33% ownership stake in Brotman, to approximately 72% via an investment of approximately $2,500,000 in cash, thereby obtaining a controlling interest. Effective November 15, 2010, Brotman completed a $3,750,000 rights offering, wherein we participated in the amount of approximately $3,065,000, increasing our ownership to approximately 78%. Brotman owns and operates Brotman Medical Center, located in Culver City, California.

Operating revenue of our Hospital Services segment consists primarily of payments for services rendered, including estimated retroactive adjustments under reimbursement arrangements with third party payors. In some cases, reimbursement is based on formulas and reimbursable amounts are not considered final until cost reports are filed and audited or otherwise settled by the various programs. We accrue for amounts that we believe will ultimately be due to or from Medicare and other third party payors and report such amounts as net patient revenues in the accompanying unaudited consolidated financial statements. We closely monitor our historical collection rates, as well as changes in applicable laws, rules and regulations and contract terms, to assure that provisions are made using the most accurate information available. However, due to the complexities involved in these estimations, actual payments from payers may be materially different from the amounts we estimate and record. A summary of the payment arrangements with major third party payers follows:

Medicare: Medicare is a Federal program that provides certain hospital and medical insurance benefits to persons aged 65 and over, some disabled persons with end-stage renal disease and certain other beneficiary categories. Inpatient services rendered to Medicare program beneficiaries are paid at prospectively determined rates per discharge, according to a patient classification system based on clinical, diagnostic and other factors. Outpatient services are paid based on a blend of prospectively determined rates and cost-reimbursed methodologies. We are also reimbursed for various disproportionate share and Medicare bad debt components at tentative rates, with final settlement determined after submission of the annual Medicare cost report and audit thereof by the Medicare fiscal intermediary. Normal estimation differences between final settlements and amounts accrued in previous years are reflected in net patient service revenue.

Medi-Cal: Medi-Cal is a joint Federal-State funded healthcare benefit program that is administered by the State of California to provide benefits to qualifying individuals who are unable to afford care. As such, Medi-Cal constitutes the version of the Federal Medicaid program that is applicable to California residents. Inpatient services rendered to Medi-Cal program beneficiaries

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are paid at contracted per diem rates. The per diem rates are not subject to retrospective adjustment. Outpatient services are paid based on prospectively determined rates per procedure.

Managed care: We also receive payment from certain commercial insurance carriers, HMOs and PPOs. The basis for payment is in accordance with negotiated contracted rates or at our standard charges for services provided.

Self-Pay: Self-pay patients represent those patients who do not have health insurance and are not covered by some other form of third party arrangement. Such patients are evaluated, at the time of service or shortly thereafter, for their ability to pay based upon Federal and State poverty guidelines, qualifications for Medi-Cal, as well as our local hospital's indigent and charity care policy.

Hospital revenues depend upon inpatient occupancy levels, the medical and ancillary services and therapy programs ordered by physicians and provided to patients, the volume of outpatient procedures and the charges or negotiated payment rates for such services. Charges and reimbursement rates for inpatient routine services vary depending on the type of services provided (e.g., medical/surgical, intensive care or behavioral health) and the geographic location of the hospital. Inpatient occupancy levels fluctuate for various reasons, many of which are beyond our control. The percentage of patient service revenue attributable to outpatient services has generally increased in recent years, primarily as a result of advances in medical technology that allow more services to be provided on an outpatient basis, as well as increased pressure from Medicare, Medi-Cal and private insurers to reduce hospital stays and provide services, where possible, on a less expensive outpatient basis. We believe that our experience with respect to our increased outpatient levels mirrors the general trend occurring in the healthcare industry and we are unable to predict the rate of growth and resulting impact on our future revenues.

Patients are generally not responsible for any difference between customary hospital charges and amounts reimbursed for such services under Medicare, Medi-Cal, some private insurance plans, and managed care plans, but are responsible for services not covered by such plans, exclusions, deductibles or co-insurance features of their coverage. The amount of such exclusions, deductibles and co-insurance has generally been increasing each year. Indications from recent Federal and State legislation are that this trend will continue. Collection of amounts due from individuals is typically more difficult than from governmental or business payers and increases in uninsured and self-pay patients unfavorably impact the collectability of our patient accounts, thereby increasing our provision for doubtful accounts and charity care provided.

The State of California has enacted Assembly Bill 1653 ("AB1383") to provide one-time supplemental payments to certain medical facilities such as the hospitals owned and operated by our subsidiaries that serve a disproportionate share of indigent and low-income patients. AB 1383, however, could not be implemented until recently when it was approved by the Centers for Medicare and Medicaid Services ("CMS"). As implemented, AB 1383 requires participating hospitals to pay fee assessments into a pool of funds to which the federal government will contribute matching funds. These funds, including the federal matching funds, will then be distributed to qualifying hospitals based on a prescribed formula relating to Medicaid services performed over the period April 1, 2009 through December 31, 2010. Depending on the formula for determining the fees assessed on participating hospitals and the separate formula for determining the supplemental payments to qualifying hospitals, some participating hospitals will be "net" payors under the program and others will be "net" beneficiaries under the program. We have not previously recognized any fees or payments under AB 1383 in our financial statements, since there was no assurance that CMS would approve this program or when or how the program would be implemented. The AB 1383 program is scheduled to expire on December 31, 2010.

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Operating expenses of our Hospital Services segment generally consist of salaries, benefits and other compensation paid to healthcare professionals that are employees of our hospitals, medical supplies, consultant and professional services, and provision for doubtful accounts.

General and administrative expenses ("G&A") of our Hospital Services segment generally consists of salaries, benefits and other compensation for our hospital administrative employees, insurance, rent, operating supplies, legal, accounting and marketing.

Hospital Services Results of Operations

The following table sets forth the results of operations for our Hospital Services segment and is used in the discussion below for the fiscal years ended September 30, 2010 and 2009 (in thousands).

		September 30,

		2010		2009		Increase (Decrease)			%
Net Hospital Services revenues:
	Medicare	$	149,323	$	99,180	$	50,143			50.6	%
	Medi-Cal		74,022		74,174		(152	)		(0.2	)%
	Managed care		47,602		27,096		20,506			75.7	%
	Self pay		5,349		3,363		1,986			59.1	%
	Other		2,783		1,691		1,092			64.6	%

Total Hospital Services revenues			279,079		205,504		73,575			35.8	%

Hospital Services operating expenses:
	Salaries, wages and benefits		126,052		94,547		31,505			33.3	%
	Supplies		20,800		16,531		4,269			25.8	%
	Provision for doubtful accounts		29,969		17,715		12,254			69.2	%
	Other operating expenses		30,085		17,556		12,529			71.4	%

Total Hospital Services operating expenses			206,906		146,349		60,557			41.4	%

General and administrative			20,704		18,154		2,550			14.0	%
Depreciation and amortization			4,929		4,301		628			14.6	%

Total non-medical expenses			25,633		22,455		3,178			14.2	%

Operating income		$	46,540	$	36,700	$	9,840			26.8	%

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The following table sets forth selected operating items, expressed as a percentage of total net Hospital Services revenue for the fiscal years ended September 30, 2010 and 2009:

		September 30,

		2010			2009
Net Hospital Services revenues:
	Medicare		53.5	%		48.3	%
	Medi-Cal		26.5	%		36.1	%
	Managed care		17.1	%		13.2	%
	Self pay		1.9	%		1.6	%
	Other		1.0	%		0.8	%

Total Hospital Services revenues			100.0	%		100.0	%
Hospital Services operating expenses:
	Salaries, wages and benefits		45.2	%		46.0	%
	Supplies		7.5	%		8.0	%
	Provision for doubtful accounts		10.7	%		8.6	%
	Other operating expenses		10.8	%		8.5	%

Total Hospital Services operating expenses			74.1	%		71.2	%

General and administrative			7.4	%		8.8	%
Depreciation and amortization			1.8	%		2.1	%

Total non-medical expenses			9.2	%		10.9	%

Operating income			16.7	%		17.9	%

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The following table shows certain selected historical operating statistics for our hospitals for the fiscal years ended September 30, 2010 and 2009:

	September 30,

	2010			2009			Increase (Decrease)
Net inpatient revenues (in thousands)(1)	$	245,488		$	186,900			31.3	%
Net outpatient revenues (in thousands)(1)	$	30,809		$	16,913			82.2	%
Other services revenues (in thousands)	$	2,782		$	1,691			64.5	%
Number of hospitals at end of period		5			5			0.0	%
Licensed beds at end of the period		759			759			0.0	%
Average licensed beds		759			759			0.0	%
Average available beds		616			616			0.0	%
Admissions(2)		23,405			18,573			26.0	%
Adjusted patient admissions(3)		26,342			20,098			11.0	%
Net inpatient revenue per admission	$	10,489		$	10,063			4.2	%
Patient days		149,864			124,004			20.9	%
Adjusted patient days		169,327			135,228			25.2	%
Average length of patients' stay (days)		6.4			6.2			3.3	%
Net inpatient revenue per patient day	$	1,638		$	1,507			8.7	%
Outpatient visits		52,626			34,999			50.4	%
Net outpatient revenue per visit	$	585		$	483			21.1	%
Occupancy rate for licensed beds(4)		54.0	%		52.7	%		2.4	%
Occupancy rate for available beds(4)		66.5	%		64.9	%		2.4	%

(1): Net inpatient revenues for the fiscal years ended September 30, 2010 and 2009 included self-pay revenues of approximately $4,539,000 and $3,071,000, respectively. Net outpatient revenues for the fiscal years ended September 30, 2010 and 2009 included self-pay revenues of approximately $810,000 and $346,000, respectively.
(2): Charity care admissions represented 2.3% and 0.7% of total admissions for the fiscal years ended September 30, 2010 and 2009, respectively. Based on our hospitals' gross charge rates, revenues foregone under the charity policy, including indigent accounts, were approximately $2,977,000 and $4,600,000 for the years ended September 30, 2010 and 2009, respectively.
(3): Adjusted admissions are total admissions adjusted for outpatient volume. Adjusted admissions are computed by multiplying admissions (inpatient volume) by the sum of gross inpatient charges and gross outpatient charges and then dividing the resulting amount by gross inpatient charges.
(4): Utilization of licensed beds represents patient days divided by average licensed beds divided by number of days in the period. Occupancy rates are affected by many factors, including the population size and general economic conditions within particular market service areas, the degrees of variation in medical and surgical products, outpatient use of hospital services, quality and treatment availability at competing hospitals and seasonality.
(5): The fiscal year ended September 30, 2009 included only 169 days of Brotman operating results, as the Company acquired a majority stake in, and began consolidating, Brotman, effective April 14, 2009.

Net Hospital Services Revenues

Net Hospital Services revenues increased $73,575,000 to approximately $279,079,000 for fiscal year 2010, from approximately $205,504,000 for fiscal year 2009. Included in Net Hospital Services revenues in fiscal year 2010 period was capitation revenue of approximately $5,965,000 earned under the

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Capitation Arrangement. Excluding revenue earned under the Capitation Arrangement for fiscal year 2010, net Alta Hospital Services revenues increased 3.4%. This increase was primarily attributable to increased inpatient Medicare admissions and increased outpatient visits, offset by decreased Medi-Cal inpatient days. The increase in inpatient admissions, on a same-store basis (i.e. hospitals owned throughout both periods), reflects the successful marketing effort in the targeted Medicare service lines, while the increase in outpatient visits was attributable primarily to increased outpatient and emergency room visits as a result of the economic slowdown.

Salaries, Wages and Benefits

Salaries, Wages and Benefits ("SWB"), as a percentage of net Hospital Services revenues decreased 1.7% to 45.2% for fiscal year 2010, as compared to 46.0% for fiscal year 2009. This decrease was attributable primarily to decreased patient days, decreased length of patient stays, and efficiencies gained in our hospitals. On a same-store basis, SWB, as a percentage of net Alta Hospital Services revenues, net of revenue earned under the Capitation Arrangement, decreased 0.8% to 43.9% for fiscal year 2010, as compared to 44.2% for fiscal year 2009. This decrease in same-store SWB expense as a percent of revenue was primarily the result of a decrease in same-store patient days, decreased length of patient stays, and improved efficiencies, offset by increased labor expense due to inflation, merit increases and higher health benefit costs.

Supplies

Supplies, as a percentage of net Hospital Services revenues, decreased 6.3% to 7.5% for fiscal year 2010, as compared to 8.0% for fiscal year 2009. On a same-store basis, supplies as a percentage of net Alta Hospital Services revenues, net of revenue earned under the Capitation Arrangement, decreased 12.6% to 5.3% for fiscal year 2010, as compared to 6.1% for fiscal year 2009. The decrease was primarily the result of decreases in same-store patient days and length of stays, efficiencies and outsourcing of our sub-acute pharmacy.

Provision for Doubtful Accounts

Provision for doubtful accounts, as a percentage of net Hospital Services revenues, increased 24.4% to 10.7% for fiscal year 2010, compared to 8.6% for fiscal year 2009. This increase is primarily attributable to the current year inclusion of Brotman for the full year. Brotman has historically had a higher percentage of self-pay patients, which is a patient category most impacted by current economic conditions. On a same-store basis, provision for doubtful accounts as a percentage of net Alta Hospital Services revenues, net of revenue earned under the Capitation Arrangement, increased 17.9% to 6.5% for fiscal year 2010, as compared to 5.5% for fiscal year 2009. The provision for doubtful accounts relates principally to self-pay amounts due from patients and commercial managed care amounts. The fluctuation was due to increased self-pay outpatient visits and also the impact of current economic conditions on individuals' ability to pay.

Other Operating Expenses

Other operating expenses, as a percentage of net Hospital Services revenues, increased 27.1% to 10.8% for fiscal year 2010, as compared to 8.5% for fiscal year, 2009. Included in other operating expenses in fiscal year 2010 were claims expenses of approximately $6,049,000 incurred under the Capitation Arrangement. On a same-store basis, other operating expenses as a percentage of net Alta Hospital Services revenues, adjusted for the effect of the Capitation Arrangement, decreased 16.1% to 5.6% for fiscal year 2010, as compared to 6.7% for fiscal year 2009. This decrease was due primarily to the reduction of registry costs, in line with decreased patient days, decreased length of patient stays and decreased contract labor costs as a result of the conversion of certain hospital personnel from

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contracted to salaried basis, offset by an increase in lease and rental expenses in fiscal year 2010 due to an unusually large amount of vendor credits recorded in fiscal year 2009.

General and Administrative

G&A consist primarily of utilities, insurance, purchased services and property taxes. G&A were $20,704,000 for fiscal year, 2010, or 7.4% of net Hospital Services revenue, compared to $18,154,000 for fiscal year 2009, or 8.8% of net Hospital Services revenue. On a same-store basis, G&A, as a percentage of net Alta Hospital Service revenues, net of revenue earned under the Capitation Arrangement, decreased 10.3% to 8.6% for fiscal year 2010, as compared to 9.6% for fiscal year 2009. This decrease was due primarily to the favorable effects of renegotiated malpractice and workers' compensation insurance premiums.

Depreciation and Amortization

Depreciation and amortization expense increased 14.6% in fiscal year 2010 to $4,929,000 compared to $4,301,000 in fiscal year 2009, primarily relates to Brotman. On a same-store basis, depreciation and amortization expenses as a percentage of Alta's net Hospital Services revenues, net of revenue earned under the Capitation Arrangement, for fiscal year 2010 remained consistent at 2.6% compared to fiscal year 2009. Included in depreciation and amortization expense was amortization of identifiable intangibles of approximately $1,417,000 and $1,333,000 in fiscal year 2010 and 2009, respectively.

Operating Income

Our Hospital Services segment reported operating income of approximately $46,540,000 and $36,700,000 for fiscal year 2010 and 2009, respectively. This increase was the result of the changes discussed above. These operating results from the Hospital Services segment include certain corporate expense allocations for insurance, professional fees, and amortization of identifiable intangibles that relate to this segment.

Medical Group Segment

The Medical Group segment provides management services to affiliated physician organizations that operate as independent physician associations ("Medical Groups"). The affiliated physician organizations enter into agreements with HMOs to provide HMO enrollees with a full range of medical services in exchange for fixed, prepaid monthly fees known as "capitation" payments. The Medical Groups contract with primary care and specialist physicians and other healthcare providers to provide enrollees with all necessary medical services.

Through our management subsidiaries—PMS and PHCA—we have entered into long-term agreements to provide management services to each of our affiliated physician organizations in exchange for a management fee. The management services we provide include HMO contracting, physician recruiting, credentialing and contracting, human resources services, claims administration, financial reporting services, provider relations, patient eligibility and related services, medical management including utilization management and quality assurance, data collection, and management information systems.

Our management subsidiaries currently provide management services to ten affiliated physician organizations, which include PMG, Nuestra Familia Medical Group, Inc. ("Nuestra"), eight other affiliated physician organizations that PMG owns or controls, and one affiliated physician organization (AMVI/Prospect Health Network) that is an unconsolidated joint venture in which PMG owns a 50% interest. PMG, which was our first affiliated physician organization, has acquired the ownership interest in all of our other affiliated physician organizations, except Nuestra. Both PMG and Nuestra are owned by our physician shareholder nominee, Dr. Arthur Lipper, and controlled through assignable option

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agreements and management services agreements (see Note 6 to the consolidated financial statements). While PMG is itself an affiliated physician organization that performs the same business in its own service area as all of our other affiliated physician organizations do in theirs, PMG also serves as a holding company for our other affiliated physician organizations.

The affiliated physician organizations provided medical services to a combined total of approximately 177,000 HMO enrollees as of September 30, 2010, including approximately 20,000 enrollees that we manage for the economic benefit of two independent third parties, and for which we earn management fee income.

As of September 30, 2010, our Medical Groups have contracts with approximately 15 HMOs, from which our revenue was primarily derived. HMOs offer a comprehensive healthcare benefits package in exchange for a capitation amount per enrollee that does not vary through the contract period regardless of the quantity or cost of medical services required or used. HMOs enroll members by entering into contracts with employer groups or directly with individuals to provide a broad range of healthcare services for a prepaid charge, with minimal deductibles or co-payments required of the members. The contracts between our affiliated physician organizations and the HMOs provide for the provision of medical services by the affiliated physician organization to the HMO enrollees in consideration for the prepayment of the fixed monthly capitation amount per enrollee.

Our Medical Group business has developed primarily through acquisitions of Medical Groups by PMG, and is concentrated in Orange County, Los Angeles County, Riverside County and San Bernardino County, all within the State of California.

Medical Group revenues consist primarily of amounts received for medical services provided by our affiliated physician organizations under capitated contracts with HMOs. Capitation revenue under HMO contracts is prepaid monthly to the affiliates based on the number of covered HMO enrollees. Capitation revenue may be subsequently adjusted to reflect changes in enrollment as a result of retroactive terminations or additions. These adjustments have historically not had a material effect on capitation revenue. Variability in capitation revenue exists under Medicare's capitation model referred to as "Risk Adjustment." Under the model, capitation with respect to Medicare enrollees is subject to subsequent adjustment by CMS based on the acuity of the enrollees to whom services were provided. Capitation for the current year is paid based on data submitted for each Medicare enrollee for preceding periods. Capitation is paid at interim rates during the year and is adjusted in subsequent periods after the final data is compiled. Positive or negative capitation adjustments are made for Medicare enrollees with conditions requiring more or less healthcare services than assumed in the interim payments. Since we do not have the information necessary to reliably predict these adjustments, periodic changes in capitation amounts earned as a result of risk adjustment are recognized once those changes are communicated to us by the health plans.

Management fees were primarily comprised of amounts earned from managing the operations of AMVI, Inc. (our joint venture partner in the AMVI/Prospect Health Network joint venture) and certain other third party entities. Management fee revenue is recognized in the month the services are delivered.

Medical Group revenues also included incentive payments from HMOs under "pay-for-performance" programs for quality medical care based on various criteria. These incentives are generally received in the third and fourth quarters of our fiscal year and are recorded when such amounts are known since we do not maintain the information necessary to independently and reliably estimate these amounts.

We also potentially earn additional incentive revenue or incur penalties under HMO contracts by sharing in the risk for hospitalization based upon inpatient services utilized. These amounts are included in capitation revenue. Shared risk deficits are generally not payable until and unless we

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generated future risk-sharing surpluses. Risk pools are generally settled in the following year. Management estimates risk pool incentives based on information received from the HMOs or hospitals with whom the risk-sharing arrangements were in place, and who typically maintain the information and record keeping related to the risk pool arrangements. Differences between actual and estimated settlements are recorded when the final outcome is known. Risk pool and pay-for-performance incentives are affected by many factors, some of which are beyond our control, and may vary significantly from year to year.

As discussed in Note 6 to the accompanying consolidated financial statements, effective March 1, 2010, we entered into a Global Capitation Arrangement whereby we agreed to provide hospital, medical and other healthcare services to approximately 2,000 senior members.

We have increased our membership through acquisitions in previous years. These increases through acquisitions have been offset by HMO enrollment declines at our Medical Groups, similar to the recent HMO enrollment trends in California. The following table sets forth the approximate number of members, by category (in thousands):

	As of September 30,

	As of September 30,				% Increase (Decrease)
Member Category	2010		2009		% Increase (Decrease)
Commercial—owned		124.1		134.1		(7.5	)%
Commercial—managed(l)		7.6		1.6		375.0	%
Senior—owned		22.1		21.6		2.3	%
Senior—managed(1)		0.6		0.2		200.0	%
Medi-Cal—owned		10.9		11.6		(6.0	)%
Medi-Cal—managed(1)		12.2		8.3		47.0	%

Total		177.5		177.4		0.1	%

(1): Represent members that we manage on behalf of third parties in exchange for a management fee.

The following table details total paid member months, by member category, for the fiscal years ended September 30, 2010 and 2009 (in thousands):

	Years Ended September 30,

	Years Ended September 30,				% Increase (Decrease)
	2010		2009		% Increase (Decrease)
Commercial—owned		1,506		1,696		(11.2	)%
Commercial—managed(1)		60		17		253	%
Senior—owned		263		258		1.9	%
Senior—managed(1)		4		2		100.0	%
MediCal—owned		133		138		(3.6	)%
MediCal—managed(1)		111		96		16	%

Total		2,077		2,207		(5.9	)%

(1): Represent members that we manage on behalf of third parties in exchange for a management fee.

Our operating expenses include costs related to the provision of medical care services (medical group cost of revenues) and general and administrative expenses. Our results of operations depend on our ability to effectively manage expenses related to health benefits and accurately predict costs incurred.

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Expenses related to medical care services include payments to contracted primary care physicians and payments to contracted specialists. In general, primary care physicians are paid on a capitation basis, while specialists are paid on either a capitation or a fee-for-service basis.

Capitation payments are fixed in advance of periods covered and are not subject to significant accounting estimates. These payments are expensed in the period the providers are obligated to provide services. Fee-for-service payments are expensed in the period services are provided to our members. Medical care costs include actual historical claims experience and estimates of incurred but not reported amounts ("IBNR"). We estimate our IBNR monthly, based on a number of factors, including prior claims experience. As part of this review, we also consider estimates of amounts to cover uncertainties related to fluctuations in provider billing patterns, claims payment patterns, membership and medical cost trends. These estimates are adjusted each month as more information becomes available. In addition to our own IBNR estimation process, we obtain semi-annual reviews of our IBNR liability from independent actuaries. We believe that our process for estimating IBNR is adequate and appropriate, but there can be no assurance that medical care costs will not materially differ from such estimates. In addition to contractual reimbursements to providers, we also make discretionary incentive payments to physicians, which are in large part based on the pay-for-performance, shared risk revenues and any favorable senior capitation risk-adjustment payments we receive. Since we record these revenues generally in the third or fourth quarter of each fiscal year, when the incentives and capitation adjustments due from the health plans are known, we also historically adjust interim accruals of discretionary physician bonuses in the same period. Because incentives and risk-adjustment revenues form the basis for these discretionary bonuses, variability in earnings due to fluctuations in revenues are mitigated by the recording of physician bonuses.

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

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Medical Group Results of Operations

The following tables summarize our net operating revenue, cost of revenues and operating income from Medical Group operations and are used in the discussions below for the fiscal years ended September 30, 2010 and 2009 (in thousands).

		September 30,

		September 30,						Increase (Decrease)
		2010			2009			Increase (Decrease)			%
Medical Group revenues:
	Capitation	$	187,718		$	194,126		$	(6,408	)		-3.3	%
	Management fees		1,153			556			597			107.4	%
	Other operating revenues		1,246			2,048			(802	)		-39.2	%

	Total Medical Group revenues		190,117			196,730			(6,613	)		-3.4	%
Medical Group cost of revenues:
	PCP capitation		32,871			33,930			(1,059	)		-3.1	%
	Specialist capitation		41,134			43,710			(2,576	)		-5.9	%
	Claims expense		72,239			71,294			945			1.3	%
	Physician salaries		2,876			3,159			(283	)		-9.0	%
	Other cost of revenues		383			(1,037	)		1,420			-136.9	%

	Total Medical Group cost of revenues		149,503			151,056			(1,553	)		-1.0	%

Gross margin			40,614			45,674			(5,060	)		-11.1	%

	General and administrative		25,894			28,397			(2,503	)		-8.8	%
	Depreciation and amortization		3,292			3,515			(223	)		-6.3	%

	Total other expenses		29,186			31,912			(2,726	)		-8.5	%
Income from unconsolidated joint venture			2,503			2,046			457			22.3	%

Operating income		$	13,931		$	15,808		$	(1,877	)		-11.9	%

Medical cost ratio			78.6	%		76.8	%

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The following table sets forth selected operating items, expressed as a percentage of total Medical Group revenue for the fiscal years ended September 30, 2010 and 2009:

		September 30,

		2010			2009
Medical Group revenues:
	Capitation		98.7	%		98.7	%
	Management fees		0.6	%		0.3	%
	Other operating revenues		0.7	%		1.0	%

	Total Medical Group revenues		100.0	%		100.0	%
Medical Group cost of revenues:
	PCP capitation		17.3	%		17.2	%
	Specialist capitation		21.6	%		22.2	%
	Claims expense		38.0	%		36.2	%
	Physician salaries		1.5	%		1.6	%
	Other cost of revenues		0.2	%		-0.5	%

	Total Medical Group cost of revenues		78.6	%		76.8	%

Gross margin			21.4	%		23.2	%

	General and administrative		13.6	%		14.4	%
	Depreciation and amortization		1.7	%		1.8	%

	Total other expenses		15.4	%		16.2	%
Income from unconsolidated joint venture			1.3	%		1.0	%

Operating income			7.3	%		8.0	%

Capitation Revenue

Capitation revenue for fiscal 2010 was approximately $187,718,000, representing a decrease of approximately $6,408,000 or 3.3% from capitation revenue for fiscal 2009 of approximately $194,126,000.

The decrease in capitation revenue for fiscal 2010 was due primarily to a decrease in commercial enrollment as a result of increased unemployment, partially offset by rate increases and a slight increase in senior enrollment.

Management fee revenue

Management fee revenue for fiscal year 2010 was approximately $1,153,000, representing an increase of approximately $597,000 or 107.4% from management fee revenue for fiscal 2009, of approximately $556,000.

The increase in management fee revenue during fiscal year 2010 was primarily due to the management fee earned in connection with the management agreements entered into on May 1, 2010 with an independent, unaffiliated managed IPA and an increase in the number of members of AMVICare Health Network, Inc.

Other revenue

Other revenue for fiscal 2010 was approximately $1,246,000, representing a decrease of $802,000 or 39.2% over other revenue for fiscal 2009, of approximately $2,048,000.

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Amounts represent incentive payments from HMOs under "pay-per-performance" programs for quality medical care based on various criteria. The incentives are recorded when such amounts are known.

The decrease in other revenue during fiscal 2010 was primarily due to current year lower funding of these programs by certain partner HMOs.

PCP Capitation Expense

Primary care physician ("PCP") capitation expense for fiscal 2010 was approximately $32,871,000, representing a decrease of approximately $1,059,000 or 3.1% over PCP capitation expense for fiscal 2009, of approximately $33,930,000.

The decrease in PCP capitation expense during fiscal 2010 was primarily due to decreased enrollment, offset by market rate adjustments, including in connection with exclusivity contracts made as part of our continued effort to attract and retain PCPs and their members.

Specialist Capitation Expense

Specialist Capitation expense for fiscal 2010 was approximately $41,134,000, representing a decrease of $2,576,000 or 5.9% from specialist capitation expense for fiscal 2009, of approximately $43,710,000.

The decrease in specialist capitation expense during fiscal 2010 was primarily due to decreased enrollment and capitation of a large portion of our radiology services at a number of our Medical Groups, which had previously been provided on a fee-for-service basis.

Claims Expense

Claims expense for fiscal 2010 was approximately $72,239,000, representing an increase of $945,000 or 1.3% over claims expense for fiscal 2009, of approximately $71,294,000.

The increase in claims expense during fiscal 2010 was primarily due to moving certain specialties to a fee-for-service basis in the current fiscal period, which was considered beneficial to the Company.

Physician Salaries Expense

Physician salaries expense for fiscal 2010 was approximately $2,876,000, representing a decrease of $283,000 or 9.0%, compared to physician salaries expense for fiscal 2009 of approximately $3,159,000.

The decrease in physician salaries expense was primarily the result of the conversion of certain physicians from employment to capitation basis during fiscal 2010.

Other Cost of Revenues

Other cost of revenues for fiscal 2010 was approximately $383,000 compared to a negative expense of approximately $1,037,000 for fiscal 2009. The negative expense in fiscal 2009 represents reinsurance/stop-loss recoveries in excess of premiums paid, which did not recur in fiscal 2010.

Gross Margin

Medical care costs as a percentage of medical revenues (the medical care ratio) largely determine our gross margin. Our gross margin decreased to 21.4% for fiscal 2010, from 23.2% for fiscal 2009.

The decrease in our gross margin percentage between fiscal 2010 and 2009 was the result of the factors discussed above.

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General and Administrative Expense

General and administrative expenses were approximately $25,894,000 for fiscal 2010, representing 13.6% of total Medical Group revenues, as compared with $28,397,000, or 14.4% of total revenues, for fiscal 2009.

The decrease in general and administrative expenses as a percentage of total Medical Group revenues during fiscal 2010 was primarily the result of the consolidation of administrative functions among our Medical Groups, resulting in the elimination of certain positions, together with overall efficiencies.

Depreciation and Amortization Expense

Depreciation and amortization expense for fiscal 2010 decreased to approximately $3,292,000 from $3,515,000 for fiscal 2009. The decrease in depreciation and amortization expense was primarily due to the full amortization of certain intangible assets related to the ProMed Acquisition.

Income from Unconsolidated Joint Venture

The income from unconsolidated joint venture for fiscal 2010 increased to approximately $2,503,000 from approximately $2,046,000 for fiscal 2009. The increase was primarily due to increased Medi/Medi and senior enrollment and increased risk pool income.

Operating Income

Our Medical Group segment reported operating incomes of approximately $13,931,000 and $15,808,000 for fiscal 2010 and 2009, respectively. This decrease was the result of the changes discussed above. The pre-tax operating results of the Medical Group segment include certain corporate expense allocations for insurance, professional fees, and amortization of identifiable intangibles.

Corporate Segment

Certain expenses incurred at the Parent Entity not specifically allocable to the Hospital Services or Medical Group segments are recorded in the Corporate segment. These expenses include salaries (including stock-based compensation), benefits, financing, rent, supplies, legal, SEC compliance, and Sarbanes-Oxley compliance. We do not allocate interest expense, gain or loss on interest rate swaps and income taxes to the other reporting segments.

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The following table summarizes our corporate expense for the Parent Entity, and is used in the discussion below for the years ended September 30, 2010 and 2009 (in thousands).

		September 30,

		2010		2009		Increase (Decrease)			%
Operating Expenses:
	General and administrative	$	13,597	$	12,215	$	1,382			11.3	%
	Depreciation and amortization		14		13		1			7.7	%

Total Operating Expenses			13,611		12,228		1,383			11.3	%

Other (Income) Expense:
	Interest expense and amortization of deferred financing costs, net		22,724		26,835		(4,111	)		-15.3	%
	Loss in value of interest rate swap arrangements		—		5,299		(5,299	)		100.0	%
	Prepayment penalty on debt refinance		—		2,588		(2,588	)		-100.0	%
	Loss on termination of interest rate swap arrangements		—		6,861		(6,861	)		100.0	%

Total Other Expenses			22,724		41,583		(18,859	)		-45.4	%

Total Corporate Expenses		$	36,335	$	53,811	$	(17,476	)		-32.5	%

The following table sets forth selected operating items, expressed as a percentage of total consolidated revenues:

		September 30,

		2010			2009
Operating Expenses:
	General and administrative		2.9	%		3.0	%
	Depreciation and amortization		0.0	%		0.0	%

Total Operating Expenses			2.9	%		3.0	%

Other (Income) Expense:
	Interest expense and amortization of deferred financing costs, net		4.8	%		6.7	%
	(Gain) loss in value of interest rate swap arrangements		0.0	%		1.3	%
	Prepayment penalty on debt refinance		0.0	%		0.7	%
	Loss on termination of interest rate swap arrangements		0.0	%		1.7	%

Total Other Expenses			4.8	%		10.4	%

Total Corporate Expenses			7.7	%		13.4	%

General and Administrative

G&A expenses as a percent of consolidated revenues from continuing operations decreased to 2.9% for fiscal year 2010 from 3.0% for fiscal year 2009. The decrease primarily related to reductions in bank, audit and outside services cost , including savings related to bringing certain functions in-house, offset by an increase in legal and outside services charges totaling approximately $1,500,000, incurred in connection with the merger transaction (see Note 4 to the accompanying consolidated financial statements).

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Depreciation and Amortization Expense

Depreciation and amortization expense increased to approximately $14,000 for fiscal year 2010 compared to approximately $13,000 for fiscal year 2009, primarily as a result of depreciation on additional office equipment acquired in fiscal year 2010.

Interest Expense and Amortization of Deferred Financing Costs, net

Interest expense and amortization of deferred financing costs, net for fiscal year 2010 was approximately $22,724,000, compared to $26,835,000, for fiscal 2009, a decrease of approximately 15.3%. During fiscal 2009, we were paying significantly higher interest rates on our prior debt facilities, including default interest, fees and "payment-in-kind" ("PIK") interest. As set forth below, following the issuance of the $160,000,000 12.75% senior secured notes and the repayment of all remaining amounts outstanding under our former $155,000,000 senior secured credit facility, the Company wrote-off approximately $550,000 of deferred financing related to its former credit facilities, which amount was recorded as interest expense in the fourth quarter of fiscal year 2009.

Gain (Loss) in Value of Interest Rate Swap Arrangements

During much of fiscal 2009, we had two interest rate swaps in place for initial notional principal amounts of $48,000,000 and $97,800,000, respectively, designed as cash flow hedges of our former floating rate term debt, with changes in fair value of the swaps being included in earnings. In fiscal year 2009, loss on interest rate swaps totaled approximately $5,299,000.

Concurrent with the Senior Secured Note transaction, the Company terminated the interest rate swap arrangements, paid approximately $11,700,000 in final settlement of all amounts owing under the swap arrangements and expensed all previously unamortized swap fluctuation amounts in the fourth quarter of fiscal year 2009.

Prepayment Penalty on Debt Refinance

As discussed in Note 9 to the accompanying consolidated financial statements, following the issuance of the $160,000,000, 12.75% senior secured notes, the Company repaid all remaining amounts outstanding under its former $155,000,000 senior secured credit facility, plus a prepayment premium of approximately $2,588,000.

Loss on Termination of Interest Rate Swap Arrangements

In connection with our July 2009 termination of prior swap arrangements, all amounts included in accumulated other comprehensive loss, including related deferred income taxes (of approximately $4,200,000) of approximately $6,800,000 was recorded as interest rate swaps termination charge.

Consolidated Results of Operations

Provision for Income Taxes

Provision for income taxes for fiscal year 2010 was approximately $10,338,000 compared to income tax benefit of approximately $(1,019,000) in fiscal year 2009. The effective tax rate was higher at 55% in fiscal 2010 compared to 30% in fiscal 2009. The higher effective tax rate in fiscal 2010 was primarily due to the change in tax valuation accounts attributable to Brotman.

Net Income (Loss) Attributable to Prospect Medical Holdings, Inc.

Net income attributable to common stockholders for fiscal year 2010 was approximately $10,372,000, or $0.45 per diluted share, as compared to a net loss of $2,420,000, or $0.12 per diluted share, for fiscal year 2009, which change in income was the result of the changes discussed above.

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Net Income (Loss) Attributable to Non-controlling Interest

Net loss, net of tax attributable to noncontrolling interests for fiscal year 2010 was approximately $1,956,000, as compared to net income of $7,000 for fiscal year 2009. The change was due to consolidation of Brotman for a full twelve months in the current fiscal year and a higher Brotman loss in fiscal 2010. As discussed in Note 5 to the accompanying consolidated financial statements, prior to October 1, 2009, a pro rata share of net income (loss) attributable to minority interest in Brotman was not included under minority interest in the Company's consolidated statement of operations, as the cumulative minority share of such income did not exceed their cumulative share of prior losses absorbed by the Company.

Liquidity and Capital Resources

As further discussed in Note 4, effective December 15, 2010, our stockholders adopted the Merger Agreement, entered into between the Company with Ivy Holdings Inc. and Ivy Merger Sub Corp., at a special meeting of stockholders. Following the merger, each holder of senior secured notes is entitled under the indenture to require the Company to repurchase all or a portion of the holder's senior secured notes at a cash purchase price equal to 101% of the principal amount of the senior secured notes plus accrued and unpaid interest. Accordingly, following the effective time of the merger, the Company has mailed a notice to each holder of such notes advising the holder that it is entitled under the indenture, within 90 days of the effective time of the merger, to require the Company to purchase the senior secured notes held by the holder at a purchase price equal to 101% of the principal amount of the senior secured notes, plus accrued and unpaid interest to the date of purchase. Pending the expiration of the 90 days redemption period, the amounts owing under the senior secured notes plus accrued and unpaid interest thereon have been reflected as current in the accompanying September 30, 2010 consolidated balance sheet (refer to Note 9).

The LGP Funds have agreed in the Merger Agreement to provide a backstop commitment letter to provide the funds that are required to comply with the change of control provisions contained in the indenture governing the Company's senior secured notes. The LGP Funds may fail to meet its obligations under the Merger Agreement and as a consequence, the Company fails to satisfy its obligations under the indenture of the senior secured notes, in which event, this would negatively impact the Company's liquidity, ability to operate and ability to continue as a going concern.

Our primary sources of cash have been funds provided by borrowings under our credit facilities, by the issuance of equity securities and by cash flow from operations. Prior to the August 8, 2007 acquisition of Alta, our primary sources of cash from operations were healthcare capitation revenues, fee-for-service revenues, risk pool payments and pay-for-performance incentives earned by our affiliated physician organizations. With the Alta acquisition and subsequently, Brotman, our sources of cash from operations now include payments for Hospital Services rendered under reimbursement arrangements with third party payers, which include the Federal government under the Medicare program, the State government under the Medi-Cal program, private insurers, HMOs, PPOs, and self-pay patients.

Our primary uses of cash include healthcare capitation and claims payments by our Medical Groups, administrative expenses, debt service, acquisitions, costs associated with the integration of acquired businesses, information systems and, with the acquisition of Alta and subsequently, Brotman, operating, capital improvement and administrative expenses related to our hospital operations. Our Medical Groups generally receive capitation revenue prior to processing provider capitation and claims payments. However, our hospitals receive payments for services rendered generally 30 to 90 days after the medical care is rendered. For some payors, the time lag between service and reimbursement can exceed one year.

Our investment strategies are designed to provide safety and preservation of capital, sufficient liquidity to meet the cash flow needs of our business operations and attainment of a competitive return.

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As of September 30, 2010, we invested our cash in interest bearing money market accounts, interest-bearing certificates of deposit and non interest-bearing checking accounts. All of these amounts are classified as current assets and included in cash and cash equivalents in our consolidated balance sheets.

Since emergence from bankruptcy, Brotman has continued to incur losses and experience liquidity issues. Additionally, pursuant to an amendment entered into effective February 10, 2010, $16,000,000 of the indebtedness due to the Los Angeles Jewish Home for Aging may have to be repaid as early as April 2011 (Note 9). Management is currently implementing operational improvements aimed at returning Brotman to profitability and is evaluating the refinancing of this debt. Prospect has limited ability to fund Brotman's post acquisition operations.

Cash Flow from Operations

Net cash provided by operating activities was approximately $16,985,000 for the fiscal year ended September 30, 2010 compared to net cash provided by operating activities of approximately $23,573,000 for the fiscal year ended September 30, 2009.

Increases as a result of:

•: Increased income from operations before income taxes, interest expense, depreciation and amortization, and loss from interest rate swap arrangements of approximately $6,976,000; and
•: Lower interest payments of approximately $23,234,000 for fiscal year ended September 30, 2010 compared to approximately $37,110,000 for fiscal year ended September 30, 2009, primarily due to lower effective interest rate on Prospect's new debt facilities (see Note 9 to the accompanying consolidated financial statements) and the consolidation of Brotman for only part of the fiscal 2009 period; and
•: Increase in non-cash share-based compensation expense $2,144,000 compared to $989,000.
•: Increase in accrued medical claims of approximately $1,035,000 compared to a decrease of $3,656,000, which increase was attributable primarily to claims incurred in our Hospital Services segment in the fiscal 2010 period related to the Capitation Arrangement totaling approximately $3,000,000, offset by decreased claims in our Medical Group segment due to decreased enrollment.

Decreases as a result of:

•: Increased income tax payments, net of approximately $6,567,000 in the fiscal 2010 period, compared to the fiscal 2009 period;
•: Payout of the Brotman match obligations under the Brotman defined contribution plan for prior years;
•: Decreased accruals of medical malpractice and workers' compensation insurance in our Hospital Services segment to reflect current independent actuarial valuation levels;
•: Increased payouts of accrued compensation in the fiscal year 2010 period;
•: Increased accounts receivable, primarily due to an increase in self-pay revenue contributed primarily by Brotman. Our consolidated days' revenues outstanding were 57 days at September 30, 2010 compared to 51.6 days at September 30, 2009, which increase was due primarily to the impact of current economic conditions on individuals' ability to pay; and
•: Reduction in liabilities related to the settlement and payment of certain prior legal matter at ProMed totaling approximately $2,573,000.

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Net cash used in investing activities was approximately $2,664,000 for the fiscal year ended September 30, 2010, compared to a use of approximately $3,550,000 for the fiscal year ended September 30, 2009.

•: During the fiscal 2010 period, we spent approximately $2,730,000 of capital expenditures for replacement equipment and general improvements, primarily at our Alta facilities; and
•: During the fiscal 2009 period, we invested approximately $2,310,000 in connection with the Brotman acquisition and approximately $1,558,000 of capital expenditures for equipment, renovations and upgrades of existing facilities.

Net cash used by financing activities was approximately $1,360,000 for the fiscal year ended September 30, 2010, as compared to a use of approximately $15,838,000 for the fiscal year ended September 30, 2009.

•: During the fiscal 2010 period, net cash used by financing activities reflect the net proceeds from Brotman's revolving line of credit and cash proceeds from exercises of stock options and warrants, offset by increased deposits into restricted cash as required by Brotman's JHA financing, principal repayments on Brotman's Creditors' Trust Note and repayment of capital lease obligations; and
•: During the fiscal 2009 period, net cash used by financing activities was comprised primarily of the repayment of our former first-lien and second-lien term debt of approximately $141,837,000, the repayment of our former revolving line of credit of approximately $7,100,000, the payment of approximately $11,312,000 in penalties in connection with the termination of the interest rate swap arrangements, and the payment of approximately $7,063,000 in fees in connection with the issuance of the $160,000,000, 12.75% senior secured note (the "Notes"), net of the proceeds from the sale of the Notes totaling approximately $147,736,000.

Prospect Note Offering

On July 29, 2009, the Company closed the offering of $160,000,000 in 12.75% senior secured notes due 2014 (the "Notes") at an issue price of 92.335%. The sale was executed in accordance with Rule 144A under the Securities Act of 1933 and Regulation S under the Securities Act of 1933. Also, in connection with the issuance of the Notes, the Company entered into a three year $15,000,000 revolving credit facility, which was undrawn at closing. The interest rate under the revolving credit facility will be at LIBOR plus an applicable margin of 7.00%, with a LIBOR floor of 2.00%. The Company used the net proceeds from the sale of the Notes to repay all amounts outstanding under the Former Credit Facility, plus a prepayment premium of approximately $2,600,000.

Brotman Financing

As part of Brotman's emergence from bankruptcy on April 14, 2009, financing was secured from the Los Angeles Jewish Home for the Aging ("JHA") and Gemino Healthcare Finance, LLC ("Gemino").

The JHA financing was comprised of two term debt components, a $16,000,000 tranche secured by assets on the west side of the Brotman campus commonly referred to as "Delmas West" and a $6,250,000 tranche on the main hospital pavilion on the east side of the property. The $16,000,000 tranche contains an option for JHA to acquire the Delmas West parcel for a purchase price equal to the outstanding debt within 24 months of the effective date of the bankruptcy. If JHA does not exercise its option, Brotman will be required to refinance the $16,000,000 tranche on or before April 14, 2011. With respect to the $16,000,000 tranche of the JHA facility, JHA also has the right to declare the unpaid loan amount, immediately due and payable at any time after April 14, 2010 and prior to April 14, 2011, provided that JHA gives 180 days' written notice of exercise. Effective February 10,

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2010, JHA and Brotman entered into an amendment to the Term A loan, whereby the earliest date on which JHA could provide notice of its exercise of the Put Right was extended from April 14, 2010 to October 14, 2010, effectively extending the earliest maturity date for the Term A Loan to April 14, 2011. Brotman and JHA are currently negotiating an amendment to the Term A Loan, pending completion of which amounts owing under this loan have been reflected as current in the Company's September 30, 2010 consolidated balance sheet. In addition, the $6,250,000 tranche of the JHA transaction will mature on April 14, 2012 and Brotman will need to secure financing to retire this portion of the debt.

The Gemino financing was comprised of a $6,000,000 (which was increased to $7,000,000 pursuant to an amendment described below), senior credit facility secured by accounts receivable. The facility expires on the earlier of April 14, 2012 and the JHA loan (see above) maturity date and bears interest at LIBOR plus 7% per annum, with a LIBOR floor of 4%. Interest is incurred based on the greater of $2,000,000 or the outstanding principal balance. The agreement also includes an unused line fee of 0.5% per annum and a collateral line fee, based on the average outstanding principal balance, of 0.5% per annum. The senior credit facility agreement contains customary covenants for facilities of this type, including restrictions on the payment of dividends, change in ownership/management, asset sales, incurrence of additional indebtedness, sale-leaseback transactions, and related party transactions. Brotman must also comply with financial covenants. Prior to a recent amendment discussed below, Brotman was required to comply with a fixed charge coverage ratio of not less than (i) 1.10:1.00 for the fiscal quarter ending June 30, 2009, (ii) 1.15:1.00 for the fiscal quarter ending September 30, 2009; and (iii) 1.20:1.00 for each fiscal quarter ending thereafter. As of September 30, 2009, Brotman was not in compliance with the required financial covenants under the Gemino credit agreement. Pursuant to an amendment entered into effective December 11, 2009, the Gemino credit agreement was amended to provide, among other things, a waiver of the specified events of default and the amendment to the definition of fixed charge coverage ratio. Under the amended credit agreement, the fixed charge coverage ratio was amended to require not less than (i) 1.00:1.00 for the fiscal quarters ended December 31, 2009 and March 31, 2010; (ii) 1.05:1.00 for the fiscal quarters ended June 30, 2010 and September 30, 2010; (iii) 1.10:1.00 for the fiscal quarters ending December 31, 2010 and March 31, 2011; and (iv) 1.20:1.00 for the fiscal quarter ending June 30, 2011 and each fiscal quarter ending thereafter. As of September 30, 2010, Brotman was in compliance with the required financial covenants under the amended credit agreement. Pursuant to an amendment entered into effective February 17, 2010, the Gemino credit agreement and promissory note were amended to increase the loan commitment by $1,000,000 to a total commitment of $7,000,000 as set forth above.

The Class 4 Note, which was executed on April 14, 2009, the Effective Date of Brotman's Plan of Reorganization, for the benefit of the allowed Class 4 claims (as defined in the Plan of Reorganization) bears interest at 7.50% per annum and is payable in sixteen equal quarterly installments of principal and accrued interest through February 15, 2013. The Note contains a covenant which, so long as amounts remain outstanding under the Note, restricts Brotman from paying Prospect in cash a consulting fee of more than $100,000 per month, as specified in the Amended and Restated Consulting Services Agreement (see Note 7 to the accompanying consolidated financial statements). As such, although the amount of the consulting fee was increased to 4.5% of Brotman's net operating revenue effective April 14, 2009, the amount of such consulting fee actually paid in cash will not exceed $100,000 per month until such time permitted by applicable agreement or the Creditor Trust Note has been amended or repaid. For the fiscal year ended September 30, 2010 and the 169-day period ended September 30, 2009, total principal repayments on the Class 4 Note were approximately $1,000,000 and $500,000, respectively.

We anticipate attempting to finance future acquisitions and potential business expansion with a combination of debt, issuances of equity instruments and cash flow from operations. In order to meet our long-term liquidity needs, we may incur, from time to time, additional bank indebtedness. Banks and traditional commercial lenders do not generally make loans to companies without substantial

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tangible net worth. Since, by the nature of our business, we accumulate substantial goodwill and intangibles on our consolidated balance sheet, it may be difficult for us to obtain this type of financing in the future. We may issue additional equity and debt securities, the availability and terms of which will depend upon market and other conditions. The corporate lending and equity markets have been affected by the current credit market conditions, resulting in both a reduction in the number of transactions as well as the amount of funds raised. Transactions that have been consummated are completed at lower valuations in the case of equity offerings and at higher interest costs in the case of debt offerings. Our ability to issue any debt or equity instruments in a public or private sale is also restricted under certain circumstances, pursuant to contractual restrictions in agreements with our lenders and the indenture governing the Notes (see above). There can be no assurance that additional financing will be available upon terms acceptable to us, if at all. The failure to raise the funds necessary to finance our future cash requirements could adversely affect our ability to pursue our strategy and could adversely affect our future results of operations.

As of September 30, 2010, Brotman failed to process the required restricted cash transfer on September 1, 2010. As such, the loan was under technical default. On October 2, 2010, Brotman processed payment, however as of the date of this filing, Brotman remains out of compliance.

Off-Balance Sheet Arrangements

None.

Critical Accounting Policies

The accounting policies described below are considered critical in preparing our audited consolidated financial statements. Critical accounting policies require difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The judgments and uncertainties affecting the application of these policies include significant estimates and assumptions made by us using information available at the time the estimates are made. Actual results could differ materially from those estimates.

Consolidation of Financial Statements

Under applicable financial reporting requirements, the financial statements of the Medical Groups with which we have management services agreements are consolidated with our own financial statements. As provided by the FASB issued interpretation guidance, the consolidation is required because we are deemed to hold a controlling financial interest in such organizations through a nominee shareholder. We can, through the assignable option agreements, change the nominee shareholder at will on an unlimited basis and for nominal cost. There is no limitation on our designation of a nominee shareholder except that any nominee shareholder must be a licensed physician or otherwise permitted by law to hold shares in a professional medical corporation. The operations of our affiliated physician organizations have a significant impact on our financial statements. The financial statements of Brotman have been included in our consolidated financial statements since April 14, 2009, when we acquired a majority stake in that entity. All intercompany accounts and balances have been eliminated in consolidation.

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Revenue Recognition

Hospital Services Segment

Third Party and Patient Reimbursement

Operating revenue of the Hospital Services segment consists primarily of net patient service revenue. A summary of the payment arrangements with major third party payers follows:

Medicare: Medicare is a Federal program that provides certain hospital and medical insurance benefits to persons aged 65 and over, some disabled persons and persons with end-stage renal disease. Inpatient services rendered to Medicare program beneficiaries are paid at prospectively determined rates per discharge, according to a patient classification system based on clinical, diagnostic, and other factors. Outpatient services are paid based on a blend of prospectively determined rates and cost-reimbursed methodologies. We are also reimbursed for various disproportionate share and Medicare bad debt components at tentative rates, with final settlement determined after submission of annual Medicare cost reports and audits thereof by the Medicare fiscal intermediary.

Medi-Cal: Medi-Cal is a joint Federal-State funded healthcare benefit program that is administered by the State of California to provide benefits to qualifying individuals who are unable to afford care. Inpatient services rendered to Medi-Cal program beneficiaries are paid at contracted per diem rates. The per diem rates are not subject to retrospective adjustment. Outpatient services are paid based on prospectively determined rates per procedure provided.

We recognize revenues in the period in which services are provided. Accounts receivable primarily consist of amounts due from third party payers and patients. Amounts we receive for treatment of patients covered by governmental programs, such as Medicare and Medi-Cal, and other third party payers such as HMOs, PPOs and other private insurers, are generally less than our established billing rates. Accordingly, our gross revenues and accounts receivable are reduced to net realizable value through an allowance for contractual discounts.

For Medicare and Medi-Cal programs, provisions for contractual adjustments are made to reduce patient charges to the estimated cash receipts based on each program's principles of payment/reimbursement (i.e., either prospectively determined or retrospectively determined costs). Under the Medi-Cal program's prospective reimbursement systems, there is no adjustment or settlement of the difference between the actual cost to provide the service and the predetermined reimbursement rates. Certain types of payments by the Medicare program (e.g. Medicare Disproportionate Share Hospital and Medicare Allowable Bad Debts) are subject to retroactive adjustment in future periods. Final settlements under these programs are subject to adjustment based on administrative review and audit by third party intermediaries, which can take several years to resolve completely. Normal estimation differences between anticipated final settlements and amounts accrued in previous years are reflected in net patient service revenue, which amounts totaled approximately $377,000 and $1,087,000 in fiscal year 2010 and 2009, respectively. As of September 30, 2010 and 2009, cost report settlements which are recorded as third-party settlements receivable or payable in the accompanying balance sheets totaled approximately $103,000 and $1,575,000, respectively.

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Estimates for contractual allowances under managed care health plans are primarily based on the payment terms of contractual arrangements, such as predetermined rates per diagnosis, per diem rates or discounted fee for service rates.

We closely monitor our historical collection rates, as well as changes in applicable laws, rules and regulations and contract terms, to ensure that provisions are made using the most appropriate and current information available. However, due to the complexities involved in these estimations, actual payments from payers may be materially different from the amounts we estimate and record. If the actual contractual reimbursement percentage under government programs and managed care contracts differed by 1% from our estimated percentage, we project that our consolidated net hospital services revenue and net income would have changed by approximately $10,514,000 and $5,467,000, respectively, for the fiscal year ended September 30, 2010 and by approximately $6,916,000 and $2,075,000, respectively, for the fiscal year ended September 30, 2009. The process of determining the allowance requires us to estimate the amount expected to be received based on payer contract provisions, historical collection data as well as other factors and requires a high degree of judgment. This process is impacted by changes in legislation, managed care contracts and other related factors. A significant increase in our estimate of contractual discounts for Medicare, Medi-Cal and managed care plans would significantly lower our earnings. This would adversely affect our results of operations, financial condition, liquidity and future access to capital.

Provision for Doubtful Accounts

Substantially all of our accounts receivable are related to providing healthcare services to our hospital patients. Collection of these accounts receivable is a primary source of cash and is critical to our operating performance. Our hospitals provide services to patients with healthcare coverage, as well as to those without healthcare coverage. Those patients with healthcare coverage are often responsible for a portion of their bill referred to as the co-payment or deductible. This portion of the bill is determined by the patient's individual healthcare or insurance plan. Patients without healthcare coverage are evaluated at the time of service, or shortly thereafter, for their ability to pay based on Federal and State poverty guidelines, qualification for Medi-Cal, as well as our policies for indigent and charity care. We maintain a uniform policy whereby patient account balances are characterized as charity and indigent care only if the patient meets certain percentages of the Federal poverty level guidelines. Because we do not pursue collection of amounts determined to qualify as charity care, they are not reported in net revenues or in accounts receivable, net. We manage our provision for doubtful accounts using hospital-specific goals and benchmarks such as total cash collections, point-of-service cash collections, accounts receivable days outstanding ("AR Days"), and accounts receivable aging. Accounts receivable balances are reserved at increasing percentages as they age. We establish a partial reserve in the allowance for doubtful accounts for self-pay balances on the date of discharge. All hospital receivables are fully reserved if they have been outstanding for greater than 365 days from the date of discharge.

Statements are sent to self-pay patients indicating the outstanding balances on their accounts. If an account is still outstanding after a period of time, it is referred to third party collection agencies for assistance in collecting the amount due. Our policy is to write-off all self-pay accounts after all collection efforts have been exhausted. All accounts that have been placed with third party collection agencies are written off. Patient responsibility accounts represent the majority of our write-offs. Accounts that are identified as self-pay accounts with insignificant balances are automatically written off in accordance with our collection policy. Non self-pay accounts are reviewed monthly and written-off on a case-by-case basis.

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The largest component of our allowance for doubtful accounts relates to self-pay accounts. These accounts include both amounts payable by uninsured patients and co-payments and deductibles payable by insured patients. In general, we attempt to collect deductibles, co-payments and self-pay accounts prior to the time of service for non-emergency care. If we do not collect the self-pay portion from the patient prior to the delivery of care, the accounts are handled through our billing and collections processes. We verify each patient's insurance coverage as early as possible before a scheduled admission or procedure, including with respect to eligibility, benefits and authorization/pre-certification requirements, in order to notify patients of the amounts for which they will be responsible. We attempt to verify insurance coverage within a reasonable amount of time for all emergency room visits and urgent admissions in compliance with applicable laws.

The table below shows the net accounts receivable and allowance for doubtful accounts by payer (in thousands):

	September 30, 2010						September 30, 2009

	Accounts Receivable before Allowance for Doubtful Accounts		Allowance for Doubtful Accounts		Net		Accounts Receivable before Allowance for Doubtful Accounts		Allowance for Doubtful Accounts		Net
Medicare	$	16,538	$	1,644	$	14,894	$	9,919	$	1,064	$	8,855
Medi-Cal		16,656		1,697		14,959		15,383		883		14,500
Managed care		11,358		1,622		9,736		10,803		1,324		9,479
Self-pay		18,553		15,573		2,980		11,391		8,183		3,208
Other		247		139		108		1,025		261		764

Total	$	63,352	$	20,675	$	42,677	$	48,521	$	11,715	$	36,806

When considering the adequacy of our allowances for doubtful accounts, accounts receivable balances are routinely reviewed in conjunction with healthcare industry trends/indicators, historical collection rates by payer and other business and economic conditions that might reasonably be expected to affect the collectability of the balance. We believe that our principal risk of collection continues to be uninsured patient accounts and patient accounts for which the primary insurance payer has paid but patient responsibility amounts (generally deductibles and co-payments) remain outstanding. If our actual collection rate changed by 1% from the estimated percentage that we used, we project that our allowance for doubtful accounts and consolidated net income would have changed by approximately $206,000 and $117,000, respectively, in the fiscal year ended September 30, 2010 and 2009, respectively. The provision for doubtful accounts as a percentage of net patient revenues was 10.7% for the year ended September 30, 2010 compared to 8.6% for the year ended September 30, 2009. The increase was attributable primarily to the current year inclusion of a full year of Brotman, which historically has a higher percentage of self-pay patients. Excluding Brotman, the provision for doubtful accounts as a percentage of net patient revenues was 6.2% for the year ended September 30, 2010, compared to 5.5% for the year ended September 30, 2009, which increase was attributable primarily to the impact of current economic conditions on individuals' ability to pay.

Of the accounts receivable identified as due from third party payers at the time of billing, a small percentage may convert to self-pay upon denials from third party payers. Those accounts are closely monitored on a routine basis for potential denial and are reclassified to the proper payer group as appropriate.

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Third party payer and self-pay balances, as a percent of total gross billed accounts receivable are summarized in the tables below:

	September 30, 2010															September 30, 2009

	Medicare			Medi-Cal			Managed Care			Self-Pay & Other			Total			Medicare			Medi-Cal			Managed Care			Self-Pay & Other			Total
0 - 60 days		82	%		72	%		51	%		13	%		66	%		84	%		77	%		50	%		25	%		68	%
61 - 120 days		8	%		16	%		24	%		24	%		16	%		9	%		11	%		22	%		23	%		14	%
121 - 180 days		6	%		6	%		14	%		20	%		9	%		3	%		7	%		16	%		28	%		10	%
Over 180 days		4	%		6	%		11	%		43	%		9	%		4	%		5	%		12	%		24	%		8	%

Total		100	%		100	%		100	%		100	%		100	%		100	%		100	%		100	%		100	%		100	%

The increase in over 180 days self-pay accounts receivable as a percentage of total net self-pay receivable is primarily attributable to the impact of current economic conditions on individuals' ability to pay, which has been included when estimating the related allowance for doubtful accounts.

Our AR Days from Hospital Services operations were 57.0 days at September 30, 2010 compared to 51.6 days at September 30, 2009, which increase was due primarily to the impact of current economic conditions on individuals' ability to pay. AR Days at September 30, 2010 and 2009 are within our target range. AR Days are calculated as our accounts receivable from Hospital Services operations on the last date in the relevant quarter divided by our net patient revenues for the quarter ended on that date divided by the number of days in the quarter.

Although we believe that our existing allowance for doubtful accounts reserve policies for all payer classes are appropriate and responsive to both the current healthcare environment and the overall economic climate, we will continue to review our overall reserve adequacy by monitoring historical cash collections as a percentage of trailing net revenue less provision for bad debts, as well as by analyzing current period net revenue and admissions by payer classification, aged accounts receivable by payer, days revenue outstanding, and the impact of our recent acquisition of Brotman.

Workers' Compensation Insurance

The workers' compensation coverage provides the statutory benefits required by law and the employer's liability limits are $1,000,000. The Alta and Prospect workers' compensation coverage for October 1, 2009 through September 30, 2010 did not have an aggregate loss limitation. The current workers' compensation policy for the period of October 1, 2010 through September 30, 2011 does not have an aggregate loss limitation. Losses within the deductible are funded via a cash loss fund and reconciled annually. At September 30, 2010 and 2009, accruals relating to Alta and Brotman for uninsured claims and claims incurred but not reported of approximately $2,769,000 and $3,220,000, respectively, are estimated based upon an actuarial valuation of the Company's claims experience, using a discount factor of 4% and 4%, respectively.

The claim reserve is based on the best data available to the Company; however, the estimate is subject to a significant degree of inherent variability. The estimate is monitored and reviewed, and as the reserve is adjusted, the difference is reflected in current operations. While the ultimate amount of the claims liability is dependent on future developments, management is of the opinion that the associated liabilities recognized in the accompanying consolidated financial statements are adequate to cover such claims. Management is aware of no potential claims whose settlement, if any, would have a material adverse effect on the Company's consolidated financial position, results of operations or cash flows.

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Medical Group Segment

Medical Group Revenues

Operating revenue of our Medical Groups consists primarily of capitation payments for medical services provided by our affiliated physician organizations under contracts with HMOs. Capitation revenue under HMO contracts is prepaid monthly to the affiliated physician organizations based on the number and type of enrollees assigned to physicians in our affiliated physician organizations.

Capitation revenue paid by HMOs is recognized in the month in which the affiliated physician organization is obligated to provide services. Capitation revenue may be subsequently adjusted to reflect changes in enrollment as a result of retroactive terminations or additions. Such retroactive terminations or additions have historically not had a material effect on capitation revenue.

Under the Risk Adjustment model, capitation for the current year is paid based on data submitted for each enrollee for previous periods. Capitation is paid at interim rates during the year and is adjusted in subsequent after the final data has been processed by CMS. Positive or negative capitation adjustments are made for Medicare enrollees with conditions requiring more or less healthcare services than assumed in the interim payments. Since we cannot reliably predict these adjustments, periodic changes in capitation amounts earned as a result of risk adjustment are recognized when those changes are communicated from the health plans, generally in the fourth quarter of the fiscal year to which the adjustments relate. We recorded approximately $4,000,000 and $4,300,000 in increased capitation revenue in the fiscal 2010 and 2009, respectively.

We also earn additional incentive revenue or incur penalties under HMO contracts by sharing in the risk for hospital related expenses including inpatient services utilized. As of September 30, 2010, except for two contracts where we are contractually obligated for down-side risk, shared risk deficits are not payable unless and until we generate future risk-sharing surpluses. Risk pools are generally settled in the third or fourth quarter of the following calendar year. Due to the lack of access to timely information necessary to estimate the related costs, shared-risk amounts receivable from the HMOs are recorded when such amounts are known. We also receive incentives under "pay-for-performance" programs for quality medical care based on various criteria. Pay-for-performance payments are generally recorded in the third and fourth quarters of our fiscal year when such amounts are known, once we are in receipt of information necessary to reliably estimate these amounts. Risk pool and pay-for-performance incentives are affected by many factors, some of which are beyond our control, and may vary significantly from year to year.

Management fee revenue is earned in the month the services have been performed.

Accrued Medical Claims

Our affiliated physician organizations are responsible for the medical services their contracted or employed physicians provide to an assigned HMO enrollee. The cost of healthcare services is recognized in the period in which it is provided and includes an estimate of the cost of services which have been incurred but not reported. The determination of our claims liability and other healthcare costs payable is particularly important to the determination of our financial position and results of operations and requires the application of significant judgment by our Management, and as a result, is subject to an inherent degree of uncertainty.

Our medical care costs include actual historical claims experience and IBNR. We, together with our independent actuaries, estimate medical claims liabilities using actuarial methods based upon historical data, adjusted for payment patterns, cost trends, product mix, utilization of healthcare services and other relevant factors. The estimation methods and the resulting reserves are frequently reviewed and updated, and adjustments, if necessary, are reflected in the period they become known. While we believe our estimates are adequate and appropriate, it is possible that future events could

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require us to make significant adjustments or revisions to these estimates. In assessing the adequacy of accruals for medical claims liabilities, we consider our historical experience, the terms of existing contracts, our knowledge of trends in the industry, information provided by our customers and information available from other sources, as appropriate.

The most significant estimates involved in determining our claims liability concern the determination of claims payment completion factors and trended per member per month cost estimates.

We consider historical activity for the current month, plus the prior 24 months, in our IBNR calculation. For the fifth month of service prior to the reporting date and earlier, we estimate our outstanding claims liability based upon actual claims paid, adjusted for estimated completion factors. Completion factors seek to measure the cumulative percentage of claims expense that will have been paid for a given month of service as of a date subsequent to that month of service. Completion factors are based upon historical payment patterns. For the four months of service immediately prior to the reporting date, actual claims paid are not a reliable measure of our ultimate liability, given the delay inherent between the patient/physician encounter and the actual submission of a claim for payment. For these months of service we estimate our claims liability based upon trended per member per month ("PMPM") cost estimates. These estimates reflect recent trends in payments and expense, utilization patterns, authorized services and other relevant factors.

The following unaudited tables reflect (i) the change in our estimate of claims liability as of September 30, 2010 that would have resulted had we changed our completion factors for all applicable months of service included in our IBNR calculation (i.e., the preceding 5th through 25th months) by the percentages indicated; and (ii) the change in our estimate of claims liability as of September 30, 2010 that would have resulted had we changed trended PMPM factors for all applicable months of service included in our IBNR calculation (i.e., the preceding 1st through 4th months) by the percentages indicated. Changes in estimate of the magnitude indicated in the ranges presented are considered reasonably likely.

Increase (Decrease) in Estimated Completion Factors	Increase (Decrease) in Accrued Medical Claims Payable

	(in thousands)
(3)%	$	(4,394	)
(2)%	$	(2,929	)
(1)%	$	(1,465	)
1%	$	1,465
2%	$	2,929
3%	$	4,394

Increase (Decrease) in Trended PMPM Factors	Increase (Decrease) in Accrued Medical Claims Payable

	(in thousands)
(3)%	$	(889	)
(2)%	$	(592	)
(1)%	$	(296	)
1%	$	296
2%	$	592
3%	$	889

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The following table shows the components of the change in medical claims and benefits payable (in thousands, unaudited):

		Years Ended September 30,

		2010			2009
IBNR as of beginning of period		$	16,824		$	20,480
Healthcare claims expense incurred during the period:
	Current year		80,945			72,424
	Prior years		(2,667	)		(1,130	)

Total incurred			78,278			71,294

Healthcare claims paid during the period:
	Current year		(63,373	)		(56,100	)
	Prior years		(13,870	)		(18,850	)

Total paid			(77,243	)		(74,950	)

IBNR as of end of period		$	17,859		$	16,824

Through September 30, 2010, the $2,667,000 change in estimate related to IBNR as of September 30, 2009 represented approximately 15.9% of the IBNR balance as of September 30, 2009, approximately 3.4% of fiscal 2009 claims expense, and after consideration of tax effect, approximately 105% of net loss for the year then ended.

Through September 30, 2009, the $1,130,000 change in estimate related to IBNR as of September 30, 2008 represented approximately 5.5% of the IBNR balance as of September 30, 2008, approximately 1.5% of fiscal 2008 claims expense, and after consideration of tax effect, approximately 57.6% of net loss from continuing operations for the year then ended.

Past fluctuations in IBNR estimates might also be a useful indicator of the potential magnitude of future changes in these estimates. Quarterly IBNR estimates include provisions for adverse development based on historical volatility. We maintain similar provisions at fiscal year end.

We also regularly evaluate the need to establish premium deficiency reserves for the probability that anticipated future healthcare costs could exceed future capitation payments from the HMOs. To date, we have determined that no material premium deficiency reserves have been necessary.

Goodwill and Intangible Assets

The FASB issued guidance for business combination requires acquired intangible assets to be separately recognized upon meeting certain criteria. Such intangible assets include, but are not limited to, trade and service marks, non-compete agreements, customer lists and licenses.

The FASB issued guidance for goodwill and other intangible assets requires that goodwill and indefinite life intangible assets not be subject to amortization but be evaluated for impairment on at least an annual basis, or more frequently if certain indicators are present. Such indicators include adverse changes in market value and/or stock price, laws and regulations, profitability, cash flows, our ability to maintain enrollment and renew payer contracts on favorable terms. A two-step impairment test is used to identify potential goodwill impairment and to measure the amount of goodwill impairment loss to be recognized (if any). The first step consists of estimating the fair value of the reporting unit based on recognized valuation techniques, which include a weighted combination of (i) the guideline company method that utilizes revenue or earnings multiples for comparable publicly-traded companies, and (ii) a discounted cash flow model that utilizes future cash flows, the timing of those cash flows, and a discount rate (or weighted average cost of capital which considers the cost of

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equity and cost of debt financing expected by a representative market participant) representing the time value of money and the inherent risk and uncertainty of the future cash flows. If the estimated fair value of the reporting unit is less than its carrying value, a second step is performed to compute the amount of the impairment by determining the "implied fair value" of the goodwill, which is compared to its corresponding carrying value.

Long-lived assets, including property, improvements and equipment and amortizable intangibles, are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. We consider assets to be impaired and write them down to fair value if estimated undiscounted cash flows associated with those assets are less than their carrying amounts.

We performed our annual goodwill impairment analysis for each reporting unit that constitutes a business for which discrete financial information is produced and reviewed by operating segment management and provides services that are distinct from the other reporting units. For the Hospital Services segment, the reporting unit for the annual goodwill impairment analysis was determined to be at the operating unit level. For the Medical Group segment, we have determined that ProMed individually and Prospect (which includes all the other affiliated physician organizations) each represent a reporting unit, based on operational characteristics. The ProMed Entities are geographically and managerially their own reporting unit.

Our impairment test at September 30, 2010 resulted in no impairment charges. In addition, no triggering events were identified that would cause impairment analysis as of September 30, 2010.

The assessment of impairment indicators, measurement of impairment loss, selection of appropriate valuation methodology, assumptions and discount factors, involve significant judgment and requires Management to project future results which are inherently uncertain.

Recent Accounting Pronouncements

Effective the first quarter of fiscal 2010, we adopted the revised accounting guidance for business combinations, which changed its previous accounting practices regarding business combinations. The more significant changes include an expanded definition of a business and a business combination; recognition of assets acquired, liabilities assumed and noncontrolling interests (including goodwill) measured at fair value at the acquisition date; recognition of acquisition-related expenses and restructuring costs separately from the business combination; recognition of assets acquired and liabilities assumed at their acquisition-date fair values with subsequent changes recognized in earnings. The guidance also amends and clarifies the application issues on initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. The adoption did not have a material impact on our consolidated financial statements for prior periods; but the pronouncement will impact the accounting for any acquisitions subsequent to that date.

Effective the first quarter of fiscal year 2010, we adopted revised accounting guidance which requires noncontrolling interests (formerly referred to as minority interest) to be presented as a separate component from the Company's equity in the equity section of the consolidated balance sheets. As required by this guidance, we have adjusted the presentation of noncontrolling interests in the prior period consolidated financial statements for comparability with the fiscal year 2010 period. The adoption of this accounting guidance had no impact on our results of operations and did not have a material impact on our financial position.

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prices in active market for identical assets or liabilities) and Level 2 (significant other observable inputs) of the fair value measurement hierarchy, including the reasons and the timing of the transfers. Additionally, the guidance requires a roll forward of activities on purchases, sales, issuance, and settlements of the assets and liabilities measured using significant unobservable inputs (Level 3 fair value measurements). Disclosures regarding transfers are required beginning January 1, 2010 and the Level 3 rollforward is to be disclosed in reporting periods beginning after December 15, 2010. Since we had no transfers between categories, the additional disclosures are not applicable to us for the periods presented.

On October 1, 2009, we adopted guidance on fair value measurement for nonfinancial assets and liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). Adoption of the new guidance did not have a material impact on our consolidated financial statements.

In June 2008, the FASB issued guidance for the accounting of share-based payment awards. Under the guidance, unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents are deemed participating securities and, therefore, are included in computing earnings per share ("EPS") pursuant to the two-class method. The two-class method determines earnings per share for each class of common stock and participating securities according to dividends or dividend equivalents and their respective participation rights in undistributed earnings. The Company adopted the guidance effective October 1, 2009. The adoption of this guidance did not impact our net income per common share for prior periods and is not expected to have an impact on future periods until such time as we declare a regular quarterly dividend.

In June 2009, the FASB issued revised guidance for the accounting of variable interest entities. This revised guidance replaces the quantitative-based risks and rewards approach with a qualitative approach that focuses on identifying which enterprise has the power to direct the activities of a variable interest entity that most significantly impact the entity's economic performance and has the obligation to absorb losses or the right to receive benefits from the entity that could be potentially significant to the variable interest entity. The accounting guidance also requires an ongoing reassessment of whether an enterprise is the primary beneficiary and requires additional disclosures about an enterprise's involvement in variable interest entities. This accounting guidance is effective for us beginning in the first quarter of fiscal 2011. We are currently evaluating the impact that the adoption of this guidance will have on its consolidated financial statements.

In June 2009, the FASB issued revised guidance for the accounting of transfers of financial assets. This guidance eliminates the concept of a qualifying special-purpose entity, removes the scope exception for qualifying special-purpose entities when applying the accounting guidance related to the consolidation of variable interest entities, changes the requirements for derecognizing financial assets, and requires enhanced disclosure. This accounting guidance is effective for us beginning in the first quarter of fiscal 2011. We are currently evaluating the impact that the adoption of this guidance will have on its consolidated financial statements.

In August 2010, the FASB approved certain modifications to existing accounting standards that will directly affect health care entities in the future. The first change provides clarification to companies in the healthcare industry on the accounting for professional liability insurance. Specifically, it states that receivables related to insurance recoveries should not be netted against the related claim liability and such claim liabilities should be determined without considering insurance recoveries. The second change clarifies that disclosures regarding the level of charity care provided by a health care entity must (i) represent the direct and indirect costs of providing such services and (ii) include a description of the method used to determine those costs. Additionally, disclosures about charity care must now include information regarding any related reimbursements received by a health care entity.

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The modified accounting standards are required to be adopted for fiscal years and interim periods that begin after December 15, 2010. Early adoption of such accounting standards is permitted. The charity care disclosure change must be applied on a retrospective basis; however, the accounting change for insurance recoveries may be applied on either a prospective or retrospective basis. We will adopt the modified accounting standards in the first quarter of fiscal year 2012 and are currently assessing the potential impact that the adoption of these modifications will have on the Company's consolidated results of operations and consolidated financial position.

Legal and Other Loss Contingencies

We are subject to contingencies, such as legal proceedings and claims arising out of our business. We record accruals for such contingencies when it is probable that a liability will be incurred and the amount of loss can be reasonably estimated. A significant amount of Management estimation is required in determining when, or if, an accrual should be recorded for a contingent matter and the amount of such accrual, if any.

Acquisitions and Divestitures

Our business has grown through a series of business combinations. These business combinations were all accounted for using the purchase method of accounting, and accordingly, the operating results of each acquisition have been included in our consolidated financial statements since their effective date of acquisition. The purchase price for each business combination was allocated to the assets, including the identifiable intangible assets, and liabilities, based on estimated fair values determined using independent appraisals where appropriate. The excess of purchase price over the net tangible assets acquired was allocated to goodwill and other intangible assets.

We have historically funded our acquisition program with debt, the sale of our common stock, and cash flow from operations. The assets that we and our affiliated physician organizations have acquired have been largely goodwill and intangible assets. The acquisition of physician organizations consists primarily of HMO contracts, physician contracts and the right to manage each physician organization through a management services agreement. The physician organizations we acquire generally do not have significant tangible net equity; therefore, our acquired assets are predominantly goodwill and other intangible assets. The acquisition of hospital operations consists primarily of trade names, covenants-not-to-compete and property, improvements and equipment.

Effective April 14, 2009, pursuant to the confirmed Plan of Reorganization of Brotman, we made an additional investment in Brotman totaling approximately $2,519,000, which increased our ownership interest from approximately 33% to approximately 72%. As discussed in Note 18 to the accompanying consolidated financial statements, effective November 15, 2010, following the consummation of a Rights Offering undertaken by Brotman, we increased our ownership stake to approximately 78%.

Inflation

According to U.S. Bureau of Labor Statistics Data, the national healthcare cost inflation rate has exceeded the general inflation rate for the last four years. We use various strategies to mitigate the negative effects of healthcare cost inflation. Specifically, we try to control physician and hospital costs through contracts with independent providers of healthcare services and close monitoring of cost trends emphasizing preventive healthcare and appropriate use of specialty and hospital services.

While we currently believe our strategies to mitigate healthcare cost inflation will continue to be successful, competitive pressures, new healthcare and pharmaceutical product introductions, demands from healthcare providers and customers, applicable regulations or other factors may affect our ability to control healthcare costs.

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Item 7A. Quantitative and Qualitative Disclosures Regarding Market Risk.

Not applicable.

Item 8. Financial Statements and Supplementary Data.

The following financial statements and financial statement schedule are included in this 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, 2010 and 2009		F-3
Consolidated Statements of Operations for the Years Ended September 30, 2010 and 2009		F-5
Consolidated Statements of Shareholders' Equity for the Years Ended September 30, 2010 and 2009		F-6
Consolidated Statements of Cash Flows for the Years Ended September 30, 2010 and 2009		F-7
Notes to Consolidated Financial Statements		F-9
Item 15: Schedule II—Valuation and Qualifying Accounts for the Years Ended September 30, 2010 and 2009		F-67

All other schedules are omitted because they are not required, or the information is included elsewhere in the accompanying Consolidated Financial Statements.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None

Item 9A. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

We carried out an evaluation as of September 30, 2010, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934. Based upon that assessment and the material weakness in the financial reporting process at Brotman Medical Center ("Brotman") discussed below, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are ineffective in timely alerting them to material information relating to us (including our consolidated subsidiaries) required to be disclosed in our reports under the Securities Exchange Act of 1934. The Chief Executive Officer and Chief Financial Officer further concluded that, as of September 30, 2010, controls and procedures over financial reporting process, are ineffective.

Management's Report on Internal Control over Financial Reporting

Our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer is responsible for establishing and maintaining effective internal control over financial reporting, or Internal Control, as such term is defined in Exchange Act Rule 13a-15(f). Our Internal Control is designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles, or GAAP. PMH's Internal Control includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of PMH; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial

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statements in accordance with GAAP, and that receipts and expenditures of PMH are being made only in accordance with authorizations of management and directors of PMH; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of PMH's assets that could have a material effect on the financial statements.

Because of inherent limitations in any Internal Control, no matter how well designed, misstatements due to error or fraud may occur and may not be detected. Accordingly, even effective Internal Control can provide only reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP.

Our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of PMH's Internal Control as of September 30, 2010. Management's assessment was based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations ("COSO") of the Treadway Commission

Previously, during the financial reporting close for the quarter ended June 30, 2009, management identified a material weakness within the financial reporting process of Brotman. We believe the material weakness identified during 2009 still remains as of September 30, 2010.

Based upon that assessment which included the evaluation of the material weakness in the financial reporting process at Brotman discussed below, management has concluded that PMH's Internal Control over financial reporting was ineffective as of September 30, 2010.

See below for discussion of material weaknesses in internal control over financial reporting at Brotman, which became a majority-owned subsidiary effective April 14, 2009.

This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by our registered public accounting firm pursuant to the rules of the Securities and Exchange Commission that permit us to provide only management's report in this annual report.

Brotman—Material Weakness in Internal Control over Financial Reporting

Summary of Material Weaknesses in Internal Control over Financial Reporting:

In 2009, we identified several deficiencies within the financial reporting process of Brotman. While improvements have been made, we believe that these deficiencies created an environment where there is a reasonable possibility that a material misstatement of Brotman's financial statements would not be detected in a timely manner. We assessed a material weakness in the financial reporting process of Brotman and its related impact on the corporate consolidating financial reporting process. The deficiencies within the financial reporting process are the lack of a formalized month-end close process and a lack of department accounting policies and procedures.

Brotman was unable to implement a structured close process. Account reconciliations were not reviewed by management in a timely manner which resulted in a significant amount of post close adjustments. Additionally, Brotman's accounting department did not utilize or implement policies and procedures to organize or streamline the close process.

As a result of these deficiencies, we are in the process of implementing significant changes in the Brotman accounting department. We added additional resources and personnel with experience in and an understanding of the complexities of the business and financial reporting process. Additional control processes and oversight procedures have been implemented; however, a longer evaluation period is needed to reasonably validate that such processes and procedures are operating at a level to have fully remediated the material weakness as of September 30, 2010. At Brotman, we continue to expend

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significant efforts on financial reporting activities, integration of operations and expansion of our disclosure controls and procedures.

Remediation Steps to Address Material Weaknesses:

Based on findings of material weaknesses in our internal control over financial reporting, we have taken steps to strengthen our internal controls within the financial reporting process. We have added to the expertise and depth of personnel within the Brotman accounting department, including the addition of senior level accounting professionals with specific and significant expertise in the critical areas identified above. We also added additional resources to assist in the review and preparation of significant account balance reconciliations as well as the implementation of new policies and procedures. Also, senior management has increased its scrutiny and oversight of Brotman's financial statements and has performed significant top-down financial statement analysis to gain additional assurance as to the accuracy of Brotman's financial information. We will continue to work on and improve the financial reporting process of Brotman and its impact on the corporate consolidating financial reporting process. The principal measures that we are in the process of undertaking to remediate the deficiencies are as follows:

•: We have reorganized accounting department to functionally report to the hospital segment Chief Accounting Officer and added additional resources to implement a sound financial reporting process;
•: We have enhanced Brotman's accounting and finance policies and implemented more robust monitoring control procedures and analytics to prevent or detect a misstatement on a timely basis;
•: We are in the process of developing a financial reporting responsibility matrix, close calendar and checklist, whereby all general ledger accounts and financial statement line items are specifically assigned to a specific member of the accounting department to perform monthly, quarterly and year-end analysis. The analysis will be reviewed by senior members of the accounting department team for accuracy and integrity;
•: We are in the process of developing a formal monthly, quarterly and annual reporting package, including specific reporting and information for identified key risk areas, with formal sign off by the financial executive with specific oversight of each area; and
•: We have enhanced corporate financial reporting process oversight of the above mentioned controls and processes.

Changes in Internal Control over Financial Reporting

Except as discussed above, regarding Brotman, there have been no changes in our Internal Control that occurred during the three months ended September 30, 2010 that have materially affected, or are reasonably likely to materially affect, our Internal Control over financial reporting.

Item 9B. Other Information.

None.

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PART III

Item 10. Directors, Executive Officers and Corporate Governance

Information concerning each of our current directors and executive officers appears below.

Directors

John Baumer, age 43, was appointed as a member of our Board of Directors effective December 15, 2010 in connection with the Ivy Merger. Mr. Baumer is a Partner at Leonard Green & Partners, L.P ("Leonard Green"). He joined Leonard Green in 1999. Previously Mr. Baumer was a Vice President at DLJ in Los Angeles, which he joined in 1995. Prior to DLJ, Mr. Baumer worked at Fidelity Investments and Arthur Andersen. Mr. Baumer presently serves on the Board of Directors of Aspen Dental Management, Inc., The Brickman Group, Ltd., Equinox, Intercontinental Art, Inc., Leslie's Poolmart, Inc., Petco Animal Supplies, Inc., and VCA Antech, Inc. Mr. Baumer earned a Bachelor of Business Administration from the University of Notre Dame and an M.B.A. from the Wharton School at the University of Pennsylvania. With significant experience in financing, analyzing, investing in and managing investments in public and private companies, Mr. Baumer has gained substantial expertise in strategic and financial matters that inform his contributions to our board of directors and enhance his oversight and direction of us. In addition, he led the diligence team that managed the acquisition of Prospect Medical in 2010, which provided him with a unique knowledge of our organization. Mr. Baumer's service as a director of other companies in a variety of industries gives him a range of experience as a director on which he can draw in serving as our director and augments his knowledge of effective corporate governance.

Samuel S. Lee, age 44, was appointed PMH's Chief Executive Officer on March 19, 2008 and as Chairman of PMH's board of directors on May 14, 2008. Mr. Lee was previously appointed as a member of PMH's board of directors and as Chief Executive Officer of Alta, on August 8, 2007. Mr. Lee is an officer of each of PMH's direct and indirect subsidiaries. He served previously as the President of Alta from January 2002 until PMH acquired Alta on August 8, 2007. In 1998, Mr. Lee co-founded Alta (formerly Alta Healthcare System, Inc.) after acquiring seven Los Angeles area hospitals from Paracelsus Healthcare Corporation. Between its formation in 1998 and its 2007 acquisition by Prospect Medical, Mr. Lee served as a member of Alta's board of directors, and Mr. Lee has subsequently served as its sole manager following its conversion into a limited liability company at the time of the acquisition. Mr. Lee's background involves healthcare and technology related private equity investment management, operational leadership, entrepreneurship, mergers and acquisitions, and leveraged financing for various corporations. Prior to joining Alta, Mr. Lee was a General Partner with Kline Hawkes & Co., a $500,000,000 private equity firm located in Brentwood, California, that focuses on healthcare, technology, and business services. Mr. Lee has been the lead or principal investor and director of several private and public companies. Additionally, Mr. Lee worked in healthcare reimbursement, business office, and operations for SFS, Inc., and in consulting and systems engineering for Andersen Consulting and Verizon. Mr. Lee brings to the Board extensive experience in the healthcare industry, including in the acquisition and management of healthcare companies.

Jeereddi A. Prasad, M.D., age 62, was appointed as a member of PMH's board of directors effective June 1, 2007 in connection with PMH's acquisition of the ProMed group of companies, which include a management services organization (or MSO), its parent company and two IPAs based in Southern California. Dr. Prasad has served as the President of each of the ProMed group entities since 1994 and since 2002 in the case of Upland Medical Group. Since 1991, Dr. Prasad has also served as the President and Medical Director of Chaparral Medical Group, Inc., a fifty-physician multi-specialty group that he founded in Southern California, within which he created an Endocrinology Department that is an ADA Certified Center of Excellence for Diabetic Education. Chaparral Medical Group, Inc. is located at 840 Town Center Drive, Pomona, California 91767. He is board certified in Endocrinology and Internal Medicine and is a Fellow of both the American College of Endocrinologists and American

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College of Physicians. Dr. Prasad brings to the Board extensive, valuable experience in the management and operation of MSOs and IPAs, which constitute an important component of our business.

Michael S. Solomon, age 35, was appointed as a member of our Board of Directors effective December 15, 2010 in connection with the Ivy Merger. Mr. Solomon is a CFA charterholder and a Principal at LGP. He joined Leonard Green in 2000. Previously he worked in the Financial Sponsors Group of Deutsche Banc Alex Brown in Los Angeles since 1996. Mr. Solomon presently serves on the Board of Directors of David's Bridal, Inc., and Petco Animal Supplies, Inc. Mr. Solomon is also actively involved with Leonard Green's investments in AsianMedia Group LLC and Jetro Cash & Carry, Inc. Mr. Solomon earned a Bachelor of Arts degree in Economics from Pomona College. With significant experience in financing, analyzing, investing in and managing investments in public and private companies, Mr. Solomon has gained substantial expertise in strategic and financial matters that inform his contributions to our board of directors and enhance his oversight and direction of us. Mr. Solomon's service as a director of other companies in a variety of industries gives him a range of experience as a director on which he can draw in serving as our director and augments his knowledge of effective corporate governance.

Alyse Wagner, age 32, was appointed as a member of our Board of Directors effective December 15, 2010 in connection with the Ivy Merger. Ms. Wagner is a Vice President at Leonard Green. She joined LGP in 2003. Prior to joining Leonard Green, she had been in the Investment Banking Division of Credit Suisse First Boston (formerly DLJ) in their Los Angeles office. She currently serves on the Board of Directors of AerSale Holdings, Inc., Aspen Dental Management, Inc., and HITS, Inc. In addition, Alyse is actively involved in Leonard Green's investments in The Brickman Group, Ltd., Del Taco Holdings, Inc., Motorsport Aftermarket Group, Inc., Petco Animal Supplies, Inc., and Varsity Brands. Ms. Wagner earned a Bachelor of Science degree in Economics from the Wharton School at the University of Pennsylvania. With significant experience in financing, analyzing, investing in and managing investments in public and private companies, Ms. Wagner has gained substantial expertise in strategic and financial matters that inform her contributions to our board of directors and enhance her oversight and direction of us. In addition, Ms. Wagner was part of the diligence team that managed the acquisition of Prospect Medical in 2010, which provided her with a unique knowledge of our organization. Ms. Wagner's service as a director of other companies in a variety of industries gives her a range of experience as a director on which she can draw in serving as our director and augments her knowledge of effective corporate governance.

Executive Officers

The following table summarizes the name, age, title and business experience for the past five years of each of our executive officers. Other than as described below, no family relationships exist between or among any of our officers.

Name		Position

Samuel S. Lee	44	Chairman, Chief Executive Officer and Director
Mike Heather	52	Chief Financial Officer
Donna Vigil	62	Vice President, Finance

Samuel S. Lee. Refer to "Directors" under Item 10 on page 102 of this Report.

Mike Heather. Mr. Heather was appointed Chief Financial Officer of the Company in April 2004. Most recently, Mr. Heather served as Co-Chief Executive Officer of WebVision, Inc. from March 2001 to June 2002, and served as the Chief Financial Officer of WebVision beginning in June 2000 and continuing through June 2002. Prior to joining WebVision, Mr. Heather was a partner at Deloitte, which he joined in 1980, and was the founder and Partner-in-Charge of the Healthcare Services Practice of Deloitte in Orange County.

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Donna Vigil. Ms. Vigil has served as our Vice President of Finance since April 2004, prior to which she served as our Chief Financial Officer commencing July 1998. Ms. Vigil served as Chief Financial Officer of NetSoft, a privately held, $20,000,000 software development company with five European subsidiaries, from October 1989 to September 1997. Ms. Vigil was Acting Chief Financial Officer/Consultant of Strategic HR Services, the staffing division for a large real estate developer in Southern California, from October 1997 to May 1998.

Terms of Office

Pursuant to the terms of the Stockholders Agreement of Ivy Holdings Inc. (the new parent company of the Company) ("Ivy Holdings"), dated December 15, 2010, the composition of the Board of Directors of the Company is identical to the composition of the Board of Directors of Ivy Holdings. In accordance with the agreement, affiliates of Leonard Green & Partners, L.P. currently have the right to designate three of the five members of the Board of Directors and the Company's management stockholders have the right to designate the other two directors. The directors currently designated by the affiliates of Leonard Green & Partners, L.P. are John Baumer, Michael Solomon and Alyse Wagner. The directors currently designated by the Company's management stockholders are Samuel Lee and Jeereddi A. Prasad, M.D.

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

Audit Committee

The Company has a standing Audit Committee, whose most recent members were the directors who resigned as directors in connection with the Ivy Merger. Therefore, the Company's Board of Directors is considering whether, or how, to reconstitute the membership of the Audit Committee, including whether to have an Audit Committee financial expert on the Audit Committee.

Code of Ethics

Based upon the advice and recommendation of the Company's Audit Committee, the Board of Directors has adopted a financial code of ethics that applies to our senior financial officers, including the principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. The financial code of ethics addresses conflicts of interest, corporate opportunities, confidentiality, protection and proper use of Company assets, financial disclosure and reporting, maintenance of books and records and compliance with laws, rules and regulations. The Financial Code of Ethics is on our website at www.prospectmedicalholdings.com.

The Board of Directors has also adopted a Code of Business Conduct and Ethical Business Practice which applies to all officers, employees and directors of the Company. The Code of Business Conduct and Ethical Business Practice is on our website at www.prospectmedicalholdings.com.

The Financial Code of Ethics and the Code of Business Conduct and Ethical Business Practice contain written standards that are intended to deter wrongdoing and to promote honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships; full, fair, accurate, timely, and understandable disclosure in reports and documents that the Company files with, or submits to, the SEC and in other public communications made by the Company; compliance with applicable governmental laws, rules and regulations; the prompt internal reporting of violations of these standards to the Company's Audit Committee or Corporate Compliance Officer; and accountability for adherence to these standards.

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Section 16(a) Beneficial Ownership Reporting Compliance

Under Section 16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), our directors, executive officers, and any persons holding more than 10% of any class of our equity securities are required to report their ownership of our equity securities and any changes in that ownership to the Securities and Exchange Commission (the "SEC"). Specific due dates for these reports have been established, and we are required to report any failure to file such reports on a timely basis. Based solely on a review of copies of reports filed with the SEC, we believe that all persons required to file such reports complied with the filing requirements applicable to them for the fiscal year ended September 30, 2010. If and when we deregister our common stock under applicable provisions of the Exchange Act, the foregoing persons will no longer be subject to Section 16(a) of the Exchange Act.

Item 11. Executive Compensation.

Summary Compensation Table

The following table sets forth certain information regarding compensation paid or earned for all services rendered to the Company in all capacities during the fiscal years ended September 30, 2010 and 2009 by our principal executive officer and our other two executive officers who were serving as executive officers as of September 30, 2010. These three executive officers are referred to as the "named executive officers" in this Annual Report on Form 10-K. No other persons served as executive officers of the Company during the fiscal year ended September 30, 2010.

SUMMARY COMPENSATION TABLE

Name and Principal Position

Samuel S. Lee	2010	950,000		1,900,000	(4)	484,000	(7)	407,065	42,688	3,783,753
Chief Executive Officer	2009	850,000	(1)	2,850,000	(4)	—		386,155	50,008	4,136,163
Mike Heather	2010	350,000		262,500		341,950	(7)	267,961	986	1,223,397
Chief Financial Officer	2009	350,000		350,000	(5)	104,000	(6)	6,341	8,810	819,151
Donna Vigil	2010	175,000		15,000	(8)	—		2,041	4,872	196,913
Vice President of Finance	2009	175,000		15,000		—		8,708	4,143	202,851

(1): Pursuant to the third amendment to executive employment agreement, dated February 12, 2009, among the Company, Alta and Mr. Lee, Mr. Lee's annual base salary was increased, retroactively to October 1, 2008, from $650,000 to $750,000. On May 12, 2009, the Company and Mr. Lee entered into an amended and restated executive employment agreement which restated and replaced in full Mr. Lee's prior employment agreement and its amendments. Under the amended and restated employment agreement, Mr. Lee's annual base salary was increased to $950,000 with retroactive effect to April 1, 2009.
(2): The amounts in this column represent the proportionate amount of the total fair value of stock awards (in the case of the column titled "Stock Awards"), or option awards (in the case of the column titled "Option Awards"), recognized by us as an expense for financial reporting purposes. The fair value of these awards and the amounts expensed were determined in accordance with Financial Accounting Standards Board Statement ASC Topic 718 (Financial Accounting Standards No. 123 (revised 2004) Share-Based Payment (FAS 123R)). The assumptions we use in calculating these amounts are discussed in Note 10, "Equity-Based Compensation Plans," to the accompanying consolidated financial statements.
(3): All Other Compensation includes a 401(k) match provided as part of our deferred compensation plan that covered Company employees prior to its suspension effective May 21, 2009 and other standard perquisites provided to a certain level of Company executives, life insurance premiums paid by the Company for all named executives, and with respect to Mr. Lee, expense reimbursement for medical and dental insurance premiums totaling $34,288 and $29,029 in fiscal 2010 and 2009, respectively, and a car allowance totaling $8,400 and $7,700 in fiscal 2010 and 2009, respectively.
(4): In accordance with the terms of his employment agreement, the Company's Compensation Committee awarded discretionary bonuses to Mr. Lee in the amount of $950,000 and none for his service during fiscal 2009 and 2010, respectively. Company performance bonuses in the amount of $1,900,000 and $1,900,000 have been recorded relating to achievement of EBITDA targets by the Company during fiscal 2010 and 2009, respectively.
(5): The Company's Compensation Committee awarded annual discretionary bonuses to Mr. Heather in the amount of $175,000 and none for his services during fiscal 2009 and 2010, respectively. Additionally, Company performance bonuses in the amount of $262,500 and $175,000 have been recorded relating to achievement of EBITDA targets by the Company during fiscal 2010 and 2009, respectively.

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(6): On July 17, 2007, the Compensation Committee of the Board of Directors approved a grant to Mr. Heather of 200,000 shares of restricted stock, which became effective on August 15, 2008 following the approval of the 2008 Omnibus Equity Incentive Plan by our stockholders at the 2008 Annual Meeting of Stockholders held on August 13, 2008. Two-thirds of the shares were vested at the effective time and the final third vested on June 14, 2009.
(7): On December 18, 2009, the Company's Compensation Committee granted an aggregate of 210,000 shares of restricted stock to Mr. Lee and Mr. Heather. As of September 30, 2010, all of the shares granted to Mr. Lee had vested and two-thirds of the shares granted to Mr. Heather had vested. As discussed in Note 4, "Agreement and Plan of Merger" to the accompanying consolidated financial statements, the final third of unvested restricted stock granted to Mr. Heather vested in full immediately prior to the effective time of the merger.
(8): Preliminary estimate.

Outstanding Equity Awards as of September 30, 2010

The following table provides information regarding unexercised stock options or other equity awards for each of the named executive officers outstanding as of September 30, 2010.

As a result of the completion of the Ivy Merger, all of the options and shares of restricted stock listed in the table have been exchanged for consideration in the Ivy Merger and are no longer outstanding.

OUTSTANDING EQUITY AWARDS AT FISCAL YEAR END

				Option Awards									Stock Awards

Name	Number of Securities Underlying Unexercised Options (#) Exercisable			Number of Securities Underlying Unexercised Options (#) Unexercisable		Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options(3)		Option Exercise Price ($)		Option Expiration Date			Number of Shares of Stock that Have Not Vested (#)			Market Value of Shares of Stock that Have Not Vested ($)		Equity Incentive Plan Awards: Number of Unearned Shares that Have Not Vested (#)		Equity Incentive Plan Awards: Market or Pay-0ut Value of Shares that Have Not Vested ($)
Samuel S. Lee		1,456,250	(1)				—		2.40		08/20/13			N/A			N/A		N/A		N/A
		386,366	(4)				—		2.40		08/20/13
		75,756	(4)				—		2.64		08/20/13
		215,868	(5)				—		4.40		12/18/14
		4,132	(5)				—		4.84		12/18/14
Mike Heather		300,000	(3)		—		—		5.00		—	(3)
		9,500	(2)		—		—		5.20		05/30/12
		91,622	(5)		43,940		—		4.40		12/18/14
		41,711	(5)		22,727		—		4.40		12/18/14
					—		—							33,334	(6)		283,339		N/A		N/A
Donna Vigil		6,666	(4)		3,334		—		2.40		08/20/13			N/A			N/A		N/A		N/A
		10,000	(2)		—		—		5.20		05/30/12

(1): On August 20, 2008, we granted Mr. Lee non-qualified stock options outside our stock option plans. The options vested as to 833,333 shares on the date of grant, as to 311,459 shares on March 19, 2009, and as to 311,458 on March 19, 2010.
(2): These options were granted under our 1998 Stock Option Plan and vest pro-rata over three years, including the date of grant (the requisite service period). Options issued under our 1998 Stock Option Plan have a five-year term.
(3): On April 8, 2004, we granted to Mr. Heather non-qualified stock options outside our stock option plans. These options vested over a three-year period and will expire three years after the date of his termination or resignation from the Company.
(4): These options were granted under our 2008 Omnibus Equity Incentive Plan. Of a total of 500,000 options awarded to Mr. Lee, 113,634 options were issued as incentive stock options ("ISOs") and 386,366 options were issued as non-qualified stock options ("NQSOs"). The NQSOs vested one-third on the date of grant, one-third on March 19, 2009, and one-third on March 19, 2010. The ISOs vested one-third on the date of grant, one-third on August 20, 2009, and one-third on August 20, 2010. All of the 10,000 options issued to Ms. Vigil were awarded as ISOs and vested, or will vest, one-third on August 20, 2009, one-third on August 20, 2010, and one-third on August 20, 2011. Options issued under our 2008 Omnibus Equity Incentive Plan have a five-year term.
(5): These options were granted on December 18, 2009 under our 2008 Omnibus Equity Incentive Plan. Of a total of 220,000 options awarded to Mr. Lee, 215,868 options were issued as non-qualified stock options ("NQSOs") and 4,132 options were issued as incentive stock options ("ISOs"). The NQSOs vested two-thirds on the date of grant and one-third on March 19,

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2010. The ISOs vested, as to 2,066 shares on the date of grant and as to 2,066 shares on March 19, 2010. Of a total of 200,000 options awarded to Mr. Heather, 135,562 options were issued as non-qualified stock options ("NQSOs") and 64,438 options were issued as incentive stock options ("ISOs"). The NQSOs have vested, or will vest, one-third on the date of grant, one-third on June 1, 2009, and one-third on June 1, 2010. The ISOs have vested, or will vest, one-third on the date of grant, one-third on June 1, 2010, and one-third on June 1, 2011 (accelerated at the effective time of the merger).

(6): Refer to Note 7 under "Summary Compensation Table" above. At the effective time of the merger, restrictions on each share of restricted stock issued under any of our equity incentive plans lapsed and each such share of restricted stock was converted into the right to receive the $8.50 per share cash merger consideration, less any applicable withholding taxes.

Employment Arrangements

On August 8, 2007, in satisfaction of a condition to the closing of our acquisition of Alta, we entered into an employment agreement with Samuel S. Lee, who is our Chief Executive Officer and the Chairman of our Board of Directors. The employment agreement was amended effective as of March 19, 2008, July 8, 2008 and February 12, 2009. On May 12, 2009, the Company and Mr. Lee entered into an Amended and Restated Executive Employment Agreement which restated and replaced in full Mr. Lee's prior employment agreement and its amendments. Under the amended and restated employment agreement, Mr. Lee is entitled to a base annual salary of $950,000, discretionary and performance based annual bonuses, and participation in any employee benefit and fringe benefit plans and programs available to other executives of the Company as well as any executive equity incentive plan adopted by the Board of Directors. Mr. Lee's employment agreement has a term of five years. The agreement is subject to termination at any time, but if termination is without cause Mr. Lee will be entitled to receive an aggregate lump sum payment in an amount equal to the sum of (i) base salary for the balance of the term of the agreement or for a period of three years, whichever is less; (ii) accrued but unused vacation, paid time off or other compensation; (iii) pro-rata bonus payments; and (iv) incurred but unpaid reimbursement for business expenses. The agreement also includes non-compete provisions. As of September 30, 2010, in the event of termination without cause, Mr. Lee would receive $2,850,000 related to base salary and $230,000 in accrued vacation. EBITDA based and discretionary bonus amounts are determined by the Company's Board of Directors annually.

Effective April 19, 2004, the Company entered into an employment agreement with our Chief Financial Officer, Mike Heather. The employment agreement provides for a minimum one-year term and provides for an initial salary of $180,000 per year. Under the agreement, Mr. Heather was awarded options to purchase 300,000 shares of common stock, at $5.00 per share, as part of his employment compensation. Upon the consummation of the Ivy Merger, Mr. Heather received cash compensation in exchange for the cancellation of any outstanding options. On January 17, 2007, the Compensation Committee increased Mr. Heather's annual base salary from $180,000 to $225,000. Effective July 17, 2007, Mr. Heather's annual base salary was further increased to $350,000. On February 12, 2009, the Company and Mr. Heather entered into a First Amendment to Employment Agreement that provided for the ability of the Compensation and Benefits Committee of the Company's Board of Directors to declare discretionary bonuses to Mr. Heather.

On June 1, 2007, in satisfaction of a condition to the closing of our acquisition of the ProMed group, we entered into an employment agreement with Dr. Jeereddi Prasad, who is a Director of the Company, under which he agreed to continue to serve as the President of each of the ProMed entities for a base annual salary of $300,000, an automobile allowance of $1,300 per month, participation in any employee fringe benefit plans and programs available to other executives of the Company. The employment agreement also provides that Dr. Prasad will receive annual incentive bonuses if certain performance standards are met by the ProMed entities. Dr. Prasad's employment agreement has an initial term of three years, which will renew automatically for successive one-year periods subject to prior written notice of non-renewal from either party at least ninety days prior to the expiration of the initial term or any renewal term. The agreement is subject to termination at any time, but if termination is without cause Dr. Prasad will be entitled to continue receiving compensation as provided for under the agreement for the balance of the term of the agreement or for a period of six months, whichever is greater, as though he were continuing to perform services under the agreement. In connection with the employment agreement, Dr. Prasad also entered into a non-compete agreement with the Company and Prospect Medical Group.

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Director Compensation

The following table summarizes the compensation of each of our directors who is not also a named executive officer for his service as a director for the fiscal year ended September 30, 2010.

DIRECTOR COMPENSATION

Name

David Levinsohn	65,000	(3)	47,760	—	N/A	N/A	N/A		112,760
Kenneth Schwartz, CPA	64,000	(4)	47,760	—	N/A	N/A	N/A		111,760
Glenn R. Robson	55,000	(5)	47,760	—	N/A	N/A	N/A		102,760
Jeereddi Prasad, MD	—		—	—	N/A	N/A	538,000	(6)	538,000	(6)

(1): Reflects cash compensation earned for the fiscal year ended September 30, 2010. Non-employee directors were paid a flat monthly fee of $2,000 per month. For his service as Audit Committee Chairman, Mr. Schwartz was paid an additional fee of $1,000 per month. Mr. Levinsohn was paid an additional fee of $1,000 per month for his service as Compensation Committee Chairman and an additional $500 per month for his service as the Lead Independent Director. Also reflected are fees earned by the independent members of the Board of Directors for their service as members of the Special Committee of the Board that had certain duties regarding the evaluation of the Ivy Merger. Special Committee members were paid a fee of $1,000 for each Special Committee meeting that they attended. Additionally, each member of the committee was paid a one time $2,000 fee for committee membership and Glenn Robson was paid an additional $2,000 for his service as the chairman of the committee.
(2): For their services during the Company's fiscal 2010, each of the Board's independent directors was granted 6,000 shares of the Company's common stock on November 10, 2010.
(3): Includes $42,000 for his service as a director, Compensation Committee Chairman and Lead Independent Director. Also includes $23,000 for his service on the Special Committee in connection with the Ivy Merger.
(4): Includes $36,000 for his service as a director and Audit Committee Chairman. Also includes $28,000 for his service on the Special Committee in connection with the Ivy Merger.
(5): Includes $24,000 for his service as a director. Also includes $31,000 for his service as Chairman of the Special Committee in connection with the Ivy Merger.
(6): Dr. Prasad receives no compensation for his service as a director of the Company, but is compensated for his service as President of one of our affiliated physician organizations. The amount shown consists of Dr. Prasad's annual salary of $304,000, performance bonus of $226,000, as well as payment or reimbursement of life and health insurance premiums and an automobile allowance.

In connection with the consummation of the Ivy Merger on December 15, 2010, Messrs. Levinsohn, Schwartz and Robson submitted their resignations. See "Terms of Office" in Part III, Item 10 above, for a description of the method of selection of the members of the Company's Board of Directors after the consummation of the Ivy Merger.

Director Compensation Policy

Under the Company's compensation structure, independent directors currently receive a flat monthly fee of $2,000 per month. Additional $1,000 monthly fees are paid for service as Audit Committee Chairman and for service as Compensation Committee Chairman, and an additional $500 per month is paid to the designated Lead Independent Director. Also, in connection with their service as members of the Special Committee of the Board that had certain duties regarding the evaluation of the Ivy Merger, a fee of $1,000 was paid for each meeting attended, an additional one time $2,000 fee was paid to each member for committee membership and the Chairman of the committee was paid an additional $2,000 fee.

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Due to the consummation of the Ivy Merger and the corresponding changes in the membership of the Company's Board of Directors, consideration will be given to whether any changes to the existing Board compensation structure are appropriate.

Our Board of Directors has engaged the services of certain compensation consultants to assist them in their determination of the appropriate compensation for the services of the Board's independent directors. Among other related information, the consultants have provided the Company with comparative analyses between compensation levels at different companies that are comparable to the Company in terms of size, revenue, industry and situation. During the fiscal years ended September 30, 2010 and 2009, the Board engaged the executive and director compensation consulting services of Lockton Companies, LLC, or Lockton. Under the engagement, Lockton has provided the Company with executive and director pay comparisons between the Company and similar companies, related information and executive and director pay recommendations that have been taken into consideration in the determination of the appropriate compensation for the Board's independent directors.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

Amount and Nature of Shares of Common Stock Beneficially Owned

The following tables set forth the beneficial ownership of the Company's common stock as of December 15, 2010, and after giving effect to the Ivy Merger:

Ownership of Prospect Medical Holdings, Inc.

Name		Number of Shares			Percent

Ivy Intermediate Holding, Inc.			100			100	%

Ownership of Ivy Intermediate Holding, Inc.

Name		Number of Shares			Percent

Ivy Holdings Inc.			100			100	%

Ownership of Ivy Holdings, Inc.

Name

Green Equity Investors V, L.P.	642,056.99	46.0	%
Green Equity Investors Side V, L.P.	192,601.66	13.8	%
Ivy LGP Co-Invest LLC	20,341.39	1.5	%
Samuel Lee	281,695.00	20.2	%
David & Alexa Topper Family Trust u/d/t September 29, 1997	208,600.00	14.9	%
Mike Heather	22,260.00	1.6	%
Jeereddi Prasad, M.D.	16,810.00	1.2	%
Other Employees of Prospect Medical Holdings, Inc.	11,625.00	0.8	%
Our Directors and Executive Officers as a Group (7 Persons)(1)	320,765	23.0	%

(1): Our remaining three directors not listed above—John Baumer, Michael Solomon and Alyse Wagner—are not the beneficial owners of any Ivy Holdings, Inc. common stock,

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and our remaining executive officer not listed above—Donna Vigil—is not the beneficial owner of any Ivy Holdings, Inc. common stock.

Equity Compensation Plans

The following table sets forth information as of September 30, 2010 regarding shares of our common stock authorized for issuance under our compensation plans, including individual compensation arrangements:

Plan Category			(b) Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights

Equity compensation plans approved by our security holders:
	1998 Stock Option Plan	88,990	$	5.61	—	(1)
	2008 Omnibus Equity Incentive Plan	2,382,710	$	3.12	833,718
Equity compensation plans not approved by our security holders:
	Options issued outside of plans(2)	1,756,250	$	2.84

	Total	4,227,950	$	3.06	833,718

(1): Upon the adoption of our 2008 Omnibus Equity Incentive Plan, we determined not to make further grants or awards under our 1998 Stock Option Plan.
(2): The options shown consist of options to purchase up to 300,000 shares of our common stock granted to Mr. Heather in connection with his employment agreement described below under "Employment Arrangements" and options to purchase up to 1,456,250 shares of our common stock at an exercise price of $2.40 per share granted to Mr. Lee.

Upon completion of the Ivy Merger on December 15, 2010, as described under Item 1, each outstanding option or warrant converted into the right to receive $8.50 for each share of the Company's common stock represented thereby, less the applicable exercise price and any applicable taxes. Therefore, as of December 15, 2010, there are no longer any options of warrants outstanding under the Company's Plans.

Item 13. Certain Relationships and Related Transactions, and Director Independence.

Jeereddi A. Prasad, M.D., who is a stockholder in the Company's new parent company, Ivy Holdings Inc., following the Ivy Merger and serves as one of our directors, owns directly or indirectly a controlling interest in the following entities (collectively, the "Prasad Entities"): Chaparral Medical Group, Inc.; Internal Medicine Medical Group; CMG Clinical Lab; Ancillary Services, Inc.; and Inland Valley Disease Management Clinic.

Pomona Valley Medical Group, Inc. and Upland Medical Group, Inc. (the "Promed Affiliates") are wholly owned subsidiaries of Prospect Medical Group, Inc., which is an affiliated physician organization of Prospect Medical Holdings, Inc. The Promed Affiliates have contracts with the Prasad Entities, which provide primary care and specialty care services to patients of the Promed Affiliates.

Payment arrangements with the Prasad Entities are on both a capitated and a fee-for-service basis. We also pay discretionary bonuses to the Prasad Entities. We paid the Prasad Entities approximately

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$12,001,000 during the fiscal year ended September 30, 2008, $12,267,000 during the fiscal year ended September 30, 2009, and $14,254,000 during the fiscal year ended September 30, 2010.

The Company entered into an Agreement and Plan of Merger, dated as of August 16, 2010 (the "Ivy Merger Agreement"), among the Company, Ivy Holdings Inc. ("Ivy Holdings"), and Ivy Merger Sub Corp. ("Merger Sub"), an indirect, wholly owned subsidiary of Ivy Holdings. On December 15, 2010, at a special meeting of the Company's stockholders, the adoption of the merger agreement was approved by the affirmative vote of a majority of the Company's common stock outstanding as of the record date for the special meeting. In accordance with the Ivy Merger Agreement and the Delaware General Corporation Law, Merger Sub subsequently merged with and into the Company on December 15, 2010 and the Company became an indirect, wholly-owned subsidiary of Ivy Holdings (the "Ivy Merger").

Ivy Holdings was formed by, and prior to the merger was solely owned by, Green Equity Investors V, L.P., a Delaware limited partnership, and Green Equity Investors Side V, L.P., a Delaware limited partnership (the "LGP Funds"). The LGP Funds are affiliates of Leonard Green & Partners, L.P., a private equity fund.

Pursuant to a contribution and subscription agreement with Ivy Holdings, immediately prior to the merger, a group of significant stockholders and management employees of Prospect Medical comprised of Samuel S. Lee (Chairman of the Board of Directors and Chief Executive Officer), Mike Heather (Chief Financial Officer), David R. Topper (the President of Prospect Medical's Alta Hospital System, LLC subsidiary) and Dr. Jeereddi A. Prasad (a director of Prospect Medical and the President of ProMed Health Services Company subsidiary), contributed to Ivy Holdings a total of 6,227,824 shares of Prospect Medical common stock in exchange for shares of Ivy Holdings common stock. As a result, Messrs. Lee, Topper and Heather and Dr. Prasad beneficially owned approximately 20.2%, 14.9%, 1.6% and 1.2%, respectively, of the outstanding common stock of Ivy Holdings immediately following the completion of the merger (excluding any stock options that may be granted pursuant to a management equity incentive plan that Ivy Holdings may adopt following the completion of the merger). Mr. Lee and Dr. Prasad remain as directors of PMH, and also have become directors of Ivy Holdings.

The foregoing description of the contribution and subscription agreement and the transactions thereunder does not purport to be complete and is subject to, and qualified in its entirety by, the contribution and subscription agreement. A copy of the contribution and subscription agreement is set forth as Annex D to PMH's Proxy Statement on Schedule 14A filed with the SEC on November 12, 2010.

Prior to the consummation of the Ivy Merger, the Company's Board of Directors included three directors, David Levinsohn, Glenn Robson and Kenneth Schwartz, that were considered "independent" under the standards of the Nasdaq Global Market. Following the consummation of the Ivy Merger, the Company is wholly-owned by Ivy Holdings and the Company's common stock is no longer listed on the NASDAQ Global Market. Therefore, the Company's Board of Directors is no longer subject to independence requirements. Under the independence standards of the NASDAQ Global Market, none of the Company's current directors would be considered "independent."

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Item 14. Principal Accountant Fees and Services.

The following table represents aggregate fees billed to us by BDO USA, LLP, our principal accountant for fiscal years ended September 30, 2010 and 2009. Audit fees relate to the audits of the respective fiscal years, notwithstanding when the fees were billed or when the services were rendered.

Name	2010		2009

Audit Fees(1)	$	1,251,429	$	1,482,582
Audit related fees		—		622,328	(2)(3)
All other fees		12,757		6,762	(2)

Total fees	$	1,264,186	$	2,111,672

(1): Includes fees and expenses related to the fiscal year audit of the consolidated financial statements and stand-alone audits of subsidiaries, quarterly reviews, and statutory and regulatory filings.
(2): These fees were all pre-approved by the Audit Committee.
(3): Includes fees and expenses related to pre-acquisition audit and reviews of Brotman Medical Center, Inc.

The Audit Committee's charter provides that the committee will pre-approve all audit services and permitted non-audit services to be performed for the Company by its independent registered public accounting firm. The Audit Committee may delegate authority to pre-approve audit services, other than the audit of the Company's annual financial statements, and permitted non-audit services to one or more committee members, provided that the decisions made pursuant to this delegated authority must be presented to the full committee at its next scheduled meeting. Pursuant to its charter, the committee has adopted procedures for the pre-approval of services by the Company's independent registered public accounting firm. The committee will, on an annual basis, retain the independent registered public accounting firm and pre-approve the scope of all audit services and specified audit-related services. The chair of the committee or the full committee must pre-approve the firm's review of any registration statements containing or incorporating by reference the firm's audit report and the provision of any related consent and the preparation and delivery of any comfort letters. The committee has pre-approved the independent registered public accounting firm's providing advice regarding isolated accounting and tax questions up to $30,000 per calendar quarter and services related to registration statements, periodic reports and filings in connection with securities offerings up to $30,000 per quarter. Any other permitted non-audit services must be pre-approved by either the chair or the full audit committee. In fiscal year 2010, 100 percent of the services provided to the Company by the independent registered public accounting firm were pre-approved in compliance with the policies described above.

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PART IV

Item 15. Exhibits and Financial Statement Schedules.

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


	2.1		Agreement and Plan of Merger, dated as of August 16, 2010, by and among Prospect Medical Holdings, Inc., Ivy Holdings Inc. and Ivy Merger Sub Corp. (incorporated by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K filed on August 16, 2010).
	3.1		Second Amended and Restated Certificate of Incorporation of Prospect Medical Holdings, Inc. (incorporated by reference to Exhibit 3.1 to the Company's Current Report on Form 8-K filed on December 16, 2010).
	3.7		Third Amended and Restated Bylaws of Prospect Medical Holdings, Inc. (incorporated by reference to Exhibit 3.1 to the Company's Current Report on Form 8-K filed on December 16, 2010).
	4.1		Indenture, dated July 29, 2009, among the Company, certain of its subsidiaries and affiliates (as subsidiary guarantors) and U.S. Bank National Association (as trustee) (incorporated by reference to Exhibit 4.1 to the Registrant's Current Report on Form 8-K filed on July 29, 2009).
	4.2		First Supplemental Indenture, dated December 15, 2010, among the Company, certain of its subsidiaries and affiliates (as subsidiary guarantors) and U.S. Bank National Association (as trustee).*
	4.3		Form of 12³/4% Senior Secured Notes, Series B, due 2014 (incorporated by reference to Exhibit 4.2 to the Company's Registration Statement on Form S-4 filed on September 30, 2009).
	10.1		Warrant, dated as of January 15, 2004, to Acquire Common Stock between Prospect Medical Holdings, Inc. and Spencer Trask Venture Investment Partners, LLC (incorporated by reference to Exhibit 10.2 to the Company's Registration Statement on Form 10 filed on May 27, 2004).
	10.2		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. (incorporated by reference to Exhibit 10.6 to the Company's Registration Statement on Form 10 filed on May 27, 2004).
	10.3		Amendment to Management Services Agreement, made as of October 1, 1998, between Prospect Medical Systems, Inc. and Prospect Medical Group, Inc. (incorporated by reference to Exhibit 10.7 to the Company's Registration Statement on Form 10 filed on May 27, 2004).
	10.4		Management Agreement, dated as of January 1, 2003, between Pinnacle Health Resources Inc. and StarCare Medical Group, Inc. dba Gateway Medical Group, Inc. (incorporated by reference to Exhibit 10.8 to the Company's Registration Statement on Form 10 filed on May 27, 2004).
	10.5		Management Agreement, dated as of January 1, 2003, between Pinnacle Health Resources Inc. and APAC Medical Group, Inc. dba Gateway Physicians Medical Associates, Inc. (incorporated by reference to Exhibit 10.9 to the Company's Registration Statement on Form 10 filed on May 27, 2004).

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	10.6		Management Services Agreement, made as of August 1, 1999, between Prospect Medical Systems, Inc. and Nuestra Familia Medical Group (incorporated by reference to Exhibit 10.10 to the Company's Registration Statement on Form 10 filed on May 27, 2004).
	10.7		Amendment to Management Services Agreement, made as of January 15, 2009, between Prospect Medical Systems, Inc. and Nuestra Familia Medical Group, Inc. (incorporated by reference to Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q filed on February 17, 2009).
	10.8		Management Services Agreement, made as of July 1, 1999, between Prospect Medical Systems, Inc. and AMVI/Prospect Medical Group (incorporated by reference to Exhibit 10.11 to the Company's Registration Statement on Form 10 filed on May 27, 2004).
	10.9		Management Services Agreement, dated as of January 1, 2001, between Prospect Medical Systems, Inc. and Prospect Health Source Medical Group, Inc. (incorporated by reference to Exhibit 10.31 to the Company's Registration Statement on Form 10 filed on May 27, 2004).
	10.10		Amendment to Management Services Agreement, dated as of November 1, 2002, between Prospect Medical Systems, Inc. and Prospect Health Source Medical Group, Inc. (incorporated by reference to Exhibit 10.32 to the Company's Registration Statement on Form 10 filed on May 27, 2004).
	10.11		Amendment to Management Services Agreement, made as of January 15, 2009, between Prospect Medical Systems, Inc. and Prospect Health Source Medical Group, Inc. (incorporated by reference to Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q filed on February 17, 2009).
	10.12		Management Services Agreement, dated as of October 1, 2003, by and between Prospect Medical Systems, Inc. and Prospect Professional Care Medical Group, Inc. (incorporated by reference to Exhibit 10.33 to the Company's Registration Statement on Form 10 filed on May 27, 2004).
	10.13		Management Services Agreement, dated as of March 1, 2004, by and between Prospect Medical Systems, Inc. and Prospect NWOC Medical Group, Inc. (incorporated by reference to Exhibit 10.34 to the Company's Registration Statement on Form 10 filed on May 27, 2004).
	10.14		Partnership Agreement, dated July 1, 1999, between AMVI/MC Health Network, Inc. and Santa Ana/Tustin Physicians Group (incorporated by reference to Exhibit 10.77 to the Company's Registration Statement on Form 10 filed on May 27, 2004).
	10.15		Prospect Medical Holdings, Inc. 1998 Stock Option Plan (incorporated by reference to Exhibit 10.90 to the Company's Registration Statement on Form 10 filed on May 27, 2004).
	10.16		First Amendment to Prospect Medical Holdings, Inc. 1998 Stock Option Plan (incorporated by reference to Exhibit 10.91 to the Company's Registration Statement on Form 10 filed on May 27, 2004).
	10.17		Cash Management Agreement among Prospect Medical Systems, Inc., Prospect Medical Holdings, Inc., and Prospect Medical Group, Inc., effective as of June 6, 1996 (incorporated by reference to Exhibit 10.194 to the Company's Amendment No. 2 to Registration Statement on Form 10 filed on August 27, 2004).
	10.18		Second Amendment to Prospect Medical Holdings, Inc. 1998 Stock Option Plan (incorporated by reference to Exhibit 10.195 to the Company's Amendment No. 3 to Registration Statement on Form 10 filed on October 21, 2004).

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	10.19		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. (incorporated by reference to Exhibit 10.198 to the Company's Amendment No. 3 to Registration Statement on Form 10 filed on October 21, 2004).
	10.20		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. (incorporated by reference to Exhibit 10.199 to the Company's Amendment No. 3 to Registration Statement on Form 10 filed on October 21, 2004).
	10.21		Form of stock option agreement used for incentive stock options granted under the Company's 1998 Stock Option Plan, as amended (incorporated by reference to Exhibit 99.1 to the Company's Current Report on Form 8-K filed on September 20, 2005).
	10.22		Form of stock option agreement used for non-qualified stock options granted under the Company's 1998 Stock Option Plan, as amended (incorporated by reference to Exhibit 99.2 to the Company's Current Report on Form 8-K filed on September 20, 2005).
	10.23		First Lien Credit Agreement, dated as of August 8, 2007, among Prospect Medical Holdings, Inc. and Prospect Medical Group, Inc. as the Borrowers, Bank of America, N.A., as Administrative Agent, Swing Line Lender, and L/C Issuer, Cratos Capital Management, LLC, as Syndication Agent, certain other Lenders, and Banc of America Securities LLC, as Sole Lead Arranger and Sole Book Manager (incorporated by reference to Exhibit 10.31 to the Company's Annual Report on Form 10-K filed on June 2, 2008).
	10.24		Second Lien Credit Agreement, dated as of August 8, 2007, among Prospect Medical Holdings, Inc. and Prospect Medical Group, Inc. as the Borrowers, Bank of America, N.A., as Administrative Agent, certain other Lenders, and Banc of America Securities LLC, as Sole Lead Arranger and Sole Book Manager (incorporated by reference to Exhibit 10.32 to the Company's Annual Report on Form 10-K filed on June 2, 2008).
	10.25		Continuing Guaranty (First Lien), dated as of August 8, 2007, by Prospect Medical Holdings, Inc., Prospect Medical Group, Inc., and certain of their Subsidiaries as the Guarantor, in favor of Bank of America, N.A., as Administrative Agent (incorporated by reference to Exhibit 10.35 to the Company's Annual Report on Form 10-K filed on June 2, 2008).
	10.26		Continuing Guaranty (Second Lien), dated as of August 8, 2007, by Prospect Medical Holdings, Inc., Prospect Medical Group, Inc., and certain of their Subsidiaries as the Guarantor, in favor of Bank of America, N.A., as Administrative Agent (incorporated by reference to Exhibit 10.36 to the Company's Annual Report on Form 10-K filed on June 2, 2008).
	10.27		Intercreditor Agreement, dated as of August 8, 2007, by Prospect Medical Holdings, Inc. and Prospect Medical Group, Inc. as the Borrowers, certain of their Subsidiaries as Guarantors, and Bank of America, N.A., as First Lien Collateral Agent, Second Lien Collateral Agent, and Control Agent (incorporated by reference to Exhibit 10.41 to the Company's Annual Report on Form 10-K filed on June 2, 2008).
	10.28		Executive Employment Agreement, dated August 8, 2007, between Alta Hospitals System, LLC, and Samuel S. Lee (incorporated by reference to Exhibit 99.4 to Samuel S. Lee's Schedule 13D filed on August 20, 2007).

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	10.29		Amendment to Executive Employment Agreement, effective March 19, 2008, by and among Prospect Medical Holdings, Inc., Alta Hospitals System, LLC and Samuel S. Lee (incorporated by reference to Exhibit 7 to the Samuel S. Lee's Schedule 13D/A filed on April 22, 2008).
	10.30		Second Amendment to Executive Employment Agreement, dated as of July 8, 2008, by and among Prospect Medical Holdings, Inc., Alta Hospitals System, LLC and Samuel S. Lee (incorporated by reference to Exhibit 8 to the Samuel S. Lee's Schedule 13D/A filed on August 15, 2008).
	10.31		Third Amendment to Executive Employment Agreement, dated as of February 12, 2009, among Prospect Medical Holdings, Inc., Alta Hospitals System, LLC, and Samuel S. Lee (incorporated by reference to Exhibit 10.6 to the Company's Quarterly Report on Form 10-Q filed on February 17, 2009).
	10.32		Amended and Restated Employment Agreement, dated as of May 12, 2009, between Prospect Medical Holdings, Inc. and Samuel S. Lee (incorporated by reference to Exhibit 10.15 to the Company's Quarterly Report on Form 10-Q filed on May 15, 2009).
	10.33		Employment Agreement, made as of April 8, 2004, but effective on April 19, 2004, between Prospect Medical Holdings, Inc. and Mike Heather (incorporated by reference to Exhibit 10.76 to the Company's Registration Statement on Form 10 filed on May 27, 2004).
	10.34		First Amendment to Employment Agreement, dated as of February 12, 2009, between Prospect Medical Holdings, Inc. and Mike Heather (incorporated by reference to Exhibit 10.5 to the Company's Quarterly Report on Form 10-Q filed on February 17, 2009).
	10.35		Employment Agreement, effective June 1, 2007, between Jeereddi Prasad, M.D. and ProMed Health Care Administrators (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q filed on February 16, 2010).
	10.36		Management Services Agreement between Pomona Valley Medical Group, Inc. and ProMed Health Care Administrators, effective October 1, 1998 (incorporated by reference to Exhibit 10.53 to the Company's Annual Report on Form 10-K filed on June 2, 2008).
	10.37		Amendment to Management Services Agreement, made as of October 1, 2007, between ProMed Health Care Administrators, Inc. and Pomona Valley Medical Group, Inc. (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q filed on February 17, 2009).
	10.38		Management Services Agreement between Upland Medical Group, A Professional Medical Corporation and ProMed Health Care Administrators, effective October 1, 2002 (incorporated by reference to Exhibit 10.54 to the Company's Annual Report on Form 10-K filed on June 2, 2008).
	10.39		Amendment to Management Services Agreement, made as of October 1, 2007, between ProMed Health Care Administrators, Inc. and Upland Medical Group, Inc. (incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q filed on February 17, 2009).
	10.40		Hospital Inpatient Services Agreement between Alta Los Angeles Hospitals, Inc. and the Department of Health Services, as amended (Certain portions of this Exhibit have been omitted pursuant to an application for confidential treatment filed with the Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934) (incorporated by reference to Exhibit 10.55 to the Company's Annual Report on Form 10-K filed on June 2, 2008).

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	10.41		Amendments Nos. 18 and 19 to Hospital Inpatient Services Agreement between Alta Los Angeles Hospitals, Inc. and the Department of Health Services (Certain portions of this Exhibit have been omitted subject to an application for confidential treatment filed with the Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934) (incorporated by reference to Exhibit 10.50 to the Company's Annual Report on Form 10-K filed on December 29, 2008).
	10.42		Amendments Nos. 20 and 21 to Hospital Inpatient Services Agreement between Alta Los Angeles Hospitals, Inc. and the Department of Health Services (Certain portions of this Exhibit have been omitted subject to an application for confidential treatment filed with the Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934) (incorporated by reference to Exhibit 10.42 to the Company's Annual Report on Form 10-K filed on December 21, 2009).
	10.43		Hospital Inpatient Services Agreement between Alta Hollywood Hospitals, Inc. and the Department of Health Services, as amended (Certain portions of this Exhibit have been omitted pursuant to an application for confidential treatment filed with the Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934) (incorporated by reference to Exhibit 10.56 to the Company's Annual Report on Form 10-K filed on June 2, 2008).
	10.44		First Lien Forbearance Agreement, dated as of February 13, 2008, by and among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc., Bank of America, N.A., as Administrative Agent, and the lenders party thereto (incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q filed on June 16, 2008).
	10.45		Second Lien Forbearance Agreement, dated as of February 13, 2008, by and among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc., Bank of America, N.A., as Administrative Agent, and the lenders party thereto (incorporated by reference to Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q filed on June 16, 2008).
	10.46		First Amendment to Forbearance Agreement, dated as of March 31, 2008, by and among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc., and Bank of America, N.A., as Administrative Agent (incorporated by reference to Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q filed on June 16, 2008).
	10.47		Consent Under Second Lien Forbearance Agreement, dated as of March 31, 2008, by and among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc., and Bank of America, N.A., as Administrative Agent (incorporated by reference to Exhibit 10.5 to the Company's Quarterly Report on Form 10-Q filed on June 16, 2008).
	10.48		Amended and Restated Forbearance Agreement, dated as of April 10, 2008, by and among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc., Bank of America, N.A., as Administrative Agent, and the lenders party thereto (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q filed on August 12, 2008).
	10.49		Amended and Restated Second Lien Forbearance Agreement, dated as of April 10, 2008, by and among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc., Bank of America, N.A., as Administrative Agent, and the lenders party thereto (incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q filed on August 12, 2008).
	10.50		Stock Purchase Agreement, dated as of April 23, 2008, among Prospect Medical Group, Inc., Prospect Medical Holdings, Inc., Greater Midwest, Sierra Medical Group Holding Company, Inc. and Richard Merkin, M.D. (incorporated by reference to Exhibit 2.1 to the Company's Quarterly Report on Form 10-Q filed on August 12, 2008).

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	10.51		Amendment No. 1, dated July 3, 2008, to Stock Purchase Agreement, dated as of April 23, 2008, among Prospect Medical Group, Inc., Prospect Medical Holdings, Inc., Greater Midwest, Sierra Medical Group Holding Company, Inc. and Richard Merkin, M.D. (incorporated by reference to Exhibit 10.50 to the Company's Registration Statement on Form S-4 filed on September 30, 2010).
	10.52		Amendment No. 2, dated August 1, 2008, to Stock Purchase Agreement, dated as of April 23, 2008, among Prospect Medical Group, Inc., Prospect Medical Holdings, Inc., Greater Midwest, Sierra Medical Group Holding Company, Inc. and Richard Merkin, M.D. (incorporated by reference to Exhibit 10.51 to the Company's Registration Statement on Form S-4 filed on September 30, 2010).
	10.53		First Amendment to Amended and Restated Forbearance Agreement, dated as of April 30, 2008, by and among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc., and Bank of America, N.A., as Administrative Agent (incorporated by reference to Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q filed on August 12, 2008).
	10.54		First Amendment to Amended and Restated Second Lien Forbearance Agreement, dated as of April 30, 2008, by and among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc., and Bank of America, N.A., as Administrative Agent (incorporated by reference to Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q filed on August 12, 2008).
	10.55		Resignation Agreement, dated as of May 12, 2008, between Prospect Medical Holdings, Inc. and Jacob Y. Terner, M.D. (incorporated by reference to Exhibit 10.5 to the Company's Quarterly Report on Form 10-Q filed on August 12, 2008).
	10.56		Second Amendment to Amended and Restated Forbearance Agreement, dated as of May 14, 2008, by and among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc., and Bank of America, N.A., as Administrative Agent (incorporated by reference to Exhibit 10.6 to the Company's Quarterly Report on Form 10-Q filed on August 12, 2008).
	10.57		Second Amendment to Amended and Restated Second Lien Forbearance Agreement, dated as of May 14, 2008, by and among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc., and Bank of America, N.A., as Administrative Agent (incorporated by reference to Exhibit 10.7 to the Company's Quarterly Report on Form 10-Q filed on August 12, 2008).
	10.58		Second Amendment to First Lien Credit Agreement, Waiver and Consent, dated as of May 15, 2008, by and among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc., Bank of America, N.A., as Administrative Agent, and the lenders party thereto (incorporated by reference to Exhibit 10.8 to the Company's Quarterly Report on Form 10-Q filed on August 12, 2008).
	10.59		Second Amendment to Second Lien Credit Agreement, Waiver and Consent, dated as of May 15, 2008, by and among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc., Bank of America, N.A., as Administrative Agent, and the lenders party thereto (incorporated by reference to Exhibit 10.9 to the Company's Quarterly Report on Form 10-Q filed on August 12, 2008).
	10.60		Third Amendment to First Lien Credit Agreement and First Amendment to Second Amendment to First Lien Credit Agreement, Waiver and Consent, dated as of June 30, 2008, by and among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc., and Bank of America, N.A., as Administrative Agent (incorporated by reference to Exhibit 10.11 to the Company's Quarterly Report on Form 10-Q filed on August 12, 2008).

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	10.61		Third Amendment to Second Lien Credit Agreement and First Amendment to Second Amendment to Second Lien Credit Agreement, Waiver and Consent, dated as of June 30, 2008, by and among Prospect Medical Holdings, Inc., Prospect Medical Group, Inc., and Bank of America, N.A., as Administrative Agent (incorporated by reference to Exhibit 10.12 to the Company's Quarterly Report on Form 10-Q filed on August 12, 2008).
	10.62		Fifth Amended and Restated Assignable Option Agreement, dated as of November 26, 2008, by and among Prospect Medical Systems, Inc., Prospect Medical Group, Inc. and Arthur Lipper, M.D. (incorporated by reference to Exhibit 10.72 to the Company's Annual Report on Form 10-K filed on December 29, 2008).
	10.63		Amendment to Fifth Amended and Restated Assignable Option Agreement, dated July 29, 2009, among Prospect Medical Systems, Inc., Prospect Medical Group, Inc. and Arthur Lipper, M.D. (incorporated by reference to Exhibit 10.11 to the Company's Quarterly Report on Form 10-Q filed on August 19, 2009).
	10.64		Third Amended and Restated Option Agreement, dated as of November 26, 2008, by and between Prospect Medical Group, Inc. and Arthur Lipper, M.D. (incorporated by reference to Exhibit 10.74 to the Company's Annual Report on Form 10-K filed on December 29, 2008).
	10.65		Amendment to Third Amended and Restated Option Agreement, dated July 29, 2009, between Prospect Medical Group, Inc. and Arthur Lipper, M.D. (incorporated by reference to Exhibit 10.12 to the Company's Quarterly Report on Form 10-Q filed on August 19, 2009).
	10.66		Stock Purchase Agreement, dated as of November 26, 2008, by and among Prospect Medical Systems, Inc., Osmundo R. Saguil, M.D., and Arthur Lipper, M.D. (re. Group shares) (incorporated by reference to Exhibit 10.76 to the Company's Annual Report on Form 10-K filed on December 29, 2008).
	10.67		Stock Purchase Agreement, dated as of November 26, 2008, by and among Prospect Medical Systems, Inc., Osmundo R. Saguil, M.D., and Arthur Lipper, M.D. (re. Nuestra shares) (incorporated by reference to Exhibit 10.78 to the Company's Annual Report on Form 10-K filed on December 29, 2008).
	10.68		Second Amended and Restated First Lien Pledge Agreement, dated as of November 26, 2008, by Arthur Lipper, M.D. in favor of Bank of America, N.A., as Administrative Agent (incorporated by reference to Exhibit 10.80 to the Company's Annual Report on Form 10-K filed on December 29, 2008).
	10.69		Second Amended and Restated Second Lien Pledge Agreement, dated as of November 26, 2008, by Arthur Lipper, M.D. in favor of Bank of America, N.A., as Administrative Agent (incorporated by reference to Exhibit 10.82 to the Company's Annual Report on Form 10-K filed on December 29, 2008).
	10.70		Form of Indemnification Agreement between Prospect Medical Holdings, Inc. and each of its executive officers and directors (incorporated by reference to Exhibit 10.83 to the Company's Annual Report on Form 10-K filed on December 29, 2008).
	10.71		Indemnification Agreement, dated November 26, 2008, by and between Prospect Medical Holdings, Inc. and Arthur Lipper, M.D. (incorporated by reference to Exhibit 10.84 to the Company's Annual Report on Form 10-K filed on December 29, 2008).
	10.72		Prospect Medical Holdings, Inc. 2008 Omnibus Equity Incentive Plan (incorporated by reference to Exhibit 10.85 to the Company's Annual Report on Form 10-K filed on December 29, 2008).

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	10.73		Form of Incentive Stock Option Agreement for grant of incentive stock options to participants under our 2008 Omnibus Equity Incentive Plan (incorporated by reference to Exhibit 10.86 to the Company's Annual Report on Form 10-K filed on December 29, 2008).
	10.74		Form of Non-Qualified Stock Option Agreement for grant of non-qualified stock options to participants under our 2008 Omnibus Equity Incentive Plan (incorporated by reference to Exhibit 10.87 to the Company's Annual Report on Form 10-K filed on December 29, 2008).
	10.75		Non-Qualified Stock Option Agreement between Prospect Medical Holdings, Inc. and Samuel S. Lee, effective as of August 20, 2008 (incorporated by reference to Exhibit 10.88 to the Company's Annual Report on Form 10-K filed on December 29, 2008).
	10.76		Restricted Stock Award Agreement for award of restricted stock under our Omnibus Equity Incentive Plan to Mike Heather, dated as of August 15, 2008 (incorporated by reference to Exhibit 10.89 to the Company's Annual Report on Form 10-K filed on December 29, 2008).
	10.77		Form of Restricted Stock Award Agreement for award of restricted stock under our Omnibus Equity Incentive Plan to participants, dated as of September 10, 2008 (incorporated by reference to Exhibit 10.90 to the Company's Annual Report on Form 10-K filed on December 29, 2008).
	10.78		Indenture, dated July 29, 2009, among the Company, certain of its subsidiaries and affiliates (as subsidiary guarantors) and U.S. Bank National Association (as trustee) (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q filed on August 19, 2009).
	10.79		Credit Agreement, dated July 29, 2009, among the Company, Royal Bank of Canada (as administrative agent), Jefferies Finance LLC (as syndication agent) and the lenders party thereto (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed on July 29, 2009).
	10.80		Consent and Agreement, dated as of December 15, 2010, among the Company, Royal Bank of Canada (as administrative agent) and certain lenders party thereto.*
	10.81		Continuing Guaranty, dated July 29, 2009, in favor of Royal Bank of Canada (as administrative agent), by: Alta Hospitals System, LLC; Alta Hollywood Hospitals, Inc.; Alta Los Angeles Hospitals, Inc.; Genesis Healthcare of Southern California, Inc., a Medical Group; Pomona Valley Medical Group, Inc.; ProMed Health Care Administrators; ProMed Health Services Company; Prospect Hospital Advisory Services, Inc.; Prospect Health Source Medical Group, Inc.; Prospect Medical Group, Inc.; Prospect Medical Systems, Inc.; Prospect NWOC Medical Group, Inc.; Prospect Professional Care Medical Group, Inc.; Starcare Medical Group, Inc.; and Upland Medical Group, a Professional Medical Corporation (incorporated by reference to Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q filed on August 19, 2009).
	10.82		Intercreditor Agreement, dated July 29, 2009, among Prospect Medical Holdings, Inc. and certain of it subsidiaries from time to time parties thereto, Royal Bank of Canada (as first lien collateral agent), U.S. Bank National Association (as second lien collateral agent) and Royal Bank of Canada (as control agent) (incorporated by reference to Exhibit 10.5 to the Company's Quarterly Report on Form 10-Q filed on August 19, 2009).
	10.83		Credit Agreement, dated April 14, 2009, between Brotman Medical Center, Inc. (as borrower) and Gemino Healthcare Finance, LLC (as lender) (incorporated by reference to Exhibit 10.6 to the Company's Quarterly Report on Form 10-Q filed on August 19, 2009).

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	10.84		First Amendment to Credit Agreement and Waiver, dated as of December 11, 2009, between Brotman Medical Center, Inc. (as borrower) and Gemino Healthcare Finance, LLC (as lender) (incorporated by reference to Exhibit 10.89 to the Company's Annual Report on Form 10-K filed on December 21, 2009).
	10.85		Second Amendment to Credit Agreement, dated as of February 17, 2010, between Brotman Medical Center, Inc. (as borrower) and Gemino Healthcare Finance, LLC (as lender) (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q filed on May 17, 2010).
	10.86		Loan Agreement, dated July 9, 2008, between Brotman Medical Center, Inc. (as borrower) and JHA West 16, LLC (as lender) (incorporated by reference to Exhibit 10.7 to the Company's Quarterly Report on Form 10-Q filed on August 19, 2009).
	10.87		Amendment No. 1 to Loan Agreement, dated April 14, 2009, between Brotman Medical Center, Inc. (as borrower) and JHA West 16, LLC (as lender) (incorporated by reference to Exhibit 10.8 to the Company's Quarterly Report on Form 10-Q filed on August 19, 2009).
	10.88		Amendment No. 2 to Loan Agreement entered into as of February 10, 2010 by Brotman Medical Center and JHA WEST 16, LLC (Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q filed on February 16, 2010).
	10.89		Amendment No. 1 to Promissory Note entered into as of February 10, 2010 by Brotman Medical Center, Inc. and JHA WEST 16, LLC (Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q filed on February 16, 2010).
	10.90		Loan Agreement, dated July 9, 2008, between Brotman Medical Center, Inc. (as borrower) and JHA East 7, LLC (as lender) (Exhibit 10.9 to the Company's Quarterly Report on Form 10-Q filed on August 19, 2009).
	10.91		Loan Agreement, dated July 9, 2008, between Brotman Medical Center, Inc. (as borrower) and JHA East 7, LLC (as lender) (incorporated by reference to Exhibit 10.9 to the Company's Quarterly Report on Form 10-Q filed on August 19, 2009).
	10.92		Amendment No. 1 to Loan Agreement, dated April 14, 2009, between Brotman Medical Center, Inc. (as borrower) and JHA East 7, LLC (as lender) (incorporated by reference to Exhibit 10.10 to the Company's Quarterly Report on Form 10-Q filed on August 19, 2009).
	10.93		Fund Guarantee, dated August 16, 2010, by and among Prospect Medical Holdings, Inc., Green Equity Investors V, L.P. and Green Equity Investors Side V, L.P. (incorporated by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K filed on August 16, 2010).
	21.1		Subsidiaries of the Company.*
	31.1		Certification of Chief Executive Officer pursuant to Rules 13a-14(a)/15d-14(a) under the Securities Exchange Act of 1934, as amended.*
	31.2		Certification of Chief Financial Officer pursuant to Rules 13a-14(a)/15d-14(a) under the Securities Exchange Act of 1934, as amended.*
	32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
	32.2		Certification of Chief Financial Officer pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*

*: Filed herewith.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Los Angeles, State of California, on December 17, 2010.

PROSPECT MEDICAL HOLDINGS, INC.
(Registrant)

/s/ SAMUEL S. LEE

Samuel S. Lee
Chairman and Chief Executive Officer

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

Signature	Title	Date


/s/ SAMUEL S. LEE Samuel S. Lee	Chairman, Chief Executive Officer and Director (Principal Executive Officer)	December 17, 2010
/s/ MIKE HEATHER Mike Heather	Chief Financial Officer (Principal Financial and Accounting Officer)	December 17, 2010
/s/ JOHN BAUMER John Baumer	Director	December 17, 2010
/s/ MICHAEL SOLOMON Michael Solomon	Director	December 17, 2010
/s/ JEEREDDI PRASAD Jeereddi Prasad	Director	December 17, 2010
/s/ ALYSE WAGNER Alyse Wagner	Director	December 17, 2010

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INDEX TO FINANCIAL STATEMENTS AND
FINANCIAL STATEMENT SCHEDULE

		Page

Report of Independent Registered Public Accounting Firm		F-2
Consolidated Balance Sheets as of September 30, 2010 and 2009		F-3
Consolidated Statements of Operations for the Years Ended September 30, 2010 and 2009		F-5
Consolidated Statements of Shareholders' Equity for the Years Ended September 30, 2010 and 2009		F-6
Consolidated Statements of Cash Flows for the Years Ended September 30, 2010 and 2009		F-7
Notes to Consolidated Financial Statements		F-9
Item 15: Schedule II—Valuation and Qualifying Accounts for the Years Ended September 30, 2010 and 2009		F-67

F-1

Table of Contents

Report of Independent Registered Public Accounting Firm

Board of Directors and Stockholders
Prospect Medical Holdings, Inc.
Los Angeles, California

We have audited the accompanying consolidated balance sheets of Prospect Medical Holdings, Inc. (the "Company") as of September 30, 2010 and 2009 and the related consolidated statements of operations, shareholders' equity, comprehensive income for 2009, and cash flows for each of the two years in the period ended September 30, 2010. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule listed as Item 15 in the accompanying index. These consolidated financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedule. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Prospect Medical Holdings, Inc. at September 30, 2010 and 2009, and the consolidated results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

Also, in our opinion, the financial statement schedule listed in the accompanying index, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

As discussed in Note 2 to the consolidated financial statements, effective October 1, 2009, the Company adopted the provisions of Accounting Standards Codification 810-10-45, which addresses the presentation of noncontrolling interests.

/s/ BDO USA, LLP

Costa Mesa, California
December 17, 2010

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PROSPECT MEDICAL HOLDINGS, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except par value and share amounts)

		September 30,

		2010		2009
ASSETS
Current assets:
	Cash and cash equivalents	$	50,729	$	37,768
	Restricted cash		3,122		1,395
	Investments, primarily restricted certificates of deposit		634		665
	Patient accounts receivable, net of allowance for doubtful accounts of $20,675 and $11,715 at September 30, 2010 and 2009, respectively		42,677		36,806
	Due from government payers		4,318		6,427
	Other receivables		2,148		1,711
	Refundable income taxes, net		782		1,558
	Deferred income taxes, net		7,671		6,644
	Inventories		3,864		4,137
	Prepaid expenses and other current assets		4,990		5,380

Total current assets			120,935		102,491
	Property, improvements and equipment, net		63,104		63,724
	Deferred financing costs, net		6,354		8,205
	Goodwill		153,250		153,250
	Intangible assets, net		42,159		46,425
	Other assets		715		1,051

Total assets		$	386,517	$	375,146

The accompanying notes are an integral part of the consolidated financial statements.

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PROSPECT MEDICAL HOLDINGS, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except par value and share amounts)

(continued)

		September 30,

		2010			2009
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
	Accrued medical claims and other healthcare costs payable	$	17,859		$	16,824
	Accounts payable and other accrued liabilities		33,206			31,773
	Accrued salaries, wages and benefits		19,114			24,903
	Due to government payers		13,834			13,834
	Current portion of capital leases		674			820
	Current portion of long-term debt		170,900			3,805
	Other current liabilities		1,121			629

Total current liabilities			256,708			92,588
	Long-term debt, net of current maturities		7,750			172,539
	Deferred income taxes, net		31,717			29,975
	Malpractice reserves		1,579			2,824
	Capital leases, net of current portion		544			569
	Other long-term liabilities		149			162

	Total liabilities		298,447			298,657

Commitments, Contingencies and Subsequent Events
Shareholders' equity:
	Common stock, $0.01 par value; 40,000,000 shares authorized; 21,399,508 and 20,619,278 shares issued and outstanding at September 30, 2010 and 2009, respectively		214			206
	Additional paid-in capital		97,675			94,498
	Accumulated deficit		(7,931	)		(18,303	)

	Total Prospect Medical Holdings, Inc.'s shareholders' equity		89,958			76,401
Noncontrolling interest			(1,888	)		88

Total shareholders' equity			88,070			76,489

Total liabilities and shareholders' equity		$	386,517		$	375,146

The accompanying notes are an integral part of the consolidated financial statements.

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PROSPECT MEDICAL HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

		Year Ended September 30,

		2010			2009
Revenues:
	Net Hospital Services revenues	$	279,079		$	205,504
	Medical Group revenues		190,117			196,730

Total revenues			469,196			402,234

Operating expenses:
	Hospital operating expenses		206,906			146,349
	Medical Group cost of revenues		149,503			151,056
	General and administrative		60,206			58,766
	Depreciation and amortization		8,235			7,829

Total operating expenses			424,850			364,000
Operating income from unconsolidated joint venture			2,504			2,046

Operating income			46,850			40,280

Other (income) expense:
	Interest expense and amortization of deferred financing costs, net		28,096			28,964
	Loss on interest rate swap arrangements		—			5,299
	Prepayment penalties on debt refinance		—			2,588
	Loss on termination of interest rate swap arrangements		—			6,861

Total other expense, net			28,096			43,712

Income (loss) before income taxes			18,754			(3,432	)
Income tax provision (benefit)			10,338			(1,019	)

Net income (loss)			8,416			(2,413	)
Net income (loss) attributable to noncontrolling interest			(1,956	)		7

Net income (loss) attributable to Prospect Medical Holdings, Inc.		$	10,372		$	(2,420	)

Per share data:
Net income (loss) attributable to Prospect Medical Holdings, Inc. per common share
	Basic	$	0.50		$	(0.12	)

	Diluted	$	0.45		$	(0.12	)

Weighted average shares outstanding:
	Basic		20,925			20,531

	Diluted		22,804			20,531

The accompanying notes are an integral part of the consolidated financial statements.

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PROSPECT MEDICAL HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands, except share amounts)

			Common Stock		Additional Paid-in Capital		Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Prospect Medical Holdings, Inc. Shareholders' Equity			Non- controlling Interest			Total Shareholders' Equity

Balance at September 30, 2008		20,508,444	$	205	$	93,407	$	(4,917	)	$	(15,883	)	$	72,812		$	81		$	72,893
Options exercised		44,167		—		102		—			—			102			—			102
Stock based compensation		66,667		1		989		—			—			990			—			990
Comprehensive income:
	Net loss	—		—		—		—			(2,420	)		(2,420	)		7			(2,413	)
	Reversal of unrealized losses upon termination of interest rate swap arrangements (net of income tax effect of $2,677)	—		—		—		4,917			—			4,917			—			4,917

Subtotal—comprehensive income		—		—		—		4,917			(2,420	)		2,497			7			2,504

Balance at September 30, 2009		20,619,278		206		94,498		—			(18,303	)		76,401			88			76,489
Options exercised		341,775		4		548		—			—			552			—			552
Stock-based compensation		212,666		2		2,142		—			—			2,144			—			2,144
Excess tax benefits from options exercised		—		—		214		—			—			214			—			214
Warrants exercised		225,789		2		273		—			—			275			—			275
Increased investment in noncontrolling interest		—		—		—		—			—			—			(20	)		(20	)
Net income (loss)		—		—		—		—			10,372			10,372			(1,956	)		8,416

Balance at September 30, 2010		21,399,508	$	214	$	97,675	$	—		$	(7,931	)	$	89,958		$	(1,888	)	$	88,070

The accompanying notes are an integral part of the consolidated financial statements.

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PROSPECT MEDICAL HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

			Year Ended September 30,

			2010			2009
Operating activities
Net income (loss)			$	8,416		$	(2,413	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
	Depreciation and amortization			8,235			7,829
	Amortization of deferred financing costs, net			1,890			1,189
	Amortization of original issue discount			1,945			284
	Provision for bad debts			29,968			17,889
	Payment-in-kind interest expense			—			277
	Amortization of other accumulated comprehensive income related to interest rate swap arrangements			—			1,179
	Deferred income taxes, net			716			(4,108	)
	Stock-based compensation			2,144			989
	Excess tax benefits from options exercised			214			—
	(Gain) loss on sale of assets			(7	)		34
	Loss on interest rate swap agreements			—			12,160
	Change in assets and liabilities, net of acquisition
		Patient, other receivables and due to/from government payors		(34,166	)		(12,467	)
		Prepaid expenses and other		392			(470	)
		Inventories		274			180
		Refundable income taxes, net		776			1,096
		Deposits and other assets		278			(161	)
		Accrued medical claims and other healthcare costs payable		1,035			(3,656	)
		Accounts payable and other accrued liabilities		(5,125	)		3,742

Net cash provided by operating activities				16,985			23,573

Investing activities
	Purchases of property, improvements and equipment			(2,730	)		(1,558	)
	Decrease in note receivable			55			50
	Cash paid for acquisition, net of cash received			—			(2,310	)
	Capitalized expenses related to acquisition			—			(37	)
	Decrease (increase) in restricted certificates of deposit			31			(27	)
	Other investing activities			(20	)		332

	Net cash used in investing activities			(2,664	)		(3,550	)

Financing activities
	Borrowings from long-term debt			—			147,736
	Borrowings (repayments) on Brotman line of credit, net			1,392			3,483
	Repayments on former line of credit			—			(7,100	)
	Repayments of former long-term debt			—			(141,837	)
	Repayments on Brotman Creditors Trust Note			(1,031	)		(595	)
	Repayments of capital leases			(782	)		(648	)
	Cash paid to terminate interest rate swap arrangements			—			(11,312	)
	Change in restricted cash			(1,727	)		1,396
	Proceeds from exercises of stock options and warrants			827			102
	Cash paid for deferred financing costs, net			(39	)		(7,063	)

	Net cash used in financing activities			(1,360	)		(15,838	)

	Increase in cash and cash equivalents			12,961			4,185
	Cash and cash equivalents at beginning of year			37,768			33,583

	Cash and cash equivalents at end of year		$	50,729		$	37,768

The accompanying notes are an integral part of the consolidated financial statements.

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PROSPECT MEDICAL HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(in thousands)

		Year Ended September 30,

		2010		2009
Supplemental disclosure of cash flow information
Equipment acquired under capital lease		$	631	$	450

Interest paid		$	23,234	$	37,110

Income taxes paid, net		$	8,634	$	2,067

Details of business acquired:
	Fair value of assets acquired	$	—	$	53,302
	Liabilities assumed or accrued for	$	—	$	(78,119	)

	Total net liabilities acquired	$	—	$	(24,817	)
	Goodwill and identifiable intangible recognized		—		27,373

	Cash paid for acquisition		—		2,556
	Less cash acquired	$	—	$	(209	)

	Net cash paid for acquisition	$	—	$	2,347

The accompanying notes are an integral part of the consolidated financial statements.

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PROSPECT MEDICAL HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Organization

Prospect Medical Holdings, Inc. ("Prospect," "Company" or the "Parent Entity") is a Delaware corporation. Prior to the August 8, 2007 acquisition of Alta Hospitals System, LLC ("Alta"), which was previously known as Alta Healthcare System, Inc., the Company was primarily engaged in providing management services to affiliated physician organizations that operate as independent physician associations ("Medical Groups") or medical clinics. Following the Alta acquisition and acquisition of a majority stake in Brotman Medical Center, Inc., a California corporation ("Brotman"), on April 14, 2009 (see Note 5), as of September 30, 2010, the Company owns and operates five community-based hospitals in Southern California, and its operations are organized into three primary reportable segments: Hospital Services, Medical Group and Corporate as discussed below.

Liquidity and Capital Resources

The LGP Funds have agreed in the Merger Agreement to provide a backstop commitment letter to provide the funds that are required to comply with the change of control provisions contained in the indenture governing the Company's senior secured notes. LGP Funds may fail to meet its obligations under the Merger Agreement and as a consequence, the Company fails to satisfy its obligations under the indenture of the senior secured notes, in which event, this would negatively impact the Company's liquidity, ability to operate and ability to continue as a going concern.

Hospital Services Segment

Alta and Brotman (collectively, the "Hospital Services segment") own and operate five hospitals in Los Angeles County, with a total of 759 licensed beds served by 746 on-staff physicians at September 30, 2010. As of September 30, 2010, Alta hospitals were accredited by the Joint Commission (formerly the Joint Commission on Accreditation of Healthcare Organizations). Brotman is currently accredited by CMS, and is in the process of accreditation by Det Norske Veritas ("DNV") Healthcare, Inc (retroactive to November 9, 2010). Alta owns (i) Alta Hollywood Hospitals, Inc., a California corporation, dba Hollywood Community Hospital and Van Nuys Community Hospital; and (ii) Alta Los Angeles Hospitals, Inc., a California corporation, dba Los Angeles Community Hospital and Norwalk Community Hospital. On April 14, 2009 (the "Acquisition Date"), the Company increased its existing approximately 33% ownership stake in Brotman, to approximately 72% via an investment of approximately $2,500,000 in cash, thereby obtaining a controlling interest. As further discussed in Note 18, following the consummation of the Rights Offering, effective November 15, 2010 the

F-9

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PROSPECT MEDICAL HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

1. Organization (Continued)

Company increased its ownership stake in Brotman to approximately 78%. Brotman owns and operates Brotman Medical Center, located in Culver City, California.

The hospitals in Hollywood, Los Angeles and Norwalk offer a comprehensive range of medical and surgical services, including general acute care hospital services, pediatrics, obstetrics and gynecology, pediatric sub-acute care, general surgery, medical-surgical services, orthopedic surgery, and diagnostic, outpatient, skilled nursing and urgent care services. The hospital in Van Nuys provides acute inpatient and outpatient psychiatric services on a voluntary basis. Brotman offers a comprehensive range of inpatient and outpatient services, including general surgery, orthopedic, spine and neurosurgery, cardiology, diagnostic outpatient, rehabilitation, psychiatric and detox services. In addition, Brotman has an active emergency room that provides emergency services to the West Los Angeles area.

The table below gives a brief overview of the Company's hospitals and the locations they serve as of September 30, 2010:

Name/Location	Primary Service	Number of Beds

Hollywood Community Hospital Hollywood, CA 100% owned	Medical/Surgical	100 licensed beds/100 staffed beds
Los Angeles Community Hospital Los Angeles, CA 100% owned	Medical/Surgical	130 licensed beds/121 staffed beds
Norwalk Community Hospital Norwalk, CA 100% owned	Medical/Surgical	50 licensed beds/50 staffed beds
Van Nuys Community Hospital Van Nuys, CA 100% owned	Psychiatric	59 licensed beds/57 staffed beds
Brotman Medical Center Culver City, CA 72% owned (Note 18)	Medical/Surgical	420 licensed beds/220 staffed beds

Admitting physicians are primarily practitioners in the local area. The Hospitals have payment arrangements with Medicare, Medi-Cal (the California version of Medicaid) and other third party payers, including some commercial insurance carriers, health maintenance organizations ("HMOs") and preferred provider organizations ("PPOs").

Medical Group Segment

The Medical Group segment is a healthcare management services organization that provides management services to affiliated physician organizations that operate as independent physician associations ("Medical Groups"). The affiliated physician organizations enter into agreements with HMOs to provide HMO enrollees with a full range of medical services in exchange for fixed, prepaid monthly fees known as "capitation" payments. The Medical Groups contract with physicians (primary care and specialist) and other healthcare providers to provide enrollees with all medical services.

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Table of Contents

PROSPECT MEDICAL HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

1. Organization (Continued)

Prospect currently manages the provision of prepaid healthcare services for its affiliated physician organizations in Southern California. The network consists of the following physician organizations as of September 30, 2010 (stand alone or individually referred to as, an "Affiliate"):

Prospect Medical Group, Inc. ("PMG")
Prospect Health Source Medical Group, Inc. ("PHS")
Prospect Professional Care Medical Group, Inc. ("PPCM")
APAC Medical Group, Inc. ("APA") (Inactive)
Genesis HealthCare of Southern California, Inc. ("Genesis")
Prospect NWOC Medical Group, Inc. ("PNW")
StarCare Medical Group, Inc. ("PSC")
Santa Ana/Tustin Physicians Group, Inc. ("SATPG") (Inactive)
AMVI/Prospect Health Network ("AMVI/Prospect")
Nuestra Familia Medical Group, Inc. ("Nuestra")
Upland Medical Group, a Professional Medical Group ("UMG")*
Pomona Valley Medical Group, Inc. ("PVMG")*

*: PVMG and UMG are collectively referred to as the "ProMed Entities."

These Affiliates are managed by the following two medical management company subsidiaries that are wholly-owned by Prospect:

Prospect Medical Systems, Inc. ("PMS")
ProMed Healthcare Administrators, Inc. ("PHCA")

All of the Affiliates are wholly-owned by PMG, with the exception of Nuestra, which is 62.2% owned by a nominee physician shareholder pursuant to an assignable option agreement described below, and AMVI/Prospect which is a 50/50 Joint Venture between AMVI and PMG. PMG is owned by the same nominee physician shareholder pursuant to a separate assignable option agreement. The results of all of these entities, with the exception of AMVI/Prospect, are consolidated in the accompanying consolidated financial statements.

The AMVI Joint Venture was formed for the sole purpose of combining enrollment in order to meet minimum enrollment levels required for participation in the CalOptima Medicaid (Medi-Cal in California) program in Orange County, California. The joint venture ownership is set at 50/50 to prevent either party from exerting control over the other; however, AMVI and Prospect's businesses are operated autonomously, and enrollees, financial results and cash flows are each separately tracked and recorded. In accordance with the joint venture partnership agreement, profits and losses are not split in accordance with the partnership ownership interest, but rather, are directly tied to the results generated by each separate portion of the business. Separate from any earnings the Company generates from their portion of business within the joint venture, the Company also earns fees for management services they provide to their partner in the joint venture. The Company accounts for their interest in the joint venture partnership using the equity method of accounting. The Company includes in the consolidated financial statements only the net results attributable to those enrollees specifically identified as assigned to the Company, together with the management fee that they charge for managing those enrollees specifically assigned to the other joint venture partner. Note 14 contains summarized unaudited financial information for the joint venture.

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PROSPECT MEDICAL HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

1. Organization (Continued)

PMS has entered into an assignable option agreement with PMG and the nominee physician shareholder of PMG. Under the assignable option agreement, Prospect acquired an assignable option for a nominal amount from PMG and the nominee shareholder to purchase all or part of PMG's assets (the Asset Option) and the right to designate the purchaser (successor physician) for all or part of PMG's issued and outstanding stock held by the nominee physician shareholder (the Stock Option) in its sole discretion. The Company may also assign the assignable option agreement to any person. The assignable option agreement has an initial term of 30 years and is automatically extended for additional terms of 10 years each, as long as the term of the related management services agreement described below (the Management Agreement) is automatically extended. Upon termination of the Management Agreement with PMG, the related Asset Option and Stock Option are automatically and immediately exercised. The Asset and Stock Options may be exercised separately or simultaneously for a purchase price of $1,000 each. Under these nominee shareholder agreements, Prospect has the unilateral right to establish or effect a change of the nominee, at will, and without the consent of the nominee, on an unlimited basis and at nominal cost throughout the term of the Management Agreement. In addition to the Management Agreement with PMG, Prospect, through one of its management company subsidiaries, has a management agreement with each Affiliate. The term of the Management Agreements is generally 30 years. PMG is the nominee shareholder of SATPG, PHS, PPCM, PNW, PSC, APA, Genesis, PVMG, and UMG. Dr. Lipper is the nominee shareholder as to the 62% interest in Nuestra.

The Company's Affiliates have each entered into a Management Agreement whereby the Affiliate has agreed to pay a management fee to PMS or PHCA, as applicable (each of which is a wholly-owned subsidiary of Prospect). The fee is based in part on the costs to the management company and on a percentage of revenues the Affiliate receives (i) for the performance of medical services by the Affiliate's employees and independent contractor physicians and physician extenders, (ii) for all other services performed by the Affiliates, and (iii) as proceeds from the sale of assets or the merger or other business combination of the Affiliates. The management fee also includes a fixed percentage fee for marketing and public relations services. The revenue from which this fee is determined includes medical capitation, all sums earned from participation in any risk pools and all fee-for-service revenue earned. Except in the case of Nuestra and AMVI/Prospect, the Management Agreements have initial terms of 30 years, renewable for successive 10-year periods thereafter, unless terminated by either party for cause. In the case of Nuestra, its Management Agreement has an initial 10 year term renewable for successive 1 year terms. In the case of AMVI/Prospect, its Management Agreement has a 1 year term with successive 1 year renewal terms. In return for payment of the management fee, Prospect has agreed to provide financial management, information systems, marketing, advertising, public relations, risk management, and administrative support, including for utilization review and quality of care. The Company has exclusive decision-making authority with respect to the establishment and preparation of operating and capital budgets, and the establishment of policies and procedures for the Affiliates, and makes recommendations for the development of guidelines for selection and hiring of health care professionals, compensation payable to such personnel, scope of services to be provided, patient acceptance policies, pricing of services, and contract negotiation and execution. At its cost, Prospect has assumed the obligations for all facilities, medical and non-medical supplies, and employment of non-physician personnel of its affiliated medical clinics.

The management fee earned by Prospect fluctuates based on the profitability of each wholly-owned Affiliate. Prospect is allocated a 50% residual interest in all profits after the first 8% of the profits or a 50% residual interest in the losses of the Affiliate, after deduction for costs to the management

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

1. Organization (Continued)

company and physician compensation. The remaining balance is retained by the Affiliates. Supplemental management fees are periodically negotiated where significant incremental efforts and expense have been incurred by Prospect on behalf of the Affiliates.

The Management Agreements are not terminable by the Affiliates except in the case of gross negligence, fraud or other illegal acts of Prospect, or bankruptcy of the Company. Through the Management Agreements and the Company's relationship with the nominee shareholder of each Affiliate, Prospect has exclusive authority over all decision-making related to the ongoing 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 Management Agreements are unilaterally salable or transferable. Based on the provisions of the Management Agreements and the assignable option agreement with PMG, Prospect has determined that it has a controlling financial interest in the Affiliates. Consequently, under applicable accounting principles, Prospect consolidates the revenues and expenses of all the Affiliates except AMVI/Prospect from the respective dates of execution of the Management Agreements. All significant inter-entity balances have been eliminated in consolidation. In the case of AMVI/Prospect, only that portion of the results which are contractually identified as Prospect's are recognized in the consolidated financial statements, together with the management fee that the Company charges AMVI for managing AMVI's share of the joint venture operations.

Prospect has also entered into management agreements with unaffiliated third parties to manage services to their HMO enrollees.

The affiliated physician organizations provided medical services to a combined total of approximately 177,500 and 177,400 HMO enrollees as of September 30, 2010 and 2009, respectively. The enrollees include approximately 20,400 and 10,100 enrollees that the Company manages for the economic benefit of two independent third parties, and for which the Company earns management fee income as of September 30, 2010 and 2009, respectively. The total paid member months, for the fiscal years ended September 30, 2010 and 2009 was 2,077,000 and 2,207,000, respectively.

Corporate Segment

Corporate segment reflects certain expenses incurred at the Parent Entity not specifically allocable to the Hospital Services or Medical Group segments. These include and are not limited to salaries, benefits and other compensation for corporate employees, financing, insurance, rent, operating supplies, legal, accounting, SEC compliance, and Sarbanes-Oxley compliance. The Company does not allocate interest expense, gain or loss on interest rate swaps and income taxes to the other reporting segments.

2. Significant Accounting Policies

Basis of Presentation

The consolidated financial statements herein have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") and include the accounts of all controlled subsidiaries, which control is effectuated through ownership of voting common stock or by other means. The Medical Group entities (subsidiaries) have been determined to be variable interest entities due to the existence of a call option under which the Company has the ability to require the holders of all of the voting common stock of the underlying subsidiaries to sell their shares at a fixed nominal price ($1,000) to

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. Significant Accounting Policies (Continued)

another designated physician chosen by the Company. This call option agreement represents rights provided through a variable interest other than the equity interest itself that caps the returns that could be earned by the equity holders. In addition, the Company has a management agreement with the subsidiaries and the holders of the voting common stock of the subsidiaries which allows the Company to direct all of the activities of the subsidiaries, retain all of the economic benefits and assume all of the risks associated with ownership of the subsidiaries. In this manner, the Company has all of the economic benefits and risks associated with the subsidiaries, but has disproportionately few voting rights (based on the terms of the equity). As the Company retains all of the economic benefits and assumes all of the risks associated with ownership of the subsidiaries, the Company is considered to be the primary beneficiary of the activities of the subsidiaries and therefore must consolidate the underlying subsidiaries. All significant intercompany transactions have been eliminated in consolidation.

Revenues

Revenues by reportable segment are comprised of the following amounts (in thousands):

		Year Ended September 30,

		2010		2009(1)
Net Hospital Services
	Inpatient	$	245,488	$	186,900
	Outpatient		30,809		16,913
	Other		2,782		1,691

	Total net Hospital Services revenues	$	279,079	$	205,504

Medical Group
	Capitation	$	187,718	$	194,126
	Management fees		1,153		556
	Other		1,246		2,048

	Total Medical Group revenues	$	190,117	$	196,730

Total revenues		$	469,196	$	402,234

(1): Brotman revenues have been included in the accompanying consolidated financial statements effective April 14, 2009, when the Company acquired a majority stake in Brotman. Accordingly, the year ended September 30, 2009 included only 169 days of Brotman operating results.

Hospital Services Segment

Net Patient Service Revenues

Operating revenue of the Hospital Services segment consists primarily of net patient service revenue. The Company reports net patient service revenue at the estimated net realizable amounts from patients and third-party payers and others in the period in which services are rendered. The Company has agreements with third-party payers, including Medicare, Medi-Cal, managed care and other insurance programs that are paid upon negotiated rates. These payment arrangements include

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. Significant Accounting Policies (Continued)

prospectively determined rates per discharge, reimbursed costs, discounted charges and per diem payments, as further described below. Estimates of contractual allowances are based upon the payment terms specified in the related contractual agreements. The Company accrues for amounts that it believes may ultimately be due to or from the third-party payers. Normal estimation differences between final settlements and amounts accrued in previous years are reported as changes in estimates in the current year. Outstanding receivables, net of allowances for contractual discounts and bad debts, are included in patient accounts receivable in the accompanying consolidated balance sheets. A summary of the payment arrangements with major third-party payers follows:

Medicare: Inpatient services rendered to Medicare program beneficiaries are paid at prospectively determined rates per discharge, according to a patient classification system based on clinical, diagnostic, and other factors. Outpatient services are paid based on a blend of prospectively determined rates and cost-reimbursed methodologies. The Company is also reimbursed for various disproportionate share and Medicare bad debt components at tentative rates, with final settlement determined after submission of annual Medicare cost reports and audits thereof by the Medicare fiscal intermediary. Normal estimation differences between final settlements and amounts accrued in previous years are reflected in net patient service revenue in the year of final settlements, which amounts totaled approximately $377,000 and $1,087,000 in fiscal years ended September 30, 2010 and 2009, respectively. As of September 30, 2010 and 2009, cost report settlements, which are recorded as net due from government payers in the accompanying consolidated balance sheets, totaled approximately $103,000 and $1,575,000 respectively.

Medi-Cal: Inpatient services rendered to Medi-Cal program beneficiaries are paid at contracted per diem rates. The per diem rates are not subject to retrospective adjustment. Outpatient services are paid based on prospectively determined rates per procedure provided. The Alta hospitals are eligible to participate in the State of California Medi-Cal Disproportionate Share ("DSH") programs, under which medical facilities that serve a disproportionate number of low-income patients receive additional reimbursements. Eligibility is determined annually based on prescribed guidelines. The Company accrues a receivable each month based on the expected total annual DSH payments. Differences between the estimated and the actual award (which have not been significant) are recorded in the period they become known. The Medi-Cal DSH receivable as of September 30, 2010 and 2009 totaled approximately $4,215,000 and $4,852,000, respectively, and were included in government program receivables in the accompanying consolidated balance sheets. For fiscal years ended September 30, 2010 and 2009, total Medi-Cal DSH payments received by Alta hospitals were approximately $15,558,000 and $11,968,000, respectively, and total Medi-Cal DSH revenues recorded were approximately $14,758,000 and $12,245,000 respectively.

Managed Care: The Company has also entered into payment agreements with certain commercial insurance carriers, HMOs, and PPOs. The basis for payment under these agreements includes prospectively determined rates per discharge, per diems and discounts from established charges. Certain agreements also include stop-loss provisions where the Company receives additional reimbursement when charges incurred exceed a predetermined amount. Where the Company provides medical care on a non-contracted basis, it receives standard billed charges or rates negotiated on a case by case basis.

See "Concentrations of Credit Risks" below for discussion of revenues received from the Medicare and Medi-Cal programs.

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2. Significant Accounting Policies (Continued)

Due to/from Governmental Payers

Following the acquisition of Brotman, effective April 14, 2009, the Company consolidated Brotman's estimated liability to the Centers for Medicare and Medicaid Services ("CMS") arising out of outlier payments received for services provided by Brotman to Medicare eligible inpatients, primarily for the last four months of calendar year 2005 and all of calendar year 2006.

While Brotman reports financial statements on a fiscal year ending September 30, Medicare cost reports are filed on a calendar year basis. Acute care hospitals receive Medicare reimbursement payments pursuant to a prospective payment methodology primarily based on the diagnosis of the patient, but are entitled to receive additional payments, referred to as "outliers" for patients whose treatment is very costly. When Brotman acquired the hospital in 2005, CMS provided a ratio of cost to charges (the "RCC") based on the statewide average. Payments on this basis were an interim estimate, subject to final determination upon auditing of the Hospital's cost reports. The Hospital filed its Medicare cost reports, but determined that its outlier reimbursement for services provided in fiscal years 2005 and 2006 might be subject to adjustment based on certain outlier reconciliation rules. The Company believes that CMS has not conducted any outlier reconciliations under current regulations, has not formally notified the Hospital of any pending reconciliation to be conducted regarding their cost reports and has not determined the amount of any liability at this point related to possible overpayments. As of September 30, 2010 and 2009, an estimated liability of $13,834,000 was included in each of the accompanying consolidated balance sheets related to this matter.

The following is a summary of due from and due to governmental payers at September 30 (in thousands):

		September 30,

		2010		2009
Due from government payers:
	Medi-Cal Disproportionate Share (DSH)	$	4,215	$	4,852
	Medicare cost report settlements, net		103		1,575

		$	4,318	$	6,427

Due to government payers:
	Outlier liability	$	13,834	$	13,834

Charity Care

The Company provides charity care to patients whose income level is below 300% of the Federal Poverty Level. Patients with income levels between 300% and 350% of the Federal Poverty Level qualify to pay a discounted rate under AB774 based on various government program reimbursement levels. Patients without insurance are offered assistance in applying for Medicaid and other programs they may be eligible for, such as state disability. Patient advocates from the Company's Medical Eligibility Program ("MEP") screen patients in the Hospital and determine potential linkage to financial assistance programs. They also expedite the process of applying for these government programs. Based on the Company's gross charge rates, revenues foregone under the charity policy, including indigent care accounts, were approximately $2,977,000 and $4,600,000, for fiscal years ended September 30, 2010 and 2009, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. Significant Accounting Policies (Continued)

The Company is not aware of any material claims, disputes, or unsettled matters with any payers that would affect revenues that have not been adequately provided for and disclosed in the accompanying consolidated financial statements.

Provisions for Contractual Allowances and Doubtful Accounts

Collection of receivables from third-party payers and patients is the Company's primary source of cash and is critical to its operating performance. The Company closely monitors its historical collection rates, as well as changes in applicable laws, rules and regulations and contract terms, to assure that provisions for contractual allowances are made using the most accurate information available. However, due to the complexities involved in these estimations, actual payments from payers may be materially different from the amounts management estimates and records. The Company's primary collection risks relate to uninsured patients and the portion of the bill which is the patient's responsibility, primarily co-payments and deductibles. Payments for services may also be denied due to issues over patient eligibility for medical coverage, the Company's ability to demonstrate medical necessity for services rendered and payer authorization of hospitalization. The Company estimates the provisions for doubtful accounts based on general factors such as payer mix, the age of the receivables and historical collection experience. Management routinely reviews accounts receivable balances in conjunction with these factors and other economic conditions which might ultimately affect the collectability of the patient accounts, and makes adjustments to the Company's allowances as warranted.

All of our facilities are subject to the Emergency Medical Treatment and Active Labor Act ("EMTALA"). This federal law requires any hospital that participates in the Medicare program to conduct an appropriate medical screening examination of every person who presents to the hospital's emergency department for treatment and, if the patient is suffering from an emergency medical condition, to either stabilize that condition or make an appropriate transfer of the patient to a facility that can handle the condition. The obligation to screen and stabilize emergency medical conditions exists regardless of a patient's ability to pay for treatment. There are severe penalties under EMTALA if a hospital fails to screen or appropriately stabilize or transfer a patient or if the hospital delays appropriate treatment in order to first inquire about the patient's ability to pay. Penalties for violations of EMTALA include civil monetary penalties and exclusion from participation in the Medicare program. In addition, an injured patient, the patient's family or a medical facility that suffers a financial loss as a direct result of another hospital's violation of the law can bring a civil suit against that other hospital. The Company believes that it is in compliance with all applicable laws and regulations and is not aware of any pending or threatened investigations involving allegations of potential wrongdoing that would have a material effect on the Company's financial statements.

The provision for bad debts for the years ended September 30, 2010 and 2009 totaled $29,968,000 and $17,889,000, respectively.

Medical Group Segment

Medical Group Revenues

Operating revenue of the Medical Group Segment consists primarily of payments for medical services provided by the Affiliates under capitated contracts with various managed care providers including HMOs. Capitation revenue under HMO contracts is prepaid monthly to the Affiliates based

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. Significant Accounting Policies (Continued)

on the number of enrollees electing any one of the Affiliates as their health care provider. See "Concentrations of Credit Risks" below for revenues received from the five largest contracted HMOs.

Capitation revenue (net of capitation withheld to fund risk share deficits discussed below) is recognized in the month in which the Affiliates are obligated to provide services. Minor ongoing adjustments to prior months' capitation, primarily arising from contracted HMOs' finalizing of monthly patient eligibility data for additions or subtractions of enrollees, are recognized in the month they are communicated to the Company. Additionally, Medicare pays capitation using a "Risk Adjustment model," which compensates managed care organizations and providers based on the health status (acuity) of each individual enrollee. Health plans and providers with higher acuity enrollees will receive more and those with healthier enrollees will receive less. Under Risk Adjustment, capitation is determined based on health severity, measured using patient encounter data. Capitation is paid on an interim basis based on data submitted for the enrollee for the preceding year and is adjusted in subsequent periods (generally in our fourth quarter) after the final data is compiled. Positive or negative capitation adjustments are made for Medicare enrollees with conditions requiring more or less healthcare services than assumed in the interim payments. Since the Company cannot reliably predict these adjustments, periodic changes in capitation amounts earned as a result of Risk Adjustment are recognized in the year to which they relate, generally in the fourth quarter, when those changes are communicated by the health plans to the Company. The Company received and recorded as an addition to revenue, approximately $4,000,000 and $4,300,000, respectively, in positive capitation risk adjustments in the fourth quarter of fiscal 2010 and 2009.

HMO contracts also include provisions to share in the risk for hospitalization, whereby the Affiliate can earn additional incentive revenue or incur penalties based upon the utilization of hospital services. Typically, any shared risk deficits are not payable until and unless the Company generates future risk sharing surpluses, or if the HMO withholds a portion of the capitation revenue to fund any risk share deficits. At the termination of the HMO contract, any accumulated risk share deficit is typically extinguished. Due to the lack of access to information necessary to estimate the related costs, shared-risk amounts receivable from the HMOs are only recorded when such amounts are known. Risk pools for the prior contract years are generally final settled in the third or fourth quarter of the following fiscal year. In fiscal years ended September 30, 2010 and 2009, Medical Group revenues include approximately $2,224,000 and $1,228,000, respectively, of additional (reduction in) revenues due to favorable (unfavorable) settlements on prior year risk-sharing arrangements. At September 30, 2010 and 2009, contingent liabilities for carry-forward risk-pool deficits expected to be forgiven, or offset against future surpluses were approximately $4,800,000 and $6,200,000, respectively, based on the available information from the health plans.

In addition to risk-sharing revenues, the Company also receives incentives under "pay-for-performance" programs for quality medical care based on various criteria. These incentives, which are included in other revenues, are generally recorded in the third and fourth quarters of the fiscal year and are recorded when such amounts are known.

Management fee revenue is earned in the month the services are rendered. Management fee arrangements provide for compensation ranging from 6% of revenues to 15% of revenues. The Company provides management services to affiliated providers whose results are consolidated in the Company's financial statements under management fee arrangements, which are generally based on a percentage of revenues and a percentage of net income or loss. Revenues and expenses relating to these inter-entity agreements have been eliminated in consolidation.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. Significant Accounting Policies (Continued)

In connection with providing services to HMO enrollees, the Affiliates are responsible for the medical services their affiliated physicians provide to assigned HMO enrollees.

Medical Group Cost of Revenues

The cost of health care services consists primarily of capitation and claims payments, pharmacy costs and incentive payments to contracted providers. These costs are recognized in the period incurred, or when the services are provided. Claims costs also include an estimate of the cost of services which have been incurred but not yet reported to the Company. The estimate for accrued medical costs is based on projections of costs using historical studies of claims paid and adjusted for seasonality, utilization and cost trends. These estimates are subject to trends in loss severity and frequency. Although considerable variability is inherent in such estimates, management records its best estimate of the amount of medical claims incurred at each reporting period. Estimates are continually monitored and reviewed and, as settlements are made or estimates adjusted, differences are reflected in current operations. See Note 13 for changes in claims estimates during the fiscal years ended September 30, 2010 and 2009.

In addition to contractual reimbursements to providers, the Company also makes discretionary incentive payments to physicians, which are in large part based on the pay-for-performance and shared risk revenues and favorable senior capitation risk adjustment payments received by the Company. Since the Company records these revenues generally in the third or fourth quarter of each fiscal year when the incentives and capitation adjustments due from the health plans are known, the Company also finalizes the discretionary physician bonuses in the same period. In fiscal years ended September 30, 2010 and 2009, the Company recorded discretionary physician incentives expense totaling approximately $2,899,000 and $3,400,000, respectively.

The Company also periodically evaluates the need to establish premium deficiency reserves for the probability that anticipated future health care costs could exceed future capitation payments from HMOs under capitated contracts. To date, management has determined that no significant premium deficiency reserves have been necessary. The Company, for certain matters, maintains stop loss coverage for health care costs that are in excess of set thresholds. The Company is currently in dispute with its previous stop loss carrier relating to 2007 and 2008 policies. The extent of this contingency cannot be determined with any certainty. Accordingly no amounts have been recorded relative to this uncertainty.

Property, Improvements and Equipment

Property, improvements and equipment are stated on the basis of cost or, in the case of acquisitions, at their acquisition date fair values. Depreciation is provided using the straight-line method over the estimated useful lives of the assets, and amortization of leasehold improvements is provided using the straight-line basis over the shorter of the remaining lease period or the estimated useful lives of the leasehold improvements. Leasehold improvements are generally depreciated over five to ten years, buildings are depreciated over twenty to twenty-eight years, equipment is depreciated over two to five years and furniture and fixtures are depreciated over two to seven years. Equipment capitalized under capital lease obligations are amortized over the life of the lease. At September 30, 2010 and 2009, the Company had assets under capitalized leases of approximately $4,626,000 and $4,059,000, respectively, and related accumulated depreciation of $2,880,000 and $2,052,000, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. Significant Accounting Policies (Continued)

Depreciation expense was approximately $3,969,000 and $3,514,000 for the fiscal years ended September 30, 2010 and 2009, respectively.

Goodwill and Other Intangible Assets

Goodwill and other intangible assets totaled approximately $195,409,000 and $199,675,000 at September 30, 2010 and 2009, respectively, and arose as a result of the ProMed, Alta and Brotman business acquisitions. Other intangible assets include customer relationships, covenants not-to-compete, trade names and provider networks. Goodwill represents the excess of the consideration paid and liabilities assumed over the fair value of the assets acquired, including identifiable intangible assets. In conjunction with these acquisitions, management of the Company has reviewed the allocation of the excess of the purchase consideration (including costs incurred related to the acquisitions) over net tangible and intangible assets acquired, and has determined that the goodwill is primarily related to the operating platforms acquired through the addition of the existing renewable HMO contracts in the case of ProMed and new business segments in the case of the Alta and Brotman acquisitions. Acquisitions are discussed further in Note 5 below.

Goodwill and other intangible assets with indefinite useful lives are not amortized; rather they are reviewed annually for impairment for each reporting unit, or more frequently if impairment indicators arise. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. A two-step impairment test is used to identify potential goodwill impairment and to measure the amount of goodwill impairment loss to be recognized, if any. As further discussed in Notes 5 and 6, the Company has four operating units, consisting of Alta, Brotman, ProMed and Prospect (which includes all other affiliated physician organizations).

The Company tests for goodwill impairment in the fourth quarter of each year, or sooner if events or changes in circumstances indicate that the carrying amount may exceed the fair value. In evaluating whether indicators of impairment exist, the Company considers adverse changes in market value and/or stock price, laws and regulations, profitability, cash flows, ability to maintain enrollment and renew payer contracts at favorable terms, among other factors. The goodwill impairment test is a two-step process. The first step consists of estimating the fair value of the reporting unit based on a weighted combination of (i) the guideline company method that utilizes revenue or earnings multiples for comparable publicly-traded companies, and (ii) a discounted cash flow model that utilizes expected future cash flows, the timing of those cash flows, and a discount rate (or weighted average cost of capital, which considers the cost of equity and cost of debt financing expected by a typical market participant) representing the time value of money and the inherent risk and uncertainty of the future cash flows. If the estimated fair value of the reporting unit is less than its carrying value, a second step is performed to compute the amount of the impairment by determining the "implied fair value" of the goodwill, which is compared to its corresponding carrying value. The impairment test at September 30, 2010 resulted in no impairment charge.

Long-Lived Assets and Amortizable Intangibles

The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. The Company considers assets to be impaired and writes them down to fair value if estimated undiscounted cash flows associated with those assets are less than their carrying amounts. Fair value is based upon the present value of the associated cash flows. Changes in circumstances (for example, changes in laws or

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2. Significant Accounting Policies (Continued)

regulations, technological advances or changes in strategies) may also reduce the useful lives from initial estimates. Changes in planned use of intangibles may result from changes in customer base, contractual agreements, or regulatory requirements. In such circumstances, management will revise the useful life of the long-lived asset and amortize the remaining net book value over the adjusted remaining useful life.

Medical Malpractice Liability Insurance

The individual physicians who contract with the Affiliates carry their own medical malpractice insurance. In the Hospital Services segment, Alta and Brotman purchase professional and general liability insurance to cover medical malpractice claims under a claims-made policies. Under the policies, insurance premiums cover only those claims actually reported during the policy term. Should the claims-made policy not be renewed or replaced with equivalent insurance, claims related to occurrences during the policy term but reported subsequent to the policy's termination may be uninsured.

Accounting principles generally accepted in the United States of America require that a health care organization record and disclose the estimated costs of medical malpractice claims in the period of the incident of malpractice, if it is reasonably possible that liabilities may be incurred and losses can be reasonably estimated. The Company has recognized an estimated liability for incurred but not reported claims and the self-insured risks (including deductibles and potential claims in excess of policy limits) based upon an actuarial valuation of the Company's historical claims experience in Alta and Brotman. At September 30, 2010, the claims liability of approximately $1,598,000 relating to Alta and Brotman was estimated using a discount factor of 4%. The claims liability at September 30, 2009 of approximately $2,824,000 relating to Alta and Brotman was estimated using a discount factor of 4%.

The claim reserve is based on the best data available to the Company; however, the estimate is subject to a significant degree of inherent variability. The estimate is continually monitored and reviewed, and as the reserve is adjusted, the difference is reflected in current operations. While the ultimate amount of medical malpractice liability is dependent on future developments, management is of the opinion that the associated liabilities recognized in the accompanying consolidated financial statements are adequate to cover such claims. Management is aware of no potential medical malpractice claims whose settlement, if any, would have a material adverse effect on the Company's consolidated financial position, results of operations or cash flows.

Workers' Compensation Insurance

The workers' compensation coverage provides the statutory benefits required by law and that the employer's liability limits are $1,000,000. The Company (excluding Brotman) workers' compensation coverage for October 1, 2009 through September 30, 2010 did not have an aggregate loss limitation. The current workers' compensation policy for the period of October 1, 2010 through September 30, 2011 does not have an aggregate loss limitation. Losses within the deductible are funded via a cash loss fund and reconciled annually. At September 30, 2010 and 2009, accruals relating to Alta and Brotman for uninsured claims and claims incurred but not reported of approximately $2,769,000 and $3,220,000, respectively, are estimated based upon an actuarial valuation of their claims experience, using a discount factor of 4% and 4%, respectively. On September 30, 2008, Brotman purchased first dollar guaranteed cost insurance and retains no liability under this policy from that point onwards.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. Significant Accounting Policies (Continued)

Earnings per Share

Basic net income per share is calculated by dividing net income attributable to common shareholders by the weighted average number of common shares outstanding. Diluted earnings per share is computed by dividing net income attributable to common shareholders by the weighted average number of common shares outstanding, after giving effect to potentially dilutive shares computed using the treasury stock method. Such shares are excluded if determined to be anti-dilutive.

The calculations of basic and diluted net income (loss) per share for the fiscal years ended September 30 are as follows (in thousands, except share and per share amounts):

	Year Ended September 30,

	2010		2009
Net income (loss) attributable to Prospect Medical Holdings, Inc.	$	10,372	$	(2,420	)

Weighted average common shares outstanding—basic		20,925,102		20,530,659
Dilutive effect of stock options and warrants		1,879,227		—

Weighted average commonshares outstanding—diluted		22,804,329		20,530,659

Basic	$	0.50	$	(0.12	)

Diluted	$	0.45	$	(0.12	)

The number of stock options and warrants excluded from the computation of diluted earnings per share due to being anti-dilutive were zero in fiscal year 2010, respectively, and were 4,333,325 and 665,973 in fiscal year 2009, respectively.

Comprehensive Income/(loss)

Comprehensive income (loss) includes net income (loss) attributable to Prospect, net of taxes, and changes in the fair value of interest rate swaps subject to hedge accounting that are recorded as other comprehensive income. As of April 1, 2008, the Company's swaps ceased to be eligible for hedge accounting. As a result, all further changes in fair value of the swaps were recorded in the consolidated statements of operations and the effective portion of the swaps of approximately $5,400,000, after tax, that was recorded in other comprehensive income through June 30, 2008 continued to be amortized to interest expense, using the effective interest method over the remaining life of the swaps. The remaining unamortized portion of the interest rate swaps was expensed in July 2009 in connection with the Company's termination of such swaps (see Note 9).

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PROSPECT MEDICAL HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. Significant Accounting Policies (Continued)

Stock Options

Prior to the completion of the merger, the Company had stock option and restricted stock agreements with certain directors, officers and employees. Share-based awards are generally issued at or above the market price of the underlying stock.

Compensation costs for option awards are measured and recognized in the financial statements based on their grant date fair value, net of estimated forfeitures over the awards' service period. The fair value of restricted stock and restricted stock unit grants are determined on the date of grant, based on the number of shares granted and the quoted price of the Company's common stock. The Company used the Black-Scholes option pricing model and a single option award approach to estimate the fair value of stock options granted. Equity-based compensation is classified within the same line items as cash compensation paid to employees. Cash retained as a result of excess tax benefits relating to share-based payments is presented in the statement of cash flows as a financing cash inflow.

The Company's equity awards vest based on continuous service and currently do not include performance or market vesting conditions. There are no liability awards that may be settled for cash.

Cash and Cash Equivalents

Cash equivalents are considered to be all liquid investments with initial maturities of three months or less when purchased. At times, cash balances held at financial institutions are in excess of federal depository insurance limits. The Company has not experienced any losses on cash and cash equivalents due to non-performance by financial institutions.

Restricted Cash

At September 30, 2010 and 2009, restricted cash primarily represent amounts set aside pursuant to the JHA loan agreements at Brotman (see Note 9), totaling $2,889,000 and $1,162,000, respectively, held in escrow for property taxes, maintenance and emergency room construction. Additionally, $233,000 and $233,000 at September 30, 2010 and 2009 was held in a restricted account in connection with workers compensation arrangements, respectively.

Investments

The Company is required to keep restricted deposits by certain HMOs for the payment of claims. Such restricted deposits are classified as a current asset in the accompanying consolidated balance sheet, as they are restricted for payment of current liabilities.

Inventories

Inventories of supplies are valued at the lower of amounts that approximates the weighted average cost or market.

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PROSPECT MEDICAL HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. Significant Accounting Policies (Continued)

Deferred Financing Costs

Deferred financing costs are amortized over the period in which the related debt is outstanding using the effective interest method. Deferred financing costs at September 30, 2010 and 2009 are as follows (in thousands):

	2010						2009

	Gross book value		Accumulated amortization		Net book value		Gross book value		Accumulated amortization		Net book value
Deferred financing costs	$	8,771	$	2,417	$	6,354	$	8,732	$	527	$	8,205

Income Taxes

Income taxes are accounted for using the liability method under which deferred income taxes are recognized for the future tax effects of temporary differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities using the enacted statutory tax rates in effect at year-end. The effect on deferred taxes for a change in tax rates is recognized in income in the period that includes the enactment date. The Company assesses the recoverability of its deferred tax assets and provides a valuation reserve when it is not more-likely-than-not the assets will be recovered. As of September 30, 2010 and 2009, the valuation allowance for deferred tax assets was approximately $20,783,000 and $23,623,000, respectively.

The Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. See Note 8, "Income Taxes," for further information regarding our income taxes.

The Company's practice is to recognize interest and/or penalties related to income tax matters in income tax. No interest or penalties related to income taxes are accrued or have been expensed as of and for the years ended September 30, 2010 and 2009.

Consolidated and separate income tax returns are filed with the U.S. Federal jurisdiction and in the State of California. The Company's filed tax returns are subject to examination by the IRS for tax year 2009, 2008, 2007 and 2006 and the State of California for fiscal years 2009, 2008, 2007, 2006 and 2005. Net operating losses that were incurred in prior years may still be adjusted by taxing authorities.

The net deferred tax liabilities are primarily comprised of temporary differences between book and tax bases for intangible and capital assets acquired and loss carryforwards.

Fair Value of Financial Instruments

The financial instruments reported in the accompanying consolidated balance sheets consist primarily of cash and cash equivalents, investments, patient and other receivables, accounts payable and accrued expenses, medical claims and related liabilities, notes receivable and payable, capital lease obligations, debt, and other liabilities. The carrying amounts of current assets and liabilities approximate their fair value due to the relatively short period of time between the origination of the instruments and their expected realization. (See Note 16 for further details).

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PROSPECT MEDICAL HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. Significant Accounting Policies (Continued)

Interest Rate Swaps

The Company recognizes all derivatives on the balance sheet at fair value. Derivatives that are not hedges are adjusted to fair value through income. If the derivative is accounted for as a hedge, depending on the nature of the hedge, changes in its fair value are offset against either the change in fair value of assets, liabilities, or firm commitments through earnings. The Company's derivative instruments comprised two interest rate swap agreements which were entered into on May 16, 2007 in conjunction with the ProMed Acquisition and on September 5, 2007 in conjunction with the Alta Acquisition.

The interest rate swap instruments were designated as cash flow hedges of expected interest payments on the Company's former term loans with the hedge effective date of the May 2007 instrument being December 31, 2007 and the hedge effective date of the September 2007 instrument being September 6, 2007. Prior to the hedge effective dates, all mark-to-market adjustments in the value of the swaps were charged to expense. After the hedge effective date, the effective portions of the fair value gains or losses on these cash flow hedges were initially recorded as a component of other comprehensive income, net of taxes, and subsequently reclassified into earnings when the forecasted transaction affected earnings. Effective April 1, 2008, the Company elected to discontinue hedge accounting, and changes in the fair value of the interest rate swaps after March 31, 2008 were recorded as other income or expense. Total net loss on the interest rate swaps included in earnings for fiscal year 2009 was approximately $5,300,000. The effective portion of the swaps of approximately $5,400,000, after tax, that was recorded in other comprehensive income through March 31, 2008, was being amortized as interest expense over the remaining life of the swap instruments.

As discussed in Note 9, concurrent with the offering of the $160,000,000 senior secured notes, effective July 23, 2009, the interest rate swap arrangements were terminated, and the unamortized portion of the swaps, amounting to approximately $4,300,000, was expensed. At September 30, 2010 the Company had no interest rate swaps.

Concentrations of Credit Risk

Financial instruments which potentially subject the Company to concentrations of credit risk consist of cash held in financial institutions which exceeds the $250,000 insurance limit of the Federal Deposit Insurance Corporation, receivables due from Medicare, Medi-Cal, patients, health plans and under shared-risk arrangements, and notes receivable.

The Company invests excess cash in liquid securities at institutions with strong credit ratings, following established guidelines relative to diversification and maturities to maintain safety and liquidity. These guidelines are periodically reviewed and modified to take into consideration of trends in yields and interest rates and principal risk. Management attempts to schedule the maturities of the Company's investments to coincide with the Company's expected cash requirements. Credit risk with respect to receivables is limited since amounts are generally due from large HMOs within the Medical Group Management segment and from the Medicare and Medi-Cal programs within the Hospital Services segment. Notes receivable are fully secured by collateral of equal or greater value. Management reviews the financial condition of these institutions on a periodic basis and does not believe the concentration of cash or receivables results in a high level of risk.

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PROSPECT MEDICAL HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. Significant Accounting Policies (Continued)

The Company was subject to interest rate fluctuation under its floating rate revolving credit facilities.

For the fiscal years ended September 30, 2010 and 2009, the Hospital Services segment received a total of 79% and 84%, respectively, of their net patient revenues from Medicare and Medi-Cal programs and its largest HMO, and the Medical Group segment received a total of 72% and 77% of their capitation revenues from it's five largest HMOs, as follows (in thousands):

		Revenue Year Ended September 30, 2010				Revenue Year Ended September 30, 2009

Hospital Services:
Government Payors:
	Medicare	$	149,289	53	%	$	96,693	47	%
	Medi-Cal		68,935	25	%		74,865	36	%

Commercial:			218,224	78	%		171,558	83	%
	Plan A		2,651	1	%		1,092	1	%

Totals		$	220,875	79	%	$	172,650	84	%

Medical Group Management:
	Plan A	$	31,233	17	%	$	37,216	19	%
	Plan B		27,425	15	%		27,073	14	%
	Plan C		26,558	14	%		28,688	15	%
	Plan D		25,042	13	%		23,579	12	%
	Plan E		33,646	18	%		33,556	17	%

Totals		$	143,904	72	%	$	150,112	77	%

Approximately 78% of Brotman's employees were covered under collective bargaining agreements as of September 30, 2010. The collective bargaining agreements with the California Nurses Association ("CNA") and Service Employees International Union ("SEIU") expired on February 28, 2010.

After months of good faith negotiations, Brotman recently entered into two new tentative collective bargaining agreements with the SEIU and CNA. The parties are currently in the process of drafting the final agreements.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities at the dates, and for the periods, that the consolidated financial statements are prepared. Actual results could materially differ from those estimates. Principal areas requiring the use of estimates include third party settlements, receivables for medical services, allowances for contractual discounts and doubtful accounts, accruals for medical claims, impairment of goodwill, long-lived assets and intangible assets, share-based payments, professional and general liability claims and workers' compensation claims, reserves for outcome of legislation and valuation allowances against deferred tax assets.

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PROSPECT MEDICAL HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. Significant Accounting Policies (Continued)

Recent Accounting Pronouncements

Effective the first quarter of fiscal year 2010, the Company adopted the revised accounting guidance for business combinations, which changed its previous accounting practices regarding business combinations. The more significant changes include an expanded definition of a business and a business combination; recognition of assets acquired, liabilities assumed and noncontrolling interests (including goodwill) measured at fair value at the acquisition date; recognition of acquisition-related expenses and restructuring costs separately from the business combination; recognition of assets acquired and liabilities assumed at their acquisition-date fair values with subsequent changes recognized in earnings. The guidance also amends and clarifies the application issues on initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. The adoption did not have a material impact on the Company's consolidated financial statements for prior periods; but the pronouncement will impact the accounting for any acquisitions subsequent to that date.

Effective the first quarter of fiscal year 2010, the Company adopted revised accounting guidance which requires noncontrolling interests (formerly minority interest) to be presented as a separate component from the Company's equity in the equity section of the consolidated balance sheets. As required by this guidance, the Company has adjusted the presentation of noncontrolling interests in the prior period consolidated financial statements so that they are comparable to those of the fiscal year 2010 period. The adoption of this accounting guidance had no impact on the Company's results of operations and did not have a material impact on the Company's financial position.

In January 2010, the Financial Accounting Standards Board ("FASB") issued guidance to amend the disclosure requirements related to recurring and nonrecurring fair value measurements. The guidance requires new disclosures on the transfers of assets and liabilities between Level 1 (quoted prices in active market for identical assets or liabilities) and Level 2 (significant other observable inputs) of the fair value measurement hierarchy, including the reasons and the timing of the transfers. Additionally, the guidance requires a roll forward of activities on purchases, sales, issuance, and settlements of the assets and liabilities measured using significant unobservable inputs (Level 3 fair value measurements). Disclosures regarding transfers are required beginning January 1, 2010 and the Level 3 rollforward is to be disclosed in reporting periods beginning after December 15, 2010. Since the Company had no transfers between categories, the additional disclosures are not applicable for the periods presented.

On October 1, 2009, the Company adopted guidance on fair value measurement for nonfinancial assets and liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). Adoption of the new guidance did not have a material impact on the Company's consolidated financial statements.

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PROSPECT MEDICAL HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. Significant Accounting Policies (Continued)

beginning in the first quarter of fiscal 2011. The Company is currently evaluating the impact that the adoption of this guidance will have on its consolidated financial statements.

In June 2009, the FASB issued revised guidance for the accounting of transfers of financial assets. This guidance eliminates the concept of a qualifying special-purpose entity, removes the scope exception for qualifying special-purpose entities when applying the accounting guidance related to the consolidation of variable interest entities, changes the requirements for derecognizing financial assets, and requires enhanced disclosure. This accounting guidance is effective for the Company beginning in the first quarter of fiscal 2011. The Company is currently evaluating the impact that the adoption of this guidance will have on its consolidated financial statements.

The modified accounting standards are required to be adopted for fiscal years that begin after December 15, 2010. Early adoption of such accounting standards is permitted. The charity care disclosure change must be applied on a retrospective basis; however, the accounting change for insurance recoveries may be applied on either a prospective or retrospective basis. The Company will adopt the modified accounting standards in the first quarter of fiscal year 2012 and is currently assessing the potential impact that the adoption will have on its consolidated results of operations and consolidated financial position.

In November 2010, the FASB issued a final consensus requiring bad debt expense to be shown on the income statement as a separate line item in the presentation of net revenue. In addition, a health care entity is required to disclose all of the following by major payor source of revenue:

•: Its policy for assessing collectability in the timing and amount of revenue and bad debt expense recognized;
•: Its net revenues; and
•: A tabular reconciliation of the activity in the allowance for doubtful accounts for the period.

The final consensus was scheduled to be effective for public entities for fiscal years beginning after December 15, 2010, and interim periods within those fiscal years. However, recently the FASB was re-exposed this consensus for comments and, as a result, may change aspects to the consensus and the effective date.

Reclassifications

Certain prior year amounts have been reclassified to conform to the current year presentation with no impact on the consolidated financial statements.

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PROSPECT MEDICAL HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. Significant Accounting Policies (Continued)

Subsequent Events

The Company's consolidated financial statements are considered issued when filed with the SEC. Accordingly, the Company has evaluated subsequent events up to the filing date of this Form 10-K with the SEC (see Note 18).

3. Property Improvements and Equipment

Property, improvements and equipment as of September 30, 2010 and 2009, consisted of the following (in thousands):

		September 30,

		2010			2009
Property, improvements and equipment:
	Land and land improvements	$	31,028		$	31,028
	Buildings and improvements		24,302			23,665
	Leasehold improvements		2,666			2,029
	Equipment		22,121			20,255
	Furniture and fixtures		892			913

			81,009			77,890
	Less accumulated depreciation		(17,905	)		(14,166	)

Property, improvements and equipment, net		$	63,104		$	63,724

4. Agreement and Plan of Merger

On August 16, 2010, the Company entered into an Agreement and Plan of Merger (the "Ivy Merger Agreement") with Ivy Holdings Inc. ("Ivy Holdings") and Ivy Merger Sub Corp. ("Merger Sub"), an indirect, wholly owned subsidiary of Ivy Holdings. On December 15, 2010, at a special meeting of our stockholders, the adoption of the Ivy Merger Agreement was approved by the affirmative vote of a majority of our common stock outstanding as of the record date for the special meeting. In accordance with the Ivy Merger Agreement and the Delaware General Corporation Law, Merger Sub subsequently merged with and into us on December 15, 2010 and the Company became an indirect, wholly-owned subsidiary of Ivy Holdings (the "Ivy Merger").

Pursuant to the Merger Agreement, at the effective time of the merger:

•: All outstanding options to purchase shares of our common stock were canceled and the holder of each such option is entitled to receive a cash payment equal to the excess of the $8.50 per share cash merger consideration over the exercise price of such option, multiplied by the number of shares subject to the option that are vested immediately prior to the effective time of the merger, less any applicable withholding taxes and after giving effect to the determination of our compensation committee to accelerate the vesting of all unvested options in connection w

PROSPECT MEDICAL HOLDINGS INC 10-K