**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

**FORM10-QSB**

**x****                             ****QUARTERLY REPORT UNDER SECION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**For thequarterly period ended September 30, 2006**

**o****        TRANSITION REPORT UNDERSECTION 13 OR 15(d) OF THE EXCHANGE ACT**

**Commissionfile number: 0-31152**

**CRDENTIA CORP.**

(Exact name ofsmall business issuer as specified in its charter)

| **Delaware**                                                     |   | **76-0585701**                     |
|------------------------------------------------------------------|--------|------------------------------------|
| (State or other  jurisdiction of incorporation or  organization) |   | (IRS Employer  Identification No.) |

 

**5001 LBJ Freeway, Suite 850,Dallas, Texas 75244**

(Address ofprincipal executive offices)

**(972) 850-0780**

(Issuer’stelephone number)

Check whether theissuer (1) filed all reports required to be filed by Section 13 or 15(d) of theExchange Act during the past 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes xNo o

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  Yes  oNo x

State the numberof shares outstanding of each of the issuer’s classes of common equity, as ofthe latest practicable date.  At November9, 2006, 14,344,230 shares of common stock, $.0001 par value, were outstanding.

Transitional SmallBusiness Disclosure Format (check one): Yes oNo x

 

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**CRDENTIACORP.**

Form 10-QSBQuarterly ReportFor Quarterly Period Ended September 30, 2006

**Table of Contents**

 
| ** **                              | **Page**                                                                                                                    |
|-----------------------------------------|-----------------------------------------------------------------------------------------------------------------------------|
| ** **                              |                                                                                                                        |   |
| **PART I — FINANCIAL INFORMATION** | 3                                                                                                                           |   |
| ** **                              |                                                                                                                        |   |
| Item  1.                                | Financial Statements                                                                                                        | 3 |   |
|                                    |                                                                                                                        |   |   |
|                                    | Unaudited  Condensed Consolidated Balance Sheets at September 30, 2006 and December 31,  2005                               | 3 |   |
|                                    |                                                                                                                        |   |   |
|                                    | Unaudited  Condensed Consolidated Statements of Operations for the Three and Nine Months  Ended September 30, 2006 and 2005 | 4 |   |
|                                    |                                                                                                                        |   |   |
|                                    | Unaudited  Condensed Consolidated Statements of Cash Flows for the Nine Months Ended  September 30, 2006 and 2005           | 5 |   |
|                                    |                                                                                                                        |   |   |
|                                    | Notes to Unaudited Condensed Consolidated Financial  Statements                                                             | 6 |   |
|                                    |                                                                                                                        |   |   |
| Item 2.                                 | Management’s Discussion and Analysis or Plan of  Operation                                                             | 19 |   |
|                                    |                                                                                                                        |   |   |
| Item 3.                                 | Controls and Procedures                                                                                                     | 37 |   |
|                                    |                                                                                                                        |   |   |
| **PART II — OTHER  INFORMATION**   | 38                                                                                                                          |   |
| ** **                              |                                                                                                                        |   |
| Item  1.                                | Legal Proceedings                                                                                                           | 38 |   |
|                                    |                                                                                                                        |   |   |
| Item 2.                                 | Unregistered Sales of Equity Securities and Use of  Proceeds                                                                | 38 |   |
|                                    |                                                                                                                        |   |   |
| Item 3.                                 | Defaults Upon Senior Securities                                                                                             | 38 |   |
|                                    |                                                                                                                        |   |   |
| Item 4.                                 | Submission of Matters to a Vote of Security Holders                                                                         | 38 |   |
|                                    |                                                                                                                        |   |   |
| Item  5.                                | Other Information                                                                                                           | 38 |   |
|                                    |                                                                                                                        |   |   |
| Item 6.                                 | Exhibits                                                                                                                    | 38 |   |
|                                    |                                                                                                                        |   |   |
| **SIGNATURES**                          | 40                                                                                                                          |   |
|                                         |                                                                                                                             |  |  |  |

 

2

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**PART 1.FINANCIAL INFORMATION**

 

**Item 1.Unaudited Condensed Consolidated Financial Statements**

 

**CRDENTIA CORP.**

**Unaudited Condensed ConsolidatedBalance Sheets**

 
|                                                                                                                                                                                                                                       | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                            | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| Current assets:                                                                                                                                                                                                                       |       |                   |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                                                                            |       | $                      | 199,572    |                  | $          | 434,921 |   |
| Marketable  securities                                                                                                                                                                                                                |       | 421,770                |       | —                |       |
| Accounts  receivable, net of allowance for doubtful accounts of $404,659 at September  30, 2006 and $275,000 at December 31, 2005                                                                                                     |       | 6,286,152              |       | 5,192,874             |       |
| Royalty  receivable                                                                                                                                                                                                                   |       | 500,000                |       | —                |       |
| Other current  assets                                                                                                                                                                                                                 |       | 855,926                |       | 464,865               |       |
| Total current assets                                                                                                                                                                                                                  |       | 8,263,420              |       | 6,092,660             |       |
|                                                                                                                                                                                                                                  |       |                   |       |                  |       |
| Property and equipment,  net                                                                                                                                                                                                          |       | 688,064                |       | 418,837               |       |
| Goodwill                                                                                                                                                                                                                              |       | 26,699,119             |       | 22,977,377            |       |
| Intangible assets, net                                                                                                                                                                                                                |       | 1,781,393              |       | 1,985,585             |       |
| Other assets                                                                                                                                                                                                                          |       | 834,495                |       | 518,001               |       |
|                                                                                                                                                                                                                                  |       |                   |       |                  |       |
| Total assets                                                                                                                                                                                                                          |       | $                      | 38,266,491 |                  | $          | 31,992,460 |   |
|                                                                                                                                                                                                                                  |       |                   |       |                  |       |
| Current liabilities:                                                                                                                                                                                                                  |       |                   |       |                  |       |
| Revolving lines  of credit                                                                                                                                                                                                            |       | $                      | 5,793,827  |                  | $          | 4,672,096 |   |
| Accounts payable  and accrued expenses                                                                                                                                                                                                |       | 2,291,747              |       | 1,447,905             |       |
| Accrued  dividends on convertible preferred stock                                                                                                                                                                                     |       | —                 |       | 800,748               |       |
| Accrued employee  compensation and benefits                                                                                                                                                                                           |       | 1,218,617              |       | 980,005               |       |
| Current portion  of notes payable to lender, net of discount of $110,150 at September 30, 2006  and $200,168 at December 31, 2005                                                                                                     |       | 809,212                |       | 1,147,634             |       |
| Debentures, net  of discount of $1,305,004                                                                                                                                                                                            |       | 434,996                |       | —                |       |
| Note payable to  majority stockholder                                                                                                                                                                                                 |       | 1,410,000              |       | —                |       |
| Current portion  of notes payable to sellers                                                                                                                                                                                          |       | —                 |       | 3,215,490             |       |
| Subordinated  convertible notes                                                                                                                                                                                                       |       | —                 |       | 12,500                |       |
| Other current  liabilities                                                                                                                                                                                                            |       | 503,595                |       | 309,463               |       |
| Net current  liabilities related to discontinued operations                                                                                                                                                                           |       | 265,099                |       | —                |       |
| Total current  liabilities                                                                                                                                                                                                            |       | 12,727,093             |       | 12,585,841            |       |
|                                                                                                                                                                                                                                  |       |                   |       |                  |       |
| Note payable to lender,  less current portion, net of discount of $200,167                                                                                                                                                            |       | —                 |       | 1,149,833             |       |
| Long term bonus payable                                                                                                                                                                                                               |       | 876,899                |       | 801,084               |       |
| Other long-term  liabilities                                                                                                                                                                                                          |       | 61,789                 |       | 7,032                 |       |
|                                                                                                                                                                                                                                  |       |                   |       |                  |       |
| Total liabilities                                                                                                                                                                                                                     |       | 13,665,781             |       | 14,543,790            |       |
|                                                                                                                                                                                                                                  |       |                   |       |                  |       |
| Commitments and  contingencies                                                                                                                                                                                                        |       |                   |       |                  |       |
|                                                                                                                                                                                                                                  |       |                   |       |                  |       |
| Minority interest in  iVOW, Inc.                                                                                                                                                                                                      |       | 3,500,000              |       | —                |       |
|                                                                                                                                                                                                                                  |       |                   |       |                  |       |
| Convertible preferred  stock, 10,000,000 shares authorized:                                                                                                                                                                           |       |                   |       |                  |       |
| Series C  convertible preferred stock $0.0001 par value, 183,028 shares outstanding at  December 31, 2005 (liquidation preference of $54,908,400 at December 31,  2005)                                                               |       | —                 |       | 10,020,048            |       |
| Series C  preferred stock warrants                                                                                                                                                                                                    |       | —                 |       | 839,555               |       |
|                                                                                                                                                                                                                                  |       |                   |       |                  |       |
| Stockholders’ equity:                                                                                                                                                                                                            |       |                   |       |                  |       |
| Common stock,  par value $0.0001, 150,000,000 shares authorized, 14,437,601 shares issued  and 14,329,960 shares outstanding at September 30, 2006 and 3,515,760 shares  issued and 3,408,125 shares outstanding at December 31, 2005 |       | 1,444                  |       | 352                   |       |
| Additional paid  in capital                                                                                                                                                                                                           |       | 126,745,882            |       | 109,802,174           |       |
| Treasury stock,  107,641 shares at cost                                                                                                                                                                                               |       | —                 |       | —                |       |
| Accumulated  deficit                                                                                                                                                                                                                  |       | (105,646,616           | )          | (103,213,459          | )          |
| Total stockholders’  equity                                                                                                                                                                                                      |       | 21,100,710             |       | 6,589,067             |       |
|                                                                                                                                                                                                                                  |       |                   |       |                  |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                       |       | $                      | 38,266,491 |                  | $          | 31,992,460 |   |

 

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

3

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**CRDENTIACORP.**

**Unaudited Condensed Consolidated Statements of Operations**

 
| ** **                                                                   | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2006**                                                 | ** ** | **2005**                                                | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenue from services                                                        |       | $                                                        | 10,299,037 |                                                    | $          | 9,553,016 |   | $ | 30,596,539 |   | $ | 23,882,837 |   |
| Direct operating  expenses                                                   |       | 8,203,650                                                |       | 7,584,125                                               |       | 24,403,664 |   | 18,743,062 |   |
| Gross profit                                                                 |       | 2,095,387                                                |       | 1,968,891                                               |       | 6,192,875 |   | 5,139,775 |   |
|                                                                         |       |                                                     |       |                                                    |       |   |   |   |   |
| Operating expenses:                                                          |       |                                                     |       |                                                    |       |   |   |   |   |
| Selling,  general, and administrative expenses                               |       | 3,246,095                                                |       | 2,470,966                                               |       | 8,937,842 |   | 6,362,117 |   |
| Loss on  impairment of intangibles                                           |       | —                                                   |       | —                                                  |       | 123,000 |   | — |   |
| Gain from  settlement of acquisition claim                                   |       | —                                                   |       | —                                                  |       | (1,064,693 | ) | — |   |
| Gain from  extinguishment of debt                                            |       | —                                                   |       | —                                                  |       | (3,215,490 | ) | — |   |
| Non-cash stock  based compensation                                           |       | 505,586                                                  |       | 401,154                                                 |       | 1,335,215 |   | 671,488 |   |
| Total operating  expenses                                                    |       | 3,751,681                                                |       | 2,872,120                                               |       | 6,115,874 |   | 7,033,605 |   |
|                                                                         |       |                                                     |       |                                                    |       |   |   |   |   |
| Income (loss) from  operations                                               |       | (1,656,294                                               | )          | (903,229                                                | )          | 77,001 |   | (1,893,830 | ) |
|                                                                         |       |                                                     |       |                                                    |       |   |   |   |   |
| Interest expense, net                                                        |       | (866,204                                                 | )          | (485,451                                                | )          | (2,510,158 | ) | (1,484,369 | ) |
|                                                                         |       |                                                     |       |                                                    |       |   |   |   |   |
| Loss before income  taxes                                                    |       | (2,522,498                                               | )          | (1,388,680                                              | )          | (2,433,157 | ) | (3,378,199 | ) |
|                                                                         |       |                                                     |       |                                                    |       |   |   |   |   |
| Income tax expense                                                           |       | —                                                   |       | —                                                  |       | — |   | — |   |
|                                                                         |       |                                                     |       |                                                    |       |   |   |   |   |
| Net loss                                                                     |       | $                                                        | (2,522,498 | )                                                       | $          | (1,388,680 | ) | $ | (2,433,157 | ) | $ | (3,378,199 | ) |
|                                                                         |       |                                                     |       |                                                    |       |   |   |   |   |
| Deemed dividend on  preferred stock                                          |       | —                                                   |       | —                                                  |       | (45,554,618 | ) | — |   |
| Non-cash preferred  stock dividends                                          |       | —                                                   |       | —                                                  |       | — |   | (2,362,979 | ) |
|                                                                         |       |                                                     |       |                                                    |       |   |   |   |   |
| Net loss attributable  to common stockholders                                |       | $                                                        | (2,522,498 | )                                                       | $          | (1,388,680 | ) | $ | (47,987,775 | ) | $ | (5,741,178 | ) |
|                                                                         |       |                                                     |       |                                                    |       |   |   |   |   |
| Basic and diluted loss  per common share attributable to common stockholders |       | $                                                        | (0.18      | )                                                       | $          | (0.52 | ) | $ | (4.68 | ) | $ | (2.56 | ) |
|                                                                         |       |                                                     |       |                                                    |       |   |   |   |   |
| Weighted average number of common shares outstanding                         |       | 13,899,960                                               |       | 2,684,133                                               |       | 10,250,945 |   | 2,244,533 |   |

 

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

4

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**CRDENTIACORP.**

**Unaudited Condensed Consolidated Statements of Cash Flows**

 
|                                                                                   | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                        | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| **Operating activities**                                                          | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| Net loss                                                                          |       | $                                                       | (2,433,157 | ) | $ | (3,378,199 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities:      |       |                                                    |       |   |   |
| Non-cash  interest expense                                                        |       | 1,583,799                                               |       | 600,284 |   |
| Amortization of  long-term bonus payable                                          |       | 75,815                                                  |       | 68,628 |   |
| Loss on  impairment of intangibles                                                |       | 123,000                                                 |       | — |   |
| Depreciation and  amortization                                                    |       | 764,641                                                 |       | 601,072 |   |
| Gain on disposal  of fixed assets                                                 |       | (500                                                    | )          | — |   |
| Gain on  settlement of acquisition claim                                          |       | (1,064,693                                              | )          | — |   |
| Gain on  extinguishment of debt                                                   |       | (3,215,490                                              | )          | — |   |
| Non-cash stock  based compensation                                                |       | 1,335,215                                               |       | 671,488 |   |
| Changes in  operating assets and liabilities, net of effects of acquisitions:     |       |                                                    |       |   |   |
| Accounts  receivable                                                              |       | (1,046,664                                              | )          | (1,107,665 | ) |
| Other assets and  liabilities                                                     |       | (425,133                                                | )          | (180,282 | ) |
| Accounts payable  and accrued expenses                                            |       | 862,116                                                 |       | (1,325,405 | ) |
| Accrued employee  compensation and benefits                                       |       | 221,050                                                 |       | 358,920 |   |
| Net cash used in  operating activities                                            |       | (3,220,001                                              | )          | (3,691,159 | ) |
|                                                                              |       |                                                    |       |   |   |
| **Investing activities**                                                          | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| Purchases of property  and equipment                                              |       | (167,503                                                | )          | (117,415 | ) |
| Net cash received  (paid) through acquisition of subsidiaries                     |       | 370,864                                                 |       | (4,956,980 | ) |
| Other                                                                             |       | —                                                  |       | 23,829 |   |
| Net cash provided by (used  in) investing activities                              |       | 203,361                                                 |       | (5,050,566 | ) |
|                                                                              |       |                                                    |       |   |   |
| **Financing activities**                                                          | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| Proceeds from issuance  of preferred stock                                        |       | 1,500,000                                               |       | — |   |
| Proceeds from exercise  of warrants for Series C preferred stock, net of expenses |       | —                                                  |       | 7,709,183 |   |
| Net increase in  revolving lines of credit                                        |       | 1,121,731                                               |       | 1,594,463 |   |
| Repayment of  subordinated convertible note                                       |       | (12,500                                                 | )          | (25,000 | ) |
| Proceeds from notes  payable to majority stockholder                              |       | —                                                  |       | 1,050,000 |   |
| Repayment of notes  payable to majority stockholder                               |       | —                                                  |       | (1,450,000 | ) |
| Proceeds from  debentures and warrants                                            |       | 2,000,000                                               |       | — |   |
| Repayment of note  payable to lender                                              |       | (1,778,438                                              | )          | — |   |
| Repayment of notes  payable to sellers                                            |       | —                                                  |       | (184,948 | ) |
| Debt issuance costs                                                               |       | (49,502                                                 | )          | (11,867 | ) |
| Net cash provided by  financing activities                                        |       | 2,781,291                                               |       | 8,681,831 |   |
|                                                                              |       |                                                    |       |   |   |
| Net decrease in cash  and cash equivalents                                        |       | (235,349                                                | )          | (59,894 | ) |
| Cash and cash  equivalents at beginning of period                                 |       | 434,921                                                 |       | 362,472 |   |
| Cash and cash equivalents at end of period                                        |       | $                                                       | 199,572    |   | $ | 302,578 |   |

 

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

 

5

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**Crdentia Corp.Notes to Unaudited Condensed Consolidated Financial StatementsSeptember 30, 2006**

**Note 1    Organization and Summary of SignificantAccounting Policies**

Organization

Crdentia Corp (the“Company”), a Delaware corporation, is a provider of healthcare staffingservices in the United States.  Suchservices include travel nursing, per diem staffing, contractual clinicalservices, locum tenens, allied services and private duty home health care.  The Company considers these services to beone segment.  Each of these servicesrelate solely to providing healthcare staffing to customers and the Companyutilizes common systems, databases, procedures, processes and similar methodsof identifying and serving these customers.

At the beginningof 2003, the Company was a development stage company with no commercialoperations.  During that year, theCompany pursued its operational plan of acquiring companies in the healthcarestaffing field and completed the acquisition of four operating companies.  The companies acquired in 2003 were BakerAnderson Christie, Inc., New Age Nurses, Inc., Nurses Network, Inc., PSR NurseRecruiting, Inc. and PSR Nurses Holdings Corp., which holds the limited partnerand general partner interests in PSR Nurses, Ltd.  During 2004, the Company completed theacquisitions of Arizona Home Health Care/Private Duty, Inc. and Care ProsStaffing, Inc.  During 2005, the Companyacquired TravMed USA, Inc. and Health Industry Professionals, LLC, Prime Staff,LP and Mint Medical Staffing Odessa.  During2006, the Company purchased Staff Search Ltd.

The accompanyingfinancial statements include the results of the wholly-owned subsidiariesdiscussed above from their respective dates of acquisition.  All intercompany transactions have beeneliminated in consolidation.

On September 20,2006, the Company entered into an Agreement and Plan of Merger with iVOW,Inc.  The completion of the merger issubject to certain conditions, including the receipt of applicable approvalsfrom the Company’s and iVOW’s stockholders. In connection with the merger, the Company and iVOW have entered into anInterim Management Agreement pursuant to which the Company has sole andexclusive responsibility, authority and discretion to, among other things,manage and control all aspects of iVOW’s business.  As a result of the Interim ManagementAgreement the Company will account for iVOW on a consolidated basis as ofSeptember 20, 2006.  If the merger is notcompleted, the accounting will be adjusted. iVOW provides services to employers, payors and unions to facilitateweight loss programs on a per patient direct basis.  See Note 13 for a discussion of thistransaction.

On April 4, 2006the Company executed a one-for-ten reverse stock split of the outstandingshares of common stock.  All common shareand per share information included in these financial statements and notes havebeen retroactively adjusted to reflect the reverse stock split.

Basisof Presentation

The accompanyingunaudited financial data as of September 30, 2006 and for the three months andnine months ended  September 30, 2006 and2005 have been prepared by the Company pursuant to the rules and regulations ofthe Securities and Exchange Commission. Certain information and footnote disclosures normally included infinancial statements prepared in accordance with accounting principlesgenerally accepted in the United States of America have been condensed oromitted pursuant to such rules and regulations. These unaudited condensed consolidated financial statements should beread in conjunction with the audited financial statements and the notes theretoincluded in the Company’s annual report on Form 10-KSB for the year endedDecember 31, 2005.

In the opinion ofmanagement, all adjustments (which include only normal recurring adjustments)necessary to present fairly the financial position, results of operations, andcash flows as of September 30, 2006 and for the three months and nine monthsended September 30, 2006 and 2005 have been made.  The results of operations for the threemonths and nine months ended September 30, 2006 are not necessarily indicativeof the expected operating results for the full year.

6

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GoingConcern

The Company usedcash in operations of $3,220,001 during the first nine months of operations in2006.   Although the Company ended thethird quarter of 2006 with a significant working capital deficit of $4,463,673,it was able to secure additional funding during this period to finance itsoperations as it continued to execute its business plan to acquire and growcompanies involved in healthcare staffing. The Company will need to raise additional funds during the next twelvemonths for working capital needs and for debt refinancing.  There is no assurance that the Company willbe able to raise the amount of debt or equity capital required to meet itsobjectives.  The Company’s challengingfinancial circumstances may make the terms, conditions and cost of anyavailable capital relatively unfavorable. If additional debt or equity capital is not readily available, theCompany will be forced to scale back its acquisition activities and itsoperations.  This would result in anoverall slowdown of the Company’s development. The Company’s short-term need for capital may force it to consider andpotentially pursue other strategic options sooner than it might otherwise havedesired.  These conditions raisesubstantial doubt about the Company’s ability to continue as a goingconcern.  The accompanying financialstatements do not include any adjustments to reflect the possible futureeffects on the recoverability and classification of assets, or the amounts andclassification of liabilities that may result from the outcome of thisuncertainty.

Management hastaken a number of steps to address the Company’s financial performance and toimprove cash flow during 2006.  TheCompany replaced a portion of its debt with new debt that has a lower interestrate, restructured the operating management team, implemented programs toobtain expense savings and entered into agreements with iVOW, Inc. that hasprovided the Company with access to iVOW cash. Management is devoting constant attention toward achieving growth bothorganically and through acquisitions so that the Company can spread itscorporate overhead over a larger base of business and achieve economies ofscale. However, there can be no assurances that these programs will besuccessful.

The Company hasentered into an agreement with its current lender that it will refinance itsexisting revolving credit facility with another lender, including over-advanceson its revolving credit facility, and outstanding term debt by November 30, 2006.  The Company also needs additional funds forworking capital purposes.  The Company iscurrently in discussions with another lender to refinance its revolving creditfacility and is actively trying to raise additional equity through a privateplacement.  There can be no assurancesthat the Company will be successful in these efforts.  If unsuccessful, the Company could be unableto fund payroll costs and could ultimately fail.

MarketableSecurities

Marketablesecurities are classified as “available-for-sale” in accordance with theprovisions of Statement of Financial Accounting Standards No. 115,”*Accounting for Certain Investments and Debt and Equity Securities (“SFAS115). *Available-for-salesecurities are carried at fair value with the unrealized gain or loss, net oftax, reported in other comprehensive income. The fair value is based on currently available market prices.  Marketable securities represent an investmentin one publicly-traded company.

RoyaltyReceivable

The royaltyreceivable represents amounts due under a patent and technology agreement thatlicensed certain patents and other technology owned by iVOW, Inc. to a thirdparty.  The receivable is stated at thepresent value of expected future amounts to be collected.

Stock-BasedCompensation

On January 1, 2006 the Company adopted the FinancialAccounting Standards Board Statement of Financial Accounting Standards No. 123(revised 2004), *Share-Based Payment*, (“SFAS 123R”),that addresses the accounting for share-based payment transactions in which anenterprise receives employee services in exchange for either equity instrumentsof the enterprise or liabilities that are based on the fair value of theenterprise’s equity instruments or that may be settled by issuance of suchequity instruments.  The statementeliminates the ability to account for share-based compensation transactionsusing the intrinsic value method as prescribed by Accounting Principles BoardOpinion No. 25, “Accounting for Stock Issued to Employees,” and generallyrequires that such transactions be accounted for using a fair-value-basedmethod and recognized as expense by the Company.

7

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The Company adopted SFAS 123R using the modifiedprospective method which requires the application of the accounting standard asof January 1, 2006.  The Company’sconsolidated interim financial statements for the three and nine months endedSeptember 30, 2006 reflect the impact of adopting SFAS 123R.  In accordance with the modified prospectivemethod, the consolidated interim financial statements for prior periods havenot been restated to reflect, and do not include, the impact of FAS 123R.  See pro forma information below.

Stock-based compensation expense recognized during theperiod is based on the value of the portion of stock-based payment awards thatis ultimately expected to vest. Stock-based compensation expense recognized in the condensedconsolidated statement of operations for the three and nine months endedSeptember 30, 2006 included compensation expense for stock-based payment awardsgranted prior to, but not yet vested, as of December 31, 2005 based on thegrant date fair value estimated in accordance with the pro forma provision ofSFAS 148 and compensation expense for the stock-based payment awards grantedsubsequent to December 31, 2005, based on the grant date fair value estimatedin accordance with SFAS 123R.  Asstock-based compensation expense recognized in the condensed consolidatedstatement of operations for the three and nine months ended September 30, 2006is based on awards ultimately expected to vest, it has been reduced forestimated forfeitures.  SFAS 123Rrequires forfeitures to be estimated at the time of grant and revised, ifnecessary, in subsequent periods if actual forfeitures differ from thoseestimates.  In the pro forma informationrequired under SFAS 148 for the periods prior to January 1, 2006, forfeitureswere accounted for as they occurred.

The table belowshows net loss per share attributable to common stockholders for the three andnine months ended September 30, 2005 as if the Company had elected the fairvalue method of accounting for stock options effective January 1, 2005.
| ** **                                                                                                                                            | ** ** | **Three months ended  September 30, 2005** | ** ** | **Nine months ended  September 30, 2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
|                                                                                                                                                  |       |                                                           |       |                                                          |       |
| Net loss  attributable to common stockholders, as reported                                                                                            |       | $                                                              | (1,388,680 | )                                                             | $          | (5,741,178 | ) |
|                                                                                                                                                  |       |                                                           |       |                                                          |       |
| Add:       stock-based  employee compensation in     reported net loss, net of related  tax effects |       | 401,154                                                        |       | 671,488                                                       |       |
| Deduct:  stock-based  employee compensation  determined under fair value method for all  awards, net of related tax effects                      |       | (465,902                                                       | )          | (790,116                                                      | )          |
| Pro forma net  loss attributable to common stockholders, as adjusted                                                                                  |       | $                                                              | (1,452,618 | )                                                             | $          | (5,859,806 | ) |
|                                                                                                                                                  |       |                                                           |       |                                                          |       |
| Loss per share  attributable to common stockholders:                                                                                                  |       |                                                           |       |                                                          |       |
| Basic and diluted, as reported                                                                                                                        |       | $                                                              | (.52       | )                                                             | $          | (2.56 | ) |
| Basic and  diluted, as adjusted                                                                                                                       |       | $                                                              | (.54       | )                                                             | $          | (2.61 | ) |

 

EarningsPer Share

Basic per sharedata has been computed on the loss attributable to common stockholders for eachperiod divided by the weighted average number of shares of common stockoutstanding for each period (excluding restricted common stock issued tocertain officers of the Company). Diluted earnings per common share include both the weighted averagenumber of common shares and any dilutive common share equivalents such asconvertible securities, options or warrants in the calculation.  As the Company recorded net losses for thethree and nine months ended September 30, 2006, and 2005, common shareequivalents outstanding would be anti-dilutive, and as such, have not been includedin diluted weighted average shares outstanding. Common share equivalents that were excluded in the three and nine monthsended September 30, 2006 were 1,847,445 and 1,890,778 respectively, and in boththe three and nine months ended September 30, 2005 were 4,154,616.

8

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**Note 2    Acquisition**

On April 18, 2006the Company acquired the assets of Staff Search Ltd. for $2,386,174, includingpreliminary acquisition costs.  TheCompany issued a promissory note in the principal amount of $1,410,000 andissued 229,128 shares of its common stock valued at $976,174 (determined by theaverage of $4.26 per share which approximates the average trading value asquoted on the OTC Bulletin Board for the three days before and three days afterthe acquisition date).  The promissorynote was purchased from the seller by the Company’s majority stockholder.  The promissory note accrues interest at arate equal to 8.00% per annum.  Theprincipal amount of the note, plus all accrued interest, is payable upon demandof the holder.  The note includes eventsof default (with grace periods, as applicable) and provides that, upon theoccurrence of certain events of default, payment of all amounts due under thenote shall become immediately payable. The primary purpose of the acquisition was to enable the Company toexpand its market share in the nurse staffing industry. The following tablesummarizes the assets acquired and liabilities assumed as of the closing date:

| Tangible assets acquired            |   | $         | 345,075   |   |
|-------------------------------------|--------|-----------|-----------|--------|
| Customer related  intangible assets |   | 486,000   |      |
| Goodwill                            |   | 1,555,099 |      |
| Total assets acquired               |   | 2,386,174 |      |
| Liabilities  assumed                |   | —    |      |
| Net assets  acquired                |   | $         | 2,386,174 |   |

 

The acquisitionwas accounted for using the purchase method of accounting. Customer related intangibleassets will be amortized over their estimated useful life of five years.  The purchase price allocated to customerrelationships was determined by management’s estimate based on a consistentmodel for all acquisitions and was initially developed by a professionalvaluation group.  Goodwill represents theexcess of merger consideration over the fair value of assets acquired. TheCompany will be required to pay additional cash and issue additional shares ofits common stock to the former stockholder of Staff Search Ltd. should itsresults of operations exceed performance standards established in the mergeragreement.  If results of operations forStaff Search Ltd. fall below performance standards established in the mergeragreement, the former stockholder of Staff Search Ltd. is required to returncertain amounts of the Company’s common stock that were issued in connectionwith the acquisition.  The goodwillacquired may be amortized for federal income tax purposes.

The Companyacquired TravMed USA, Inc. and Health Industry Professionals, LLC on March 29,2005, and Prime Staff, LP and Mint Medical Staffing Odessa on May 4, 2005.

UnauditedPro Forma Summary Information

The followingunaudited pro forma summary approximates the consolidated results of operationsas if the acquisitions disclosed above had occurred as of January 1, 2005,after giving effect to certain adjustments, including amortization ofspecifically identifiable intangibles and interest expense.  The pro forma financial information does notpurport to be indicative of the results of operations that would have occurredhad the transactions taken place at the beginning of the period presented or offuture results of operations.
| ** **                                                                       | ** ** | **Three Months  Ended  September 30,  2006** | ** ** | **Three Months  Ended  September 30,  2005** | ** ** | **Nine Months  Ended  September 30,  2006** | ** ** | **Nine Months  Ended  September 30,  2005** | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------------------|------------|-------------------------------------------------------|------------|-------------------------------------------------------|------------|
| Revenue from  services                                                           |       | $                                                      | 10,299,037 |                                                   | $          | 12,604,201                                            |       | $                                                     | 33,647,724 |   | $ | 35,320,644 |   |
|                                                                             |       |                                                   |       |                                                   |       |                                                  |       |                                                  |       |
|                                                                             |       |                                                   |       |                                                   |       |                                                  |       |                                                  |       |
| Net loss  attributable to common stockholders                                    |       | (2,522,498                                             | )          | (1,197,317                                             | )          | (47,796,412                                           | )          | (5,104,129                                            | )          |
| Basic and  diluted net loss per common share attributable to common stockholders |       | (0.18                                                  | )          | (0.14                                                  | )          | (4.62                                                 | )          | (2.06                                                 | )          |
| Weighted-average shares  of common stock outstanding (basic and diluted)         |       | 13,899,960                                             |       | 2,913,261                                              |       | 10,334,874                                            |       | 2,473,661                                             |       |
|                                                                                  |            |                                                        |            |                                                        |            |                                                       |            |                                                       |            |  |  |  |  |

 

9

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**Note 3    Settlement of Acquisition Claim**

In 2005, theCompany asserted a claim against a seller of one of the Company’s 2003acquisitions.  In January 2006, theCompany and the seller settled with the seller returning 59,150 shares of theCompany’s common stock that had been issued in connection with theacquisition.  The Company reported a gainon settlement of acquisition claim of $1,064,693 representing the fair value ofthe stock returned on the date of the settlement.  The offset to the gain recorded was areduction in common stock and additional paid-in capital.  The returned shares were retired immediately.

**Note 4    Accounts Payable and Accrued Expenses**

Accounts payableand accrued expenses consist of the following:
| ** **       | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------|------------|------------------------------|------------|-----------------------------|------------|
|             |       |                         |       |                        |       |
| Accounts payable |       | $                            | 1,461,868  |                        | $          | 825,986 |   |
| Accrued expenses |       | 829,879                      |       | 621,919                     |       |
|             |       |                         |       |                        |       |
|             |       | $                            | 2,291,747  |                        | $          | 1,447,905 |   |

 

**Note 5    Revolving Line of Credit**

On June 16, 2004, the Company entered into a Loan andSecurity Agreement with Bridge Healthcare Finance, LLC (“Bridge Healthcare”),pursuant to which the Company obtained a revolving credit facility that allowedfor maximum borrowings of up to $15,000,000 (the “Loan”).  During the first quarter of 2005, the maximumborrowings under the Loan were reduced to $10,000,000 permitting the Company tolower its effective interest rate through lower unused line fees.  The Loan had an original term of three yearsand bears interest at a rate equal to the greater of three percent (3.0%) perannum over the prime rate or nine and one-half percent (9.5%) per annum (11.25%at September 30, 2006) with interest payable monthly.  Accounts receivable serves as security forthe Loan and the Loan is subject to certain financial and reporting covenants.  Customer payments are used to repay theadvances on the Loan after deducting charges for interest expense, unused lineand account management fees.  Except incertain limited circumstances, the Loan cannot be prepaid in full without theCompany incurring a significant prepayment penalty.  The financial covenants are for themaintenance of minimum tangible net worth, minimum debt service coverageratios, minimum EBITDA, maximum capital expenditure limits and maximumoperating lease obligations.* *In May 2005 the Companyrenegotiated covenants related to the Loan; however, at December 31, 2005 andeach quarter thereafter, the Company is not in compliance with the revisedcovenants.  Bridge Healthcare waived compliancewith the covenants for 2005.  However, insubsequent quarters, the Company had not obtained a waiver fornon-compliance.  Management is currentlyconsidering various alternatives to rectify covenant non-compliance, includingrenegotiating the covenants with Bridge Healthcare or negotiating a newfacility with a new lender.  The Companywas charged fees by Bridge Healthcare for various compliance violations andrelated waivers granted during 2005 and 2006. The Company has entered into an agreement with its current lender thatit will refinance its existing revolving credit facility with another lender,including over-advances on its revolving credit facility by November 30, 2006,or at some later date if extended by mutual agreement.

During the third quarter of 2005, Bridge Healthcaremade a $600,000 credit line available to the Company in the form of anover-advance on the Company’s Loan.  Theline of credit was used as necessary to pay certain remaining amounts due onacquisitions completed in March 2005 and for working capital purposes.  During the first quarter of 2006, the Companyused proceeds from a private offering (as discussed in Note 8) to repay the$600,000 over-advance.  During the secondand third quarters of 2006, Bridge Healthcare made $1,425,000 available to theCompany in the form of over-advances on the Loan.  The over-advances were used for workingcapital purposes and are to be repaid on or before November 30, 2006, or atsome later date if extended by mutual agreement.  The $1,425,000 over-advances are partiallysecured by a guaranty from MedCap Partners L.P. (“MedCap”), the Company’smajority stockholder, with the remainder secured by personal guaranties from C.Fred Toney, a member of the Company’s board of directors, and the managingmember of MedCap Management & Research LLC, the general partner of MedCap,and from James D. Durham, Chief Executive Officer and Chairman of the Board ofthe Company.  Bridge Healthcare chargesmonthly fees to the Company in excess of normal Loan interest charges for allover-advances.

10

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The Loan includes events of default (with graceperiods as applicable) and provides that, upon the occurrence of certain eventsof default, payment of all amounts payable under the Loan, including theprincipal amount of, and accrued interest on, the Loan may be accelerated.  As a result of our non-compliance withcovenants, Bridge Healthcare could declare us in default and accelerate theLoan at any time.  There are also crossdefault provisions between the Loan and the Term Loan discussed in Note 6.  The outstanding balance on the Loan is$5,793,827 at September 30, 2006, which represents the total availability underthe line relative to the amount of receivables outstanding at that date plusover-advances of $1,425,000 discussed above. The maturity date of the Loan was extended for an additional yearthrough June 2008.  The prepaymentpenalty discussed above is applicable for the one-year extension period exceptthe amount is reduced in the event of a change in control of the Company.

**Note 6    Notes Payable to Lender**

Pursuant to a loanagreement dated August 31, 2004, the Company obtained a term loan creditfacility (“Term Loan”) in the amount up to $10,000,000 from Bridge OpportunityFinance, LLC, an affiliate of Bridge Healthcare.  The Company may obtain loans under theagreement to fund permitted acquisitions. Any loans obtained under the Term Loan are due and payable in full onAugust 31, 2007 and bear interest at the rate of fifteen and one-quarterpercent (15.25%) per annum with interest payable monthly.  The Term Loan is secured by all assets of theCompany.  On August 31, 2004, the Companyreceived proceeds from the Term Loan of $2,697,802 for the acquisitions ofArizona Home Health Care/Private Duty, Inc. and Care Pros Staffing, Inc.

The Term Loanprovides that the Company shall issue warrants to purchase shares of commonstock to the lender up to 12% of the Company’s overall capitalization on thedate of borrowing.  On August 31, 2004,the Company issued warrants to purchase 90,578 shares of common stock at aprice of $31.50 per share in connection with the first borrowing under thecredit facility.  As a result, the TermLoan has been recorded net of a discount of $810,000 which represents theestimated fair market value related to the warrants at the date ofissuance.  The discount is beingamortized to interest expense over the life of the Term Loan.  During the first quarter of 2006, the Companyused proceeds from a private offering (as discussed in Note 8) to repay$1,350,000 of the Term Loan.  As a resultof this repayment, the Company recorded $200,168 of additional interestrelating to the proportionate amount of unamortized discount associated withthe repayment.  Amortization of theremaining discount totaled $90,015 during the first nine months of 2006.  During the second quarter of 2006, BridgeHealthcare demanded further repayments of the term loan amounting to $300,000and future monthly principal payments of $45,742 until the Term Loan is paid infull.  The outstanding balance of theTerm Loan is $919,362 at September 30, 2006, which is before an unamortizeddiscount of $110,150.

Except in certainlimited circumstances, based on terms of the agreement, the Term Loan cannot beprepaid in full without the Company incurring a significant prepaymentpenalty.  Bridge Healthcare has indicatedan intent to waive the prepayment penalty if the Company repays the Term Loanduring 2006.  The Company is currentlyseeking to refinance the Term Loan and has agreed to refinance it by November30, 2006, or at some later date if extended by mutual agreement.  The Term Loan also contains certain financialcovenants, including the maintenance of minimum tangible net worth, minimumdebt service coverage ratios, minimum EBITDA, maximum capital expenditurelimits and maximum operating lease obligations. At March 31, 2005, the Company was out of compliance with certainfinancial covenants of the Term Loan, for which a waiver was received from thelender.  In May 2005 the Companyrenegotiated covenants related to the term loan; however, at December 31, 2005and in subsequent quarters, the Company is not in compliance with the revisedcovenants.  Bridge Healthcare waivedcompliance with the covenants for 2005. However, during 2006, the Company has not obtained waivers fornon-compliance.  Accordingly, the TermLoan has been classified as a current liability on the accompanying balancesheet as of September 30, 2006.  The Companywas charged fees by Bridge for various compliance violations and relatedwaivers granted during 2005 and 2006. Management is currently considering various alternatives to rectify thiscovenant non-compliance, including renegotiating the covenants with BridgeHealthcare or negotiating a new facility with a new lender.  The Term Loan includes events of default(with grace periods as applicable) and provides that, upon the occurrence ofcertain events of default, payment of all amounts payable under the Term Loan,including the principal amount of, and accrued interest on, the Term Loan maybe accelerated.  There are also crossdefault provisions between the Term Loan and the Loan.  ** **As a result of our non-compliancewith covenants, Bridge Healthcare could declare us in default and acceleratethe Term Loan at any time.

11

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**Note 7    Notes Payable to Sellers**

As partialconsideration for the acquisition of TravMed USA, Inc. (“TravMed”) on March 29,2005, the Company issued unsecured subordinated notes to the former TravMedstockholders in the total amount of $3,215,490. The notes were three-year convertible notes bearing interest at7.75%.  Monthly interest payments wererequired for the first six months followed by principal and interest paymentsthe next thirty months to fully repay the debt. The Company did not make debt service payments required by terms ofthese notes payable to sellers as claims had been asserted in State DistrictCourt in Dallas, Texas against the sellers of TravMed for breach ofnon-competition/solicitation agreements, breach of fiduciary duty, tortiousinterference with existing and prospective contracts and business relations,and declaratory relief.  The Companyreceived a notice of default in early November 2005 and the due date of thenotes was accelerated such that the entire balance of the notes payable tosellers was due.  The default under thenotes payable to sellers triggered defaults under the Loan and Term Loandiscussed in Notes 5 and 6, as well as the Debentures discussed in Note 8.  Also, as a result of this default, BridgeHealthcare has discontinued making revolving credit loans to the Company onreceivables of TravMed.

On May 9, 2006,under terms of agreements to acquire TravMed, the Company returned to thesellers the shares in TravMed that it had acquired on March 29, 2005.  Upon return of the shares to the sellers, theCompany was permitted to retain TravMed receivables existing on May 9, 2006,and the $3,215,490 of seller notes payable were extinguished.  Following the return of the shares, thesellers are released from covenants not to compete, and the Company and thesellers are free to compete for existing customer contracts (See furtherdiscussion in Note 12).  Managementbelieves that substantially all customers will elect to contract directly withthe Company. Based on management’s estimated loss of customers, the Company hasrecorded an impairment charge of $123,000 of intangibles assigned to customerrelationships.  In addition, the Companyhas reported a gain on extinguishment of seller debt of $3,215,490 and hasreversed $132,000 of interest expense accrued on the $3,215,490 note.  All of these amounts were recorded during thesecond quarter of 2006.

**Note 8    Debentures**

In January 2006,the Company completed a private placement totaling $4 million.  The first phase was completed on December 30,2005 and consisted of $2 million, or 333,333 shares of common stock and thesecond phase consisted of $2 million of 8% convertible debentures.  The convertible debentures have a term ofthree years and bear interest at a rate of 8% per year, payable semi-annuallyin cash or registered stock at the Company’s option.  The debentures are convertible into commonstock at a price of $6.00 per share.  Thesale of convertible debentures included common stock warrant coverage allowingdebenture holders to exercise warrants to purchase 500,000 common shares.  Warrants to purchase 166,667 common shareshave a five year term and an exercise price of $7.50 per share.  Warrants to purchase 333,333 common shares atan exercise price of $6.00 per share expired on June 14, 2006 with none beingexercised.  The Company computed therelative fair value of the warrants at $1,443,265 and the beneficial conversionfeature related to the debentures at $556,735, and recorded these amounts as adiscount to the debentures which is being amortized over the term of thedebentures.

Terms of anagreement with the placement agent representing the Company required placementfees upon a private placement of at least $5 million.  Although the minimum was not achieved, feeshave been accrued and warrants recorded based on the lower amount offunding.  Per the terms of the agreement,$589,722 was recorded as deferred financing costs associated with thedebentures and $294,867 was recorded as an offset to proceeds from the equityportion of the funding.  The $589,722will be amortized over the three year term of the debentures.   A portion of the placement fees werewarrants to purchase 50,000 shares of common stock at $6.00 per share.  The warrants have a five year life and werevalued at $629,589 ($419,722 recorded as deferred financing costs and $209,867recorded as an offset to proceeds from the equity offering).  The remaining portion of the fee totaling$255,000 is to be paid in cash.

On February 16,2006, a holder of the debentures converted $260,000 of the debentures into43,333 shares of the Company’s common stock. The Company recognized expense in the amount of $72,117 relating to thedeferred financing fees associated with the converted debentures and expense inthe amount of $238,333 related to the proportionate share of the unamortizeddiscount on the converted debentures.

The debentureshave cross-default provisions with the Company’s revolving line of credit andnotes payable to lender.  Since theCompany is in default on its revolving line of credit and notes payable tolender, it is also in default on the debentures.  Accordingly, the amount of the debentures($1,740,000 face value outstanding and $434,996 carrying value

12

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after a discountof $1,305,004) has been classified as a current obligation on the accompanyingbalance sheet as of September 30, 2006. Amortization of the remaining discount on debentures totaled $456,663for the nine months ended September 30, 2006. The holders of the debentures could declare us in default and acceleratethe debentures at any time.

The Company hasregistered the shares (including the shares issuable upon conversion of thedebentures and exercise of the warrants) for resale on a registrationstatement.  The Company has used theproceeds from the private placement for working capital and the retirement of50% of its outstanding $2.7 million Term Loan (discussed in Note 6) as well asretirement of the initial $600,000 over-advance facility (discussed in Note 5).

**Note 9    Convertible Preferred Stock**

On April 3, 2006 aspecial committee of the Board of Directors recommended, the Board of Directorsapproved and holders of the Preferred Stock and Warrants agreed to the exchangeof all outstanding Series C Convertible Preferred Stock, Series C warrants andSeries B-1 warrants into common stock as follows:

| Description of security     | ** ** | **Shares to  be exchanged** | ** ** | **Common stock  to be issued** | ** ** |
|---------------------------------------|------------|---------------------------------------|------------|-----------------------------------------------|------------|
|                                  |       |                                  |       |                                          |       |
| Series C  Convertible Preferred Stock |       | 183,028                               |       | 9,151,400                                     |       |
| Series C  Warrants                    |       | 124,086                               |       | 1,054,731                                     |       |
| Series B-1 Warrants                   |       | 6,000                                 |       | 51,000                                        |       |

 

The exchange asapproved by the Board of Directors varied from existing Preferred Stockconversion ratios and was based on recommendations from the special committeeof the Board of Directors after they sought guidance from an outside firm.  The effect of this exchange transferred thecarrying value of the Convertible Preferred Stock and the Series C and B-1preferred stock warrants on the Company’s balance sheet to stockholders’ equityresulting in an increase in stockholders’ equity of $10,859,603.  This exchange also resulted in therecognition of a deemed dividend of $45,554,618.  This deemed dividend was calculated byvaluing the 10,257,131 shares of common stock issued in the exchange at theclosing price of the stock on the date of the exchange ($5.50) less thecarrying value of the Convertible Preferred Stock and Warrants of $10,859,603.

**Note 10  Common Stock and Stock Options**

In the first ninemonths of 2006 the Company completed further equity financings with MedCapPartners L.P., the Company’s majority stockholder, for $1,500,000 at per shareprices ranging from $6.00 to $8.00.  Theproceeds were used for working capital purposes.

On April 4, 2006,the Company implemented a one-for-ten reverse split of its outstanding sharesof common stock.  At the Company’s AnnualMeeting of Stockholders held on November 8, 2005, its stockholders approved aproposal to amend its Amended and Restated Certificate of Incorporation toeffect a reverse stock split of all of its outstanding shares of common stockat an exchange ratio ranging from one-to-two to one-to-ten, with the finalratio to be determined by the Board of Directors following stockholderapproval.  Pursuant to a resolution ofthe Board of Directors effective March 1, 2006, the directors approved areverse stock split at an exchange ratio of one-to-ten.  No fractional shares were issued inconnection with the reverse stock split. In lieu of fractional shares, stockholders received a cash payment basedon the market price, after adjustment for the effect of the stock split, of theCompany’s common stock on the effective date of the stock split.  The cash payment for fractional shares wasnominal.  The reverse stock split alsoaffected options, warrants and other securities convertible into orexchangeable for shares of the Company’s common stock that were issued andoutstanding immediately prior to the effective time of the stock split.  All common and per share information includedin these financial statements and notes have been retroactively adjusted toreflect the reverse stock split.

13

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EmployeeStock Options and Restricted Stock Grants

The Companyentered into a Restricted Stock Bonus Agreement with James D. Durham, its ChiefExecutive Officer dated effective March 24, 2006.  Pursuant to the agreement, the Company issuedMr. Durham 150,000 shares of its common stock with an aggregate fair marketvalue of $675,000.  The shares ofrestricted stock vest in accordance with the following schedule: 1/4 of thetotal shares vest on March 24, 2007 and 1/48 of the total shares vest monthlythereafter.  In addition to the timevesting requirement, these shares are also subject to minimum stock tradingvolume levels.  In the event of a “CorporateTransaction” (as defined in the agreement), the shares shall immediately becomefully vested if, within five years after the Corporate Transaction, Mr. Durham’sservice is terminated by the successor company, the Company or a related entitywithout “Cause” or voluntarily by Mr. Durham with “Good Reason.”  The Company is expensing the fair marketvalue of these restricted shares over the four year vesting period.  The Company recorded $42,188 in expense inthe third quarter of 2006 associated with this restricted stock grant.

On March 24, 2006the Company granted James J. TerBeest, its Chief Financial Officer an option topurchase 150,000 shares of common stock at a per share exercise price of$4.50.  The shares of common stocksubject to the option vest in accordance with the following schedule: 1/4 ofthe total shares vest on March 24, 2007 and 1/48 of the total shares vestmonthly thereafter.

On May 2, 2006,the Board of Directors granted 177,318 options to purchase the Company’s commonstock to employees of the Company at a per share exercise price of $4.00 pershare and on August 9, 2006, the Board of Directors granted 17,000 options topurchase the Company’s common stock to an employee of the Company at a pershare exercise price of $1.00 per share.

Impactof the Adoption of SFAS 123R

The Company adopted SFAS 123R using the modifiedprospective transition method beginning January 1, 2006.  The Company’s consolidated interim financialstatements for the three and nine months ended September 30, 2006 reflect theimpact of adopting SFAS 123R.   Theimpact on the Company’s results of operations of recording stock-basedcompensation for the three and nine months ended September 30, 2006 wasapproximately $150,563 and $344,523, respectively, and was recorded in selling,general, and administrative expenses.

SFAS 123R requirescash flows resulting from excess tax benefits to be classified as a part ofcash flows from financing activities. Excess tax benefits are realized tax benefits from tax deductions forexercised options in excess of the deferred tax asset attributable to stockcompensation costs for such options. There were no stock options exercised in the three or nine months endedSeptember 30, 2006 and 2005.

ValuationAssumptions

The Companycalculated the fair value of each option award on the date of grant using theBlack-Scholes option pricing model.  Thefollowing assumptions were used for the three and nine months ended September30, 2006.

|                            | ** ** | **Three Months Ended  September 30, 2006** | ** ** | **Nine Months Ended  September 30, 2006** | ** ** |
|----------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
|                       |       |                                                           |       |                                                          |       |
| Risk-free  interest rate   |       | 4.6                                                            | %          | 4.6                                                           | %          |
| Expected lives (in  years) |       | 4                                                              |       | 4                                                             |       |
| Dividend Yield             |       | 0                                                              |       | 0                                                             |       |
| Expected volatility        |       | 117                                                            | %          | 103% - 11                                                     | 7%         |

 

14

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Stockoption activity is summarized as follows:
| ** **                         | ** ** | **Three Months Ended  September 30, 2006** | ** ** | **Nine Months Ended  September 30, 2006** | ** ** |
|------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
|                               |       |                                                           |       |                                                          |       |
| Outstanding,  July 1 and January 1 |       | 807,245                                                        |       | 500,667                                                       |       |
| Granted                            |       | 17,000                                                         |       | 344,315                                                       |       |
| Exercised                          |       | —                                                         |       | —                                                        |       |
| Forfeited                          |       | (4,045                                                         | )          | (24,785                                                       | )          |
| Outstanding, September  30         |       | 820,200                                                        |       | 820,200                                                       |       |

 
| ** **                                              | ** ** | **Three Months Ended  September 30, 2006** | ** ** | **Nine Months Ended  September 30, 2006** | ** ** |
|---------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
|                                                    |       |                                                           |       |                                                          |       |
| Exercisable at  September 30                            |       | 405,323                                                        |       | 405,323                                                       |       |
| Non-vested, July  1 and January 1                       |       | 435,222                                                        |       | 349,517                                                       |       |
| Non-vested,  September 30                               |       | 414,877                                                        |       | 414,877                                                       |       |
| Granted                                                 |       | 17,000                                                         |       | 344,318                                                       |       |
| Forfeited                                               |       | 4,045                                                          |       | 24,785                                                        |       |
| Vested, net of  forfeitures                             |       | 33,300                                                         |       | 104,079                                                       |       |
|                                                    |       |                                                           |       |                                                          |       |
| Average exercise  price per share:                      |       |                                                           |       |                                                          |       |
| Outstanding,  July 1 and January 1                      |       | $                                                              | 9.50       |                                                          | $          | 10.21 |   |
| Granted                                                 |       | 1.00                                                           |       | 4.07                                                          |       |
| Exercised                                               |       | —                                                         |       | —                                                        |       |
| Forfeited                                               |       | 16.31                                                          |       | 21.34                                                         |       |
| Outstanding,  September 30                              |       | 7.32                                                           |       | 7.32                                                          |       |
| Exercisable                                             |       | 8.19                                                           |       | 8.19                                                          |       |
| Non-vested, July  1 and January 1                       |       | 8.41                                                           |       | 9.50                                                          |       |
| Non-vested, September  30                               |       | 6.62                                                           |       | 6.62                                                          |       |
|                                                    |       |                                                           |       |                                                          |       |
| Weighted-average  remaining term of outstanding options |       | 8.36 years                                                     |       | 8.36 years                                                    |       |
| Weighted-average  remaining term of exercisable options |       | 7.39 years                                                     |       | 7.39 years                                                    |       |
|                                                    |       |                                                           |       |                                                          |       |
| Weighted-average  grant date fair value                 |       | .78                                                            |       | 3.04                                                          |       |
| Total future  cost of unvested options                  |       | 1,367,205                                                      |       | 1,367,205                                                     |       |
| Weighted-average period  of unvested options            |       | 9.31 years                                                     |       | 9.31 years                                                    |       |
|                                                         |            |                                                                |            |                                                               |            |  |  |

 

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**Note 11  Supplemental Disclosure to the Statements ofCash Flows**
| ** **                                                                                               | ** ** | **September 30,  2006** | ** ** | **September 30,  2005** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| Supplemental  cash flow disclosures:                                                                     |       |                         |       |                         |       |
| Cash paid for interest                                                                                   |       | $                            | 935,005    |                         | $          | 754,830 |   |
| Cash paid for income taxes                                                                               |       | —                       |       | —                       |       |
| Non-cash  investing and financing activities:                                                            |       |                         |       |                         |       |
| Conversion of preferred stock into common stock                                                          |       | —                       |       | 30,873,400                   |       |
| Conversion of debentures into common stock                                                               |       | 260,000                      |       | —                       |       |
| Issuance of the following in connection with acquisitions:                                               |       |                         |       |                         |       |
| Common stock issued                                                                                      |       | 976,174                      |       | 2,888,864                    |       |
| Revolving credit line assumed                                                                            |       | —                       |       | 941,390                      |       |
| Notes payable issued for acquisition                                                                     |       | 1,410,000                    |       | 3,215,490                    |       |
| Common stock issued as payment of preferred stock dividends                                              |       | 800,748                      |       | 3,390,233                    |       |
| Common stock issued associated with working capital loans  from majority stockholder                     |       | —                       |       | 162,500                      |       |
| Common stock issued for interest on debentures                                                           |       | 69,600                       |       | —                       |       |
| Common stock issued in exchange for Series C preferred  stock, Series B-1 warrants and Series C warrants |       | 10,859,603                   |       | —                       |       |
| Costs accrued  associated with sale of common stock                                                      |       | 211,569                      |       | —                       |       |
| Value of  debentures allocated to attached common stock warrants and beneficial  conversion feature      |       | 2,000,000                    |       | —                       |       |
| Fair value of  warrants issued as placement fee related to debentures                                    |       | 419,722                      |       | —                       |       |
| Fair value of stock returned in connection with  settlement of acquisition claim                         |       | 1,064,693                    |       | —                       |       |
|                                                                                                          |            |                              |            |                              |            |  |  |

 

**Note 12  Legal Proceedings**

On January 27,2006, the Company filed suit against the sellers of TravMed USA, Inc. assertingclaims for breach of non-competition/solicitation agreements, breach offiduciary duty, tortious interference with existing and prospective contractsand business relations, and declaratory relief arising out of the acquisitionagreement.  The Company is seekingdamages related to the above claim.  OnMay 5, 2006, the sellers of TravMed USA, Inc. filed a counterclaim and applicationfor temporary restraining order and injunctive relief claiming breach of contract.  Management believes this counterclaim iswithout merit and the Company intends to vigorously defend the counterclaim.

On January 31,2006, the Company filed suit against the sellers of Arizona Home Health/PrivateDuty, Inc. asserting claims for fraud, indemnity, and declaratory reliefarising out of the acquisition agreement. On February 23, 2006, the sellers filed a counterclaim.  Management believes this counterclaim iswithout merit and the Company intends to vigorously defend the counterclaim.

From time to time,the Company may become involved in various lawsuits and legal proceedings whicharise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverseresult in these or other matters may arise from time to time that may harm theCompany’s business.  Other than asdescribed above, the Company is not currently aware of any such legalproceedings or claims that are expected to have, individually or in theaggregate, a material adverse affect on the Company’s business, financialcondition or operating results.

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**Note 13  Minority Interest in iVOW, Inc.**

On September 20,2006, the Company entered into an Agreement and Plan of Merger with iVOW, Inc.(“iVOW”), pursuant to which iVOW Acquisition Corp., a wholly-owned subsidiaryof the Company, will merge with and into iVOW, with iVOW continuing as thesurviving corporation and a wholly-owned subsidiary of the Company.  The completion of the merger is subject to severalconditions, including the receipt of applicable approvals from the Company’sand iVOW’s stockholders. The merger is expected to close by December 31, 2006.At the effective time of the merger, all shares of iVOW common stock issued andoutstanding immediately prior to the effective time will be convertedautomatically into the right to receive, in the aggregate, approximately $3.5million in shares of the Company’s common stock, subject to reduction based onlevels of iVOW debt and other items addressed in the merger agreement.

In connection withthe merger, the Company and iVOW have entered into an Interim ManagementAgreement pursuant to which the Company has sole and exclusive responsibility,authority and discretion to (a) conduct, manage, direct and control all aspectsof the business and operations of iVOW and (b) utilize iVOW’s cash and workingcapital to defray any and all expenses of both the Company and iVOW.

TheCompany will account for the merger as a business combination on the effectivedate.  As a result of the InterimManagement Agreement entered into in connection with the merger, the Companywill account foriVOW on a consolidated basis as of September 20, 2006, the effective date ofthe Interim Management Agreement.  If themerger is not completed, the accounting treatment will be adjusted.

Uponcompletion of the merger, the Company will record the issuance of approximately$3.5 million in shares of its common stock, the fair value of iVOW’soutstanding debt and other liabilities at the time of the merger, and theamount of direct transaction costs associated with the merger, as the estimatedpurchase price of acquiring iVOW.  TheCompany will allocate the estimated purchase price to the tangible andidentifiable intangible assets acquired and liabilities assumed based on theirrespective fair values at the effective time of the merger.  Any excess of the estimated purchase priceover the fair value of net assets acquired will be accounted for as goodwill.

Management iscurrently assessing the fair values of the tangible and intangible assets andliabilities of iVOW to be acquired or assumed by the Company.  For purposes of these consolidated financialstatements at September 30, 2006, management has made a preliminary estimate ofthe fair values of the assets and liabilities of iVow to be acquired and,accordingly, the excess of purchase price to be paid by the Company to acquireiVOW over the fair value of the net assets acquired has been preliminarilyallocated to goodwill.  These estimatesare preliminary and the actual purchase price and the fair values of the assetsand liabilities actually recorded may differ substantially from these estimates.The Company’s ultimate issuance of $3.5 million in shares of the Company’scommon stock to complete the merger has been reflected as a minority interestin iVOW on the accompanying balance sheet at September 30, 2006 as itapproximates the estimated fair value of iVOW’s net equity included in theCompany’s September 30, 2006 consolidated balance sheet.  The following table summarizes the assets andliabilities of iVOW to be consolidated as of the effective date:

| Tangible assets |   | $         | 1,982,225 |   |
|-----------------|--------|-----------|-----------|--------|
| Goodwill        |   | 2,166,202 |      |
| Total assets    |   | 4,148,427 |      |
| Liabilities     |   | 648,427   |      |
| Net assets      |   | $         | 3,500,000 |   |

 

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**Note 14  Subsequent Events**

Subsequent toSeptember 30, 2006, Bridge Healthcare made $1,000,000 available to the Companyin the form of additional over-advances on the Company’s Loan.  The over-advances are being used for workingcapital purposes, are to be repaid on or before November 30, 2006, or at somelater date if extended by mutual agreement, and are secured by a personalguaranty from C. Fred Toney, a member of the Company’s board of directors, andthe managing member of MedCap Management & Research LLC, the generalpartner of MedCap, MedCap Partners, L.P. and James D. Durham, Chief ExecutiveOfficer of Crdentia and Chairman of the Board.

Subsequent toSeptember 30, 2006, the Company engaged an investment banker to raise equitythrough a private placement.  The Companyis also negotiating with a lender to refinance its revolving creditfacility.  If these fund raisingactivities are successful, proceeds would be used to refinance substantiallyall existing debt, to fund working capital needs and to make additionalacquisitions.

On October 6,2006, one of the debenture holders converted $76,000 of debentures at $6.00 percommon share.  In connection with theconversion, the Company issued 14,270 shares of Crdentia common stock whichincluded shares for interest accrued to date on the converted debentures.

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**Item 2.    Management’s Discussion and Analysis or Planof Operation**

**OVERVIEW**

*Thefollowing discussion and analysis should be read in conjunction with theUnaudited Condensed Consolidated Financial Statements and related Notes toUnaudited Condensed Consolidated Financial Statements included in Item 1of Part I of this Quarterly Report on Form 10-QSB.*

*We haveincluded in this Quarterly Report certain “forward-looking statements” withinthe meaning of the Private Securities Litigation Reform Act of 1995 concerningour business, operations and financial condition. “Forward-looking statements”consist of all non-historical information, and the analysis of historicalinformation, including the references in this Quarterly Report to futurerevenue growth, future expense growth, future profitability, anticipated cashresources, anticipated capital expenditures, capital requirements and our plansfor future periods. In addition, the words “could,” “expects,” “anticipates,” “objective,”“plan,” “may affect,” “may depend,” “believes,” “estimates,” “projects” andsimilar words and phrases are also intended to identify such forward-lookingstatements.*

*There arevarious factors — many beyond our control — that could cause our actual resultsor the occurrence or timing of expected events to differ materially from thoseanticipated in our forward-looking statements. Such factors may also causesubstantial volatility in the market price of our Common Stock. We haveincluded below under “Risk Factors” a description of the known risks that webelieve to be material. All forward-looking statements included in thisQuarterly Report are current only as of the date of this Quarterly Report. Wedo not undertake any obligation to publicly update any forward-lookingstatement to reflect events or circumstances after the date on which any suchstatement is made or to reflect the occurrence of unanticipated events.*

We are a provider of healthcare staffing services, focusing on theareas of travel nursing, per diem staffing, locum tenens, allied services andprivate duty home care.  Our travelnurses are recruited domestically as well as internationally, and placed ontemporary assignments at healthcare facilities across the United States.  Our per diem nurses are local nurses placedat healthcare facilities on short-term assignments.  Our contractual clinical services groupprovides complete clinical management and staffing for healthcarefacilities.  Under our locum tenensprogram, physicians contract with us to perform medical services for healthcareorganizations for a specified length of time. Our allied services primarily consist of diagnostic imaging,respiratory, laboratory, therapies and administrative modalities and ourprivate duty home care group provides nursing case management and staffing forskilled and non-skilled care in the home. We consider the different services described above to be one segment aseach of these services relate solely to providing healthcare staffing tocustomers that are healthcare providers and utilize similar distributionmethods, common systems, databases, procedures, processes and similar methodsof identifying and serving these customers.

Wedid not have any revenue in 2003 until we completed our first acquisition inAugust 2003.  During 2003 we beganoperating four newly acquired companies, combining the various back offices andsupport staff into a central location and began streamlining theoperations.  We have continued to pursueour operational plan of acquiring companies in the healthcare staffing fieldand purchased two companies in 2004, three companies in 2005 and one company onApril 18, 2006.

On September 20,2006, we entered into an Agreement and Plan of Merger with iVOW, Inc. (“iVOW”).  iVOW is a Nasdaq listed company focusedexclusively on the disease state management of chronic and morbid obesity.  Thecompletion of the merger is subject to several conditions, including thereceipt of applicable approvals from the stockholders of both companies. Themerger is expected to close by December 31, 2006. At the effective time of themerger, all shares of iVOW common stock issued and outstanding immediatelyprior to the effective time will be converted automatically into the right toreceive, in the aggregate, approximately $3.5 million in shares of Crdentiacommon stock, subject to reduction based on levels of iVOW debt and other itemsaddressed in the merger agreement.  Inconnection with the merger, we and iVOW entered into an Interim ManagementAgreement pursuant to which we have sole and exclusive responsibility, authorityand discretion to, among other things, manage and control all aspects of iVOW’sbusiness.  As a result of the InterimManagement Agreement, we will account for iVOW on a consolidated basis as ofSeptember 20, 2006.  iVOW providesservices to employers, payors and unions to facilitate weight loss programs ona per patient direct basis.

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Some key factors we are focusing on to improveperformance are as follows:

·                  We continue to identify innovative ways toattract and retain nurses.

·                  We are vigorously managing the amounts billedto healthcare facilities in relation to the payroll cost of our nurses in aneffort to improve gross margins.

·                  We are managing selling, general andadministrative costs at our field office locations to limit these expenses tono more than 10% of the revenue at each location.

·                  We are aggressively expanding our locumtenens business, our allied services and our home health business in an effortto improve gross margins through a better mix of the services provided.

·                  We are devoting constant attention towardachieving growth both organically and through acquisitions so that we canspread our corporate overhead over a larger base of business and achieveeconomies of scale.

·                  We are seeking to raise additional debt andequity capital to refinance existing debt to reduce interest expense.  Additional funds will also be used tocontinue to pursue acquisitions.

·                  We are seeking to list our common stock onthe Nasdaq Market or another national exchange (our common stock is currentlyquoted on the OTC Bulletin Board).

**LIQUIDITYAND CAPITAL RESOURCES**

During the first nine months of 2006, we raised $2,000,000 indebentures and $1,500,000 in equity.  Theseproceeds were used to repay $1,650,000 on the term loan, a $600,000over-advance on our revolving line of credit and the balance was used forworking capital purposes.  We arecurrently working to raise additional debt and equity for working capital needs,for debt refinancing and for continuing our acquisition program.

On June 16, 2004, we entered into a Loan and SecurityAgreement with Bridge Healthcare Finance, LLC (“Bridge Healthcare”), pursuantto which we obtained a revolving credit facility up to $15,000,000 (the “Loan”).  During the first quarter of 2005, the Loanwas reduced to $10,000,000 permitting us to lower its effective interest ratethrough lower unused line fees.  The Loanhad an original term of three years and bears interest at a rate equal to thegreater of three percent (3.0%) per annum over the prime rate or nine andone-half percent (9.5%) per annum (11.25% at September 30, 2006).  Interest is payable monthly.  Accounts receivable serves as security forthe Loan and the Loan is subject to certain financial and reportingcovenants.  Customer payments are used torepay the advances on the Loan after deducting charges for interest expense,unused line and account management fees. Except in certain limited circumstances, the Loan cannot be prepaid infull without our incurring a significant prepayment penalty.  The financial covenants are for themaintenance of minimum tangible net worth, minimum debt service coverageratios, minimum EBITDA, maximum capital expenditure limits and maximumoperating lease obligations.* *In May 2005 we renegotiatedcovenants related to the Loan; however, at December 31, 2005 and each quarterthereafter, we are not in compliance with the revised covenants.  Bridge Healthcare waived compliance with thecovenants for 2005.  However, insubsequent quarters, we have not obtained a waiver for non-compliance.  Management is currently considering variousalternatives to rectify covenant non-compliance, including renegotiating thecovenants with Bridge Healthcare or negotiating a new facility with a newlender. We have been charged fees by Bridge Healthcare for various complianceviolations and related waivers in 2005 and 2006.  As a result of our non-compliance withcovenants, Bridge Healthcare could declare us in default and accelerate theLoan at any time.

During the third quarter of 2005, Bridge Healthcaremade a $600,000 credit line available to us in the form of an over-advance onour Loan.  The line of credit was used asnecessary to pay certain remaining amounts due on acquisitions completed inMarch 2005 and for working capital purposes. During the first quarter of 2006, we used proceeds from a privateoffering as discussed below to repay the $600,000 over-advance.  During the second and third quarters of 2006,Bridge Healthcare made $1,425,000 available to us in the form of over-

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advances on our Loan. The over-advances were used for working capital purposes and are to berepaid on or before November 30, 2006, or at some later date if extended bymutual agreement.  The $1,425,000 ofover-advances are partially secured by a guaranty from MedCap Partners L.P. (“MedCap”),our majority stockholder, with the remainder secured by a personal guarantyfrom C. Fred Toney, a member of our board of directors, and the managing memberof MedCap Management & Research LLC, the general partner of MedCap, and bya personal guaranty from James D. Durham, our Chief Executive Officer andChairman of the Board.  Bridge Healthcarecharges us monthly fees in excess of normal Loan interest charges for allover-advances.

Subsequent toSeptember 30, 2006, Bridge Healthcare made $1,000,000 available to us in theform of additional over-advances on our Loan. The over-advances are being used for working capital purposes, are to berepaid on or before November 30, 2006, or at some later date if extended bymutual agreement, and are secured by a personal guaranty from C. Fred Toney, amember of our board of directors, and the managing member of MedCap Management& Research LLC, the general partner of MedCap, MedCap Partners, L.P. andJames D. Durham, Chief Executive Officer of the Company and Chairman of theBoard.

The Loan includes events of default (with graceperiods as applicable) and provides that, upon the occurrence of certain eventsof default, payment of all amounts payable under the Loan, including theprincipal amount of, and accrued interest on, the Loan may be accelerated.  There are also cross default provisionsbetween the Loan and the Term Loan discussed below.  The outstanding balance on the Loan is$5,793,827 at September 30, 2006, which represents the total availability underthe line relative to the amount of receivables outstanding at that date plusover-advances discussed above.  The maturitydate of the Loan was extended for an additional year through June 2008.  The prepayment penalty discussed above isapplicable for the one-year extension period except the amount is reduced inthe event of a change in control of Crdentia.

Pursuant to a loanagreement dated August 31, 2004, we obtained a term loan credit facility (“TermLoan”) in the amount up to $10,000,000 from Bridge Opportunity Finance, LLC, anaffiliate of Bridge Healthcare.  We mayobtain loans under the agreement to fund permitted acquisitions.  Any loans obtained under the Term Loan aredue and payable in full on August 31, 2007 and bear interest at the rate offifteen and one-quarter percent (15.25%) per annum.  Interest is payable monthly.  The Term Loan is secured by all of ourassets.  On August 31, 2004, we receivedproceeds from the Term Loan of $2,697,802 for the acquisitions of Arizona HomeHealth Care/Private Duty, Inc. and Care Pros Staffing, Inc.

The Term Loanprovides that we shall issue warrants to purchase shares of common stock to thelender up to 12% of our overall capitalization on the date of borrowing.  On August 31, 2004, we issued warrants topurchase 90,578 shares of common stock at a price of $31.50 per share inconnection with the first borrowing under the credit facility.  As a result, the Term Loan has been recordednet of a discount of $810,000 which represents the estimated fair market valuerelated to the warrants at the date of issuance.  The discount is being amortized to interestexpense over the life of the Term Loan. During the first quarter of 2006, we used proceeds from a privateoffering as discussed below to repay $1,350,000 of the Term Loan.  As a result of this repayment, we recorded$200,168 of additional interest relating to the proportionate amount ofunamortized discount associated with the repayment.  Amortization of the remaining discounttotaled $90,015 during the first nine months of 2006.  During the second quarter of 2006, BridgeHealthcare demanded further repayments of the Term Loan amounting to $300,000and future monthly principal payments of $45,742 until the Term Loan is paid infull.  The outstanding balance of theTerm Loan is $919,362 at September 30, 2006, which is before an unamortizeddiscount of $110,150.

Except in certainlimited circumstances, based on terms of the agreement, the Term Loan cannot beprepaid in full without our incurring a significant prepayment penalty.  Bridge Healthcare has indicated intent towaive the prepayment penalty if we repay the Term Loan during 2006.  We are currently seeking to refinance theTerm Loan and have agreed to refinance it by November 30, 2006, or at somelater date if extended by mutual agreement. The Term Loan also contains certain financial covenants, including themaintenance of minimum tangible net worth, minimum debt service coverageratios, minimum EBITDA, maximum capital expenditure limits and maximumoperating lease obligations.  At March31, 2005, we were out of compliance with certain financial covenants of theTerm Loan, for which a waiver was received from the lender.  In May 2005 we renegotiated covenants relatedto the term loan; however, at December 31, 2005 and in subsequent quarters, weare not in compliance with the revised covenants.  Bridge Healthcare waived compliance with thecovenants for 2005.  However, during2006, we have not obtained waivers for non-compliance.  Accordingly, the Term Loan has beenclassified as a current liability on the accompanying balance sheet as ofSeptember 30, 2006.  We were charged feesby Bridge for various compliance violations and related waivers granted during2005 and 2006.  Management is currentlyconsidering various alternatives to rectify this covenant non-compliance,including renegotiating the covenants with Bridge Healthcare or negotiating anew facility with a new lender.  The TermLoan includes events of default (with grace periods as applicable) and providesthat, upon the occurrence of certain events of default, payment of all amountspayable under the Term Loan, 

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including theprincipal amount of, and accrued interest on, the Term Loan may beaccelerated.  There are also crossdefault provisions between the Term Loan and the Loan.  As a result of our non-compliance withcovenants, Bridge Healthcare could declare us in default and accelerate theTerm Loan at any time.

As partialconsideration for the acquisition of TravMed USA, Inc. (“TravMed”) on March 29,2005, we issued unsecured subordinated notes to the former TravMed stockholdersin the total amount of $3,215,490.  Thenotes were three-year convertible notes bearing interest at 7.75%.  Monthly interest payments were required forthe first six months followed by principal and interest payments the nextthirty months to fully repay the debt. We did not make debt service payments required by terms of these notespayable to sellers since claims were asserted in State District Court inDallas, Texas against the sellers of TravMed for breach ofnon-competition/solicitation agreements, breach of fiduciary duty, tortiousinterference with existing and prospective contracts and business relations,and declaratory relief.  We received anotice of default in early November 2005 and the due date of the notes wasaccelerated such that the entire balance of the notes payable to sellers wasdue.  The default under the notes payableto sellers triggered defaults under the Loan and Term Loan discussed above, aswell as the Debentures discussed below. Also, as a result of this default, Bridge Healthcare has discontinuedmaking revolving credit loans to us on receivables of TravMed.

On May 9, 2006,under terms of agreements to acquire TravMed, we returned to the sellers theshares in TravMed that it had acquired on March 29, 2005.  Upon return of the shares to the sellers, wewere permitted to retain TravMed receivables existing on May 9, 2006, and the$3,215,490 of seller notes payable were extinguished.  Following the return of the shares, thesellers are released from covenants not to compete, and we and the sellers arefree to compete for the customer contracts existing on May 9, 2006.  Management believes that substantially allcustomers will elect to contract directly with us. Based on management’sestimated loss of customers we have recorded a write-down of $123,000 ofintangibles assigned to customer relationships at the time of the acquisitionof TravMed.   In addition, we havereported a gain on extinguishment of seller debt of $3,215,490 and havereversed $132,000 of interest expense accrued on the $3,215,490 note.

In January 2006,we completed a private placement totaling $4 million.  The first phase was completed on December 30,2005 and consisted of $2 million, or 333,333 shares of common stock and thesecond phase consisted of $2 million of 8% convertible debentures.  The convertible debentures have a term of threeyears and bear interest at a rate of 8% per year, payable semi-annually in cashor registered stock at our option.  Thedebentures are convertible into common stock at a price of $6.00 per share.  The sale of convertible debentures includedcommon stock warrant coverage allowing debenture holders to exercise warrantsto purchase 500,000 common shares. Warrants to purchase 166,667 common shares have a five year term and anexercise price of $7.50 per share. Warrants to purchase 333,333 common shares at an exercise price of $6.00per share expired on June 14, 2006 with none being exercised.  We computed the relative fair value of thewarrants at $1,443,265 and the beneficial conversion feature related to thedebentures at $556,735, and recorded these amounts as a discount to thedebentures which will be amortized over the term of the debentures.

Terms of anagreement with the placement agent representing us required placement fees upona private placement of at least $5 million. Although the minimum was not achieved, fees have been accrued andwarrants recorded based on the lower amount of funding.  Per the terms of the agreement, $589,722 wasrecorded as deferred financing costs associated with the debentures and $294,867was recorded as an offset to proceeds from the equity portion of thefunding.  The $589,722 will be amortizedover the three year term of the debentures.  A portion of the placement fees were warrants to purchase 50,000 sharesof common stock at $6.00 per share.  Thewarrants have a five year life and were valued at $629,589 ($419,722 recordedas deferred financing costs and $209,867 recorded as an offset to proceeds fromthe equity offering).  The remainingportion of the fee totaling $255,000 is to be paid in cash.

On February 16,2006, a holder of the debentures converted $260,000 of the debentures into43,333 shares of our common stock.  Werecognized expense in the amount of $72,117 relating to the deferred financingfees associated with the converted debentures and expense in the amount of$238,333 related to the proportionate share of the unamortized discount on theconverted debentures.

The debentureshave cross-default provisions with our revolving line of credit and notespayable to lender.  Since we are indefault on our revolving line of credit and notes payable to lender, we arealso in default on the debentures. Accordingly, the amount of the debentures ($1,740,000 face valueoutstanding and $434,996 after a discount of

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$1,305,004) hasbeen classified as a current obligation on the accompanying balance sheet as ofSeptember 30, 2006.  The holders of thedebentures could declare us in default and accelerate the debentures at anytime.

We were obligatedto register the shares (including the shares issuable upon conversion of thedebentures and exercise of the warrants) for resale on a registrationstatement.  We have used the proceedsfrom the private placement for working capital and the retirement of 50% of ouroutstanding $2.7 million Term Loan discussed above as well as retirement of the$600,000 over-advance facility discussed above.

On October 6,2006, one of the debenture holders converted $76,000 of debentures at $6.00 pershare.  In connection with theconversion, we issued 14,270 shares of Crdentia common stock which includedshares for interest accrued to date on the converted debentures.

We used cash inoperations of $3,220,001 during the first nine months of operations in2006.   Although we ended the thirdquarter of 2006 with a significant working capital deficit of $4,463,673, wewere able to secure additional funding during this period to finance ouroperations as we continued to execute our business plan to acquire and growcompanies involved in healthcare staffing. We will need to raise additional funds during the next twelve months forworking capital needs and for debt refinancing. There is no assurance that we will be able to raise the amount of debtor equity capital required to meet our objectives.  Our challenging financial circumstances maymake the terms, conditions and cost of any available capital relativelyunfavorable.  If additional debt orequity capital is not readily available, we will be forced to scale back ouracquisition activities and our operations. This would result in an overall slowdown of our development.  Our short-term need for capital may force usto consider and potentially pursue other strategic options sooner than we mightotherwise have desired.  These conditionsraise substantial doubt about our ability to continue as a going concern.  The accompanying financial statements do notinclude any adjustments to reflect the possible future effects on therecoverability and classification of assets, or the amounts and classificationof liabilities that may result from the outcome of this uncertainty.

Management hastaken a number of steps to address our financial performance and to improvecash flow during 2006.  We have replaceda portion of our debt with new debt that has a lower interest rate,restructured the operating management team, implemented programs to obtainexpense savings and entered into agreements with iVOW, Inc. that has providedus with access to iVOW cash.  Management is devoting constant attentiontoward achieving growth both organically and through acquisitions so that wecan spread our corporate overhead over a larger base of business and achieveeconomies of scale.  However,there can be no assurances that these programs will be successful.

We have enteredinto an agreement with our current lender to refinance its existing revolvingcredit facility, including over-advances on its revolving credit facility, andoutstanding term debt by November 30, 2006. We also need additional funds for working capital purposes.  We are currently in discussions with anotherlender to refinance our revolving credit facility and are actively trying toraise additional equity through a private placement.  There can be no assurances that we will besuccessful in these efforts.  Ifunsuccessful, we could be unable to fund payroll costs and could ultimatelyfail.

As describedabove, on September 20, 2006, we entered an Agreement and Plan of Merger withiVOW.  In connection with the merger, weand iVOW entered into an Interim Management Agreement pursuant to which we havesole and exclusive responsibility, authority and discretion to (a) conduct,manage, direct and control all aspects of the business and operations of iVOWand (b) utilize iVOW’s cash and working capital to defray any and all expensesof both companies.  iVOW has availablecash and certain other assets that can be converted into cash in the nearterm.  Our access to this cash and otherassets of iVOW will provide us with needed working capital which may besufficient until the debt and equity funds referred to above can be madeavailable to us.

In early Novemberwe engaged an investment banker to raise up to $10 million in equity through aprivate placement.  We are also negotiatingwith a lender to refinance our revolving credit facility.  If these fund raising activities aresuccessful, proceeds would be used to refinance substantially all existingdebt, to fund working capital needs and to make additional acquisitions.

Our capitalcommitments for the next twelve months are minimal as our business does notrequire the purchase of plants, factories, extensive capital equipment orinventory.

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**CRITICALACCOUNTING POLICIES AND MANAGEMENT JUDGEMENT**

The preparation of the financial statements in accordance withaccounting principles generally accepted in the United States of Americarequires us to make judgments, estimates, and assumptions regardinguncertainties that affect the reported amounts of assets and liabilities,disclosure of contingent assets and liabilities, and the reported amounts ofrevenues and expenses.  Areas thatrequire significant judgments, estimates, and assumptions include theassignment of fair values upon acquisition of goodwill and other intangibleassets, testing for impairment of long-lived assets and valuation of the stockused to consummate our acquisitions.  Weuse historical experience, qualified independent consultants and all availableinformation to make these judgments and estimates, and actual results willinevitably differ from those estimates and assumptions that are used to preparethe Company’s financial statements at any given time.

**AccountsReceivable**

Accounts receivable are reduced by an allowance for doubtful accountsthat provides a reserve with respect to those accounts for which revenue wasrecognized but with respect to which management subsequently determines thatpayment is not expected to be received. We analyze the balances of accounts receivable to ensure that therecorded amounts properly reflect the amounts expected to be collected.  This analysis involves the application ofvarying percentages to each accounts receivable category based on the age ofthe uncollectible accounts receivable. The amount ultimately recorded as the reserve is determined aftermanagement also analyzes the collectibility of specific large or problematicaccounts on an individual basis, as well as the overall business climate andother factors.  Our estimate of thepercentage of uncollectible accounts may change from time to time and any suchchange could have a material impact on our financial condition and results ofoperations.

**PurchaseAccounting, Goodwill and Intangible Assets**

All business acquisitions have been accounted for using the purchasemethod of accounting and, accordingly, the statements of operations include theresults of each acquired business since the date of acquisition.  The assets acquired and liabilities assumedare recorded at their estimated fair value as determined by management andsupported in some cases by an independent third-party valuation.  We finalize the allocation of the purchaseprice to the fair value of the assets acquired and liabilities assumed when weobtain information sufficient to complete the allocation, but in any case,within one year after acquisition.

Goodwill arising from the acquisitions of businesses is recorded as theexcess of the purchase price over the estimated fair value of the net assets ofthe businesses acquired.  Statement ofFinancial Accounting Standards No. 142 (“Goodwill and Other Intangible Assets”)provides that goodwill is to be tested for impairment annually or morefrequently if circumstances indicate potential impairment.  Consistent with this standard, we will reviewgoodwill, as well as other intangible assets and long-term assets, forimpairment annually or more frequently as warranted, and if circumstances indicatethat the recorded value of any such other asset is impaired, such asset iswritten down to its new, lower fair value. If any item of goodwill or such other asset is determined to beimpaired, an impairment loss would be recognized equal to the amount by whichthe recorded value exceeds the estimated fair market value.

**Stock-Based Compensation**

On January 1,2006, we adopted the modified prospective method of SFAS No. 123 (Revised2004), *Share-Based Payment* (“SFAS No. 123R”),which is a revision of SFAS No. 123, *Accounting for Stock-BasedCompensation* (“SFAS No. 123”). SFAS No. 123R supersedes APB Opinion No. 25, and amends SFAS No. 95, *Statement of Cash Flows*. SFAS No. 123R requires all share-based payments to employees, includinggrants of employee stock options, to be recognized in the income statementbased on their fair values.  Pro formadisclosure is no longer an alternative. Under the modified prospective application, SFAS No. 123R is applied tonew awards and to awards modified, repurchased or cancelled after the effectivedate.  Compensation cost for the portionof awards for which requisite service has not been rendered that areoutstanding as of the effective date is recognized as the service is renderedon or after the effective date.  The compensationcost for that portion of awards is based on the grant date fair value of thoseawards as calculated for pro forma disclosures under SFAS No. 123.  In accordance with the modified prospectivemethod, the consolidated

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financialstatements for the prior periods have not been restated to reflect, and do notinclude, the impact of SFAS No. 123R.

The adoption ofSFAS No. 123R will require us to record substantial non-cash compensationexpenses.  While the adoption of SFAS No.123R is not expected to have a significant effect on our financial condition orcash flows, it is expected to have a significant effect on our results ofoperations.  The future impact of theadoption of SFAS No. 123R cannot be predicted at this time because it willdepend on the levels of share-based payments granted by us in the future.  However, had we adopted SFAS No. 123R inprior periods, the impact of the standard would have approximated the impact ofSFAS No. 123 as described in the pro forma net loss attributable to commonshareholders.

Prior to January1, 2006, we accounted for stock-based employee compensation arrangements inaccordance with provisions of Accounting Principles Board (“APB”) Opinion No.25, *Accounting for Stock Issued to Employees,*and complied with the disclosure provisions of SFAS No. 123 as amended by SFASNo. 148.  Under APB Opinion No. 25,compensation expense for employees is based on the excess, if any, on the dateof grant, of the fair value of our stock over the exercise price and isrecognized on a straight-line basis over the vesting term of the option.

We account forequity instruments issued to non-employees in accordance with the provisions ofSFAS No. 123 and SFAS No. 148 and Emerging Issues Task Force Issue No. 96-18, *Accounting for Equity Instruments That Are Issued to Other ThanEmployees for Acquiring, or in Conjunction with Selling, Goods or Services*.  All transactions in which goods or servicesare the consideration received for the issuance of equity instruments areaccounted for based on the fair value of the consideration received or the fairvalue of the equity instrument issued, whichever is more reliablymeasurable.  The measurement date of thefair value of the equity instrument issued is the earlier of the date on whichthe counterparty’s performance is complete or the date on which it is probablethat performance will occur.

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**RESULTSOF OPERATIONS**

The followingcondensed financial information includes Crdentia Corp. plus the results ofoperations of all companies acquired from their respective dates of acquisition(in thousands).
| ** **                                    | ** ** | **For the three months** | ** ** | **For the nine months** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** **                                    | ** ** | **ended September 30,**       | ** ** | **ended September 30,**      | ** ** |
| ** **                                    | ** ** | **2006**                                | ** ** | **2005**                               | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                          |       |                                    |       |                                   |       |   |   |   |   |
| Revenue from  services                        |       | $                                       | 10,299     |                                   | $          | 9,553 |   | $ | 30,596 |   | $ | 23,883 |   |
| Direct operating  expenses                    |       | 8,204                                   |       | 7,584                                  |       | 24,403 |   | 18,743 |   |
| Gross profit                                  |       | 2,095                                   |       | 1,969                                  |       | 6,193 |   | 5,140 |   |
|                                          |       |                                    |       |                                   |       |   |   |   |   |
| Operating  expenses:                          |       |                                    |       |                                   |       |   |   |   |   |
| Selling, general and administrative expenses  |       | 3,246                                   |       | 2,471                                  |       | 8,939 |   | 6,362 |   |
| Loss on impairment of intangibles             |       | —                                  |       | —                                 |       | 123 |   | — |   |
| Gain from settlement of acquisition claim     |       | —                                  |       | —                                 |       | (1,065 | ) | — |   |
| Gain from extinguishment of debt              |       | —                                  |       | —                                 |       | (3,216 | ) | — |   |
| Non-cash stock based compensation             |       | 505                                     |       | 401                                    |       | 1,335 |   | 672 |   |
| Total operating  expenses                     |       | 3,751                                   |       | 2,872                                  |       | 6,116 |   | 7,034 |   |
|                                          |       |                                    |       |                                   |       |   |   |   |   |
| Income (loss)  from operations                |       | (1,656                                  | )          | (903                                   | )          | 77 |   | (1,894 | ) |
|                                          |       |                                    |       |                                   |       |   |   |   |   |
| Interest  expense, net                        |       | (866                                    | )          | (486                                   | )          | (2,510 | ) | (1,484 | ) |
|                                          |       |                                    |       |                                   |       |   |   |   |   |
| Loss before  income taxes                     |       | (2,522                                  | )          | (1,389                                 | )          | (2,433 | ) | (3,378 | ) |
|                                          |       |                                    |       |                                   |       |   |   |   |   |
| Income tax  expense                           |       | —                                  |       | —                                 |       | — |   | — |   |
|                                          |       |                                    |       |                                   |       |   |   |   |   |
| Net loss                                      |       | (2,522                                  | )          | (1,389                                 | )          | (2,433 | ) | (3,378 | ) |
|                                          |       |                                    |       |                                   |       |   |   |   |   |
| Deemed dividends  on preferred stock          |       | —                                  |       | —                                 |       | (45,555 | ) | — |   |
| Non-cash  preferred stock dividends           |       | —                                  |       | —                                 |       | — |   | (2,363 | ) |
| Net loss attributable  to common stockholders |       | $                                       | (2,522     | )                                      | $          | (1,389 | ) | $ | (47,988 | ) | $ | (5,741 | ) |

 

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***Three months ended September 30, 2006 compared to the three monthsended September 30, 2005***

 

Revenues in thethird quarter of 2006 were $10,299,000 compared to revenues of $9,553,000 inthe third quarter of 2005.  Revenues haveincreased in the third quarter of 2006 compared to the third quarter of 2005 dueprincipally to our acquisition of Staff Search Ltd. in April 2006.  However, the increase in revenue due to ouracquisition was offset in part by decreases in revenue related to closingportions of our operations in California and to the loss of customers relatedto litigation surrounding the TravMed acquisition. In the third quarter of 2006approximately 21% (39% in the third quarter of 2005) of our revenue was derivedfrom the placement of travel nurses on assignment, typically 13 weeks inlength.  Such assignments generallyinvolve temporary relocation to the geographic area of the assignment.  In the third quarter of 2006, we alsoprovided per diem nurses to satisfy the very short-term needs of healthcarefacilities.  Per diem services provided63% of our revenue in the third quarter of 2006 (53% in the third quarter of2005).  The remaining amount of ourrevenue in the third quarter of 2006 came from providing clinical managementand staffing to healthcare facilities, private duty homecare, locum tenensrevenue and allied services.  In 2005 theremaining revenue came from providing clinical management and staffing tohealthcare facilities and private duty homecare. During the third quarter of2006 and 2005, most of our customers were acute care hospitals locatedthroughout the continental United States.

Our overall grossprofit in the third quarter of 2006 was $2,095,000 or 20.3% of revenuescompared to $1,969,000 or 20.6% of revenues in the third quarter of 2005. Ourgross profit is the difference between the revenue we realize when we bill ourcustomers for the services of our healthcare professionals and our directoperating costs, which include the cost of the healthcare professionals and therelated housing and travel costs, certain employment related taxes,professional liability insurance, health insurance for professionals andworkers compensation insurance coverage.

Our selling,general and administrative costs were $3,246,000******or31.5% of revenues in the third quarter of 2006 compared to $2,471,000 or 25.9%******of revenues in the third quarter of2005.  Selling, general andadministrative expenses are comprised primarily of personnel costs, legal andaccounting fees related to being a public company and various other office andadministrative expenses.  Selling,general and administrative costs as a percentage of revenue have increased inthe third quarter of 2006, partly due to legal fees incurred in connection withseveral lawsuits initiated by us against sellers of some of our acquiredbusinesses.  Management is currentlyendeavoring to reduce selling, general and administrative costs at certainlocations where cost percentages are higher compared to some of our otherbenchmark locations where costs are lower and better controlled.  In addition, price increases and organicgrowth should bring selling, general and administrative costs as a percentageof revenue more in line with previous periods.

Non-cash stockbased compensation expense increased from $401,000 in 2005 to $505,000 in2006.  This increase resulted from theCompany’s adoption of SFAS 123R requiring expensing of the fair value ofoptions granted and from additional restricted stock being granted in 2006. Amajority of the expense in 2006 and all of the expense in 2005 relates toamortization of restricted stock granted to officers of the Company.

Interest costsincreased from $486,000 in the third quarter of 2005 to $866,000 in the thirdquarter of 2006.  This increase ininterest cost is due to higher rates on our revolving credit facility and togreater non-cash interest expense arising from discounts on our debentures andamortization of additional deferred financing costs.

***Ninemonths ended September 30, 2006  comparedto the nine months ended September 30, 2005***

Revenues in thefirst nine months of 2006 were $30,596,000 compared to revenues of $23,883,000in the first nine months of 2005. Revenues have increased in the first nine months of 2006 compared to thefirst nine months of 2005 due principally to acquisitions in March and May of 2005and our acquisition of Staff Search Ltd. in April 2006.  However, the increase in revenue due to ouracquisitions was offset in part by decreases in revenue related to closingportions of our operations in California and to the loss of customers relatedto litigation surrounding the TravMed acquisition. In the first nine months of2006 approximately 27% (38% in the first nine months of 2005) of our revenuewas derived from the placement of travel nurses on assignment, typically 13weeks in length.  Such assignmentsgenerally involve temporary relocation to the geographic area of theassignment.  In the first nine months of2006, we also provided per diem nurses to satisfy the very short-term needs ofhealthcare facilities.  Per diem servicesprovided 60% of our revenue in the first nine months of 2006 (51% in the firstnine months of 2005).  The remainingamount of our revenue in the first nine months of 2006 came from providingclinical management and staffing to healthcare

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facilities,private duty homecare, locum tenens revenue and allied services.  In 2005 the remaining revenue came fromproviding clinical management and staffing to healthcare facilities and privateduty homecare. During the first nine months of 2006 and 2005, most of ourcustomers were acute care hospitals located throughout the continental UnitedStates.

Our overall grossprofit in the first nine months of 2006 was $6,193,000 or 20.2% of revenuescompared to $5,140,000 or 21.5% of revenues in the first nine months of 2005.Our gross profit is the difference between the revenue we realize when we billour customers for the services of our healthcare professionals and our directoperating costs, which include the cost of the healthcare professionals and therelated housing and travel costs, certain employment related taxes,professional liability insurance, health insurance for professionals andworkers compensation insurance coverage. Price increases have not kept pace with increases in labor, housing andtravel costs.  The gross profitpercentage in the first nine months of 2006 is less than the percentage in thefirst nine months of 2005 reflecting a need for price increases in 2006.  As new contracts are negotiated withhealthcare facilities in 2006, we are implementing price increases which webelieve is consistent with a trend in the temporary staffing industry in2006.  Since price increases are beingimplemented during 2006, the majority of the benefit of these increases willnot be reflected in higher margin percentages until later in 2006 and on into2007.

Our selling,general and administrative costs were $8,939,000******or29.2% of revenues in the first nine months of 2006 compared to $6,362,000 or26.6%******of revenues in the first ninemonths of 2005.  Selling, general andadministrative expenses are comprised primarily of personnel costs, legal andaudit fees related to being a public company and various other office andadministrative expenses.  Selling,general and administrative costs as a percentage of revenue have increased inthe first nine months of 2006, partly due to legal fees incurred in connectionwith several lawsuits initiated by us against sellers of some of our acquiredbusinesses.    Management is currentlyendeavoring to reduce selling, general and administrative costs at certainlocations where cost percentages are higher compared to some of our otherbenchmark locations where costs are lower and better controlled.  In addition, price increases and organicgrowth should bring selling, general and administrative costs as a percentageof revenue more in line with previous periods.

We lost certaincustomer relationships that were obtained with the TravMed acquisition.   We have recorded a write-down of $123,000 in2006 related to intangibles assigned to these customer relationships.  We do not anticipate any future write-downsrelated to these intangibles.

In 2005, weasserted a claim against a seller of one of our 2003 acquisitions.  In January 2006, we and the seller settledwith the seller returning 59,150 shares of our stock that had been issued inconnection with the acquisition.  Wereported a gain on this settlement of $1,064,693 representing the fair value ofthe stock returned on the date of the settlement.

In the first ninemonths of 2006, in connection with claims asserted against the sellers ofTravMed, we returned to the sellers shares in TravMed that we had acquired onMarch 29, 2005.  Upon return of theshares to the sellers, $3,215,490 of seller notes payable were extinguished inaccordance with terms of the acquisition agreements.  This resulted in a gain from extinguishmentof debt of $3,215,490 in the first nine months of 2006.

Non-cash stockbased compensation expense increased from $672,000 in the first nine months of2005 to $1,335,000 in the first nine months of 2006. This increase resultedfrom the Company’s adoption of SFAS 123R requiring expensing of the fair valueof options granted and from additional restricted stock being granted in 2006.A majority of the expense in 2006 and all of the expense in 2005 relates toamortization of restricted stock granted to officers of the Company.

Interest costsincreased from $1,484,000 in the first nine months of 2005 to $2,510,000 in thefirst nine months of 2006.  This increasein interest cost is due to higher rates on our revolving credit line, greaternon-cash interest expense relating to discounts on our debentures, acceleratedwrite-off of discounts on retired term debt and amortization of additionaldeferred financing costs.

During the firstnine months of 2006 a special committee of the Board of Directors recommended,the Board of Directors approved and holders of the Preferred Stock and Warrantsagreed to the exchange of all outstanding Series C Convertible Preferred Stock,Series C warrants and Series B-1 warrants into common stock.  The exchange as approved by the Board ofDirectors varied from existing Preferred Stock conversion ratios and was basedon recommendations

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from the specialcommittee of the Board of Directors after they sought guidance from an outsidefirm.  The effect of this exchangetransferred the carrying value of the Convertible Preferred Stock and theSeries C preferred stock warrants on our balance sheet to stockholders’ equityresulting in an increase in stockholders’ equity of $10,859,603.  This exchange also resulted in therecognition of a deemed dividend of $45,554,618.  This deemed dividend was calculated byvaluing the 10,257,131 shares of common stock issued in the exchange at theclosing price of the stock on the date of the exchange ($5.50) less therecorded value of the Convertible Preferred Stock and Warrants of $10,859,603.

The non-cashpreferred stock dividends in the first nine months of 2005 relate to commonstock dividends declared by the Board of Directors on our Series B, Series B-1and Series C convertible preferred stock as well as cumulative common stockdividends declared for September 30, 2004, December 31, 2004 and March 31, 2005related to the warrants exercised on March 29, 2005 for 108,333 shares ofSeries C convertible preferred stock and cumulative common stock dividendsdeclared for December 31, 2004 and March 31, 2005 related to the warrantsexercised on May 2, 2005 for 22,187 shares of Series C convertible preferredstock.   The common stock dividends on thewarrants were payable once the warrants were exercised.

**RISKFACTORS**

We were formed inNovember 1997, and commenced operations on August 7, 2003 following ouracquisition of Baker Anderson Christie, Inc. Any investment in our common stock involves a high degree of risk.  You should consider carefully the followinginformation about these risks, together with the other information contained inthis report and our other SEC filings, before you decide to buy our commonstock.  The risks and uncertainties describedbelow are not the only ones we face. Additional risks and uncertainties not presently known to us or that wecurrently deem immaterial may also impair our operations.  If any of the following risks actually occur,our business would likely suffer and our results could differ materially fromthose expressed in any forward-looking statements contained in thisreport.  In such case, the trading priceof our common stock could decline, and you may lose all or part of the moneyyou paid to buy our common stock.

**Our independent registered publicaccounting firm issued a going concern opinion on our financial statements,questioning our ability to continue as a going concern.**

Our independentregistered public accounting firm’s opinion on our 2005 financial statementsincluded an explanatory paragraph indicating substantial doubt about ourability to continue as a going concern. Since our inception, we have operated with limited operating capital,and we continue to face immediate and substantial cash needs.

We have limited cashresources and will need to raise additional capital through public or privatefinancings or other arrangements in order to meet current commitments andcontinue development of our business.  Wecannot assure you that additional capital will be available to it when needed,if at all, or, if available, will be obtained on terms attractive to is.  Our failure to raise additional capital whenneeded could cause it to cease our operations.

We have financed ouroperations since inception primarily through the private placement of equityand debt securities and loan facilities. Although our management recognizes the need to raise funds in the nearfuture, there can be no assurance that we will be successful in consummatingany fundraising transaction, or if we do consummate such a transaction, thatits terms and conditions will not require us to give investors warrants orother valuable rights to purchase additional interest in our company, or beotherwise unfavorable to us.  Among otherthings, the agreements under which we issued some of our existing securitiesinclude, and any securities that we may issue in the future may also include,terms that could impede our ability to raise additional funding.  The issuance of additional securities couldimpose additional restrictions on how we operate and finance our business.  In addition, our current debt financingarrangements involve significant interest expense and restrictive covenantsthat limit our operations.

There is no assurancethat we will be successful in raising the additional capital that we need tooperate our business, and if we are not successful in raising capital in theshort-term we could be harmed and could be unable to meet payroll costs.

**We may face difficultiesidentifying acquisitions and integrating these acquisitions into ouroperations.  These acquisitions may beunsuccessful, involve significant cash expenditures or expose us to unforeseenliabilities.**

We continually evaluateopportunities to acquire healthcare staffing companies that complement orenhance our business and frequently have preliminary acquisition discussionswith such companies.  Since 2003, we haveacquired nine businesses.  Theseacquisitions involve numerous risks, including:

·                  potential lossof revenues following the acquisition;

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·                  difficultiesintegrating acquired personnel and distinct cultures into our business;

·                  difficultiesintegrating acquired companies into our operating, financial planning andfinancial reporting systems;

·                  diversion ofmanagement attention from existing operations; and

·                  assumption ofliabilities and exposure to unforeseen liabilities of acquired companies,including liabilities for their failure to comply with healthcare regulations.

These acquisitions mayalso involve significant cash expenditures, debt incurrence and integrationexpenses that could seriously harm our financial condition and results ofoperations.  We may fail to achieveexpected efficiencies and synergies.  Anyacquisition may ultimately have a negative impact on our business and financialcondition.

**There is no active public market for our commonstock, and the trading price of our common stock is subject to volatility.**

The quotation of sharesof our common stock on the OTC Bulletin Board began on February 24, 2003.  There can be no assurances that an activepublic market will develop or continue for our common stock.  Our common stock is thinly traded andexperiences significant price fluctuations. In addition, our stock is considered a “penny stock” under Rule 3a51-1under the Exchange Act.  In general, a “pennystock” includes securities of companies which are not listed on the principalstock exchanges or the Nasdaq Global Market and have a bid price in the marketof less than $5.00; and companies with net tangible assets of less than$2,000,000 ($5,000,000 if the issuer has been in continuous operation for lessthan three years), or which have recorded revenues of less than $6,000,000 inthe last three years.  “Penny stocks” aresubject to Rule 15g-9, which imposes additional sales practice requirements onbroker-dealers that sell such securities to persons other than establishedcustomers and “accredited investors” (generally, individuals with net worth inexcess of $1,000,000 or annual incomes exceeding $200,000, or $300,000 togetherwith their spouses, or individuals who are officers or directors of the issuerof the securities).  For transactionscovered by Rule 15g-9, a broker-dealer must make a special suitabilitydetermination for the purchaser and have received the purchaser’s writtenconsent to the transaction prior to sale. Consequently, this rule may adversely affect the ability ofbroker-dealers to sell our common stock, and therefore, may adversely affectthe ability of our stockholders to sell common stock in the public market.

The trading price of ourcommon stock is likely to be subject to wide fluctuations.  Factors affecting the trading price of ourcommon stock may include:

·                  variations inour financial results;

·                  announcements ofinnovations, new solutions, strategic alliances or significant agreements by Usor by our competitors;

·                  recruitment ordeparture of key personnel;

·                  changes inestimates of our financial results or changes in the recommendations of any securitiesanalysts that elect to follow our common stock;

·                  marketconditions in our industry, the industries of our customers and the economy asa whole; and

·                  sales ofsubstantial amounts of our common stock, or the perception that substantialamounts of our common stock will be sold, by our existing stockholders in thepublic market.

**Our need to raise additional capital in the futurecould have a dilutive effect on your investment.**

We will need to raiseadditional capital.  One possibility forraising additional capital is the public or private sale of common stock orsecurities convertible into or exercisable for our common stock.  Such sales could be consummated at asignificant discount to the trading price of our stock.

If we sell additionalshares of our common stock, such sales will further dilute the percentage ofour equity that our existing stockholders own. In addition, our recent private placement financings have involved theissuance of securities at a price per share that represented a discount to thetrading prices listed for our common stock on the OTC Bulletin Board and it ispossible that we will close future private placements involving the issuance ofsecurities at a discount to prevailing trading prices.  Depending upon the price per share ofsecurities that we sell in the future, a stockholder’s interest in us will befurther diluted by any adjustments to the number of shares and the applicableexercise price required pursuant to the terms of the agreements under which wepreviously issued securities.  Noassurance can be given that previous or future investors, finders or placementagents will not claim that they are entitled to additional anti-dilution

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adjustmentsor dispute the calculation of any such adjustments.  Any such claim or dispute could require us toincur material costs and expenses regardless of the resolution and, if resolvedunfavorably to us, to affect dilutive securities issuances or adjustments topreviously issued securities.  Inaddition, future financings may include provisions requiring us to makeadditional payments to the investors if we fail to obtain or maintain theeffectiveness of SEC registration statements by specified dates or take otherspecified action.  Our ability to meetthese requirements may depend on actions by regulators and other third parties,over which we will have no control. These provisions may require us to make payments or issue additionaldilutive securities, or could lead to costly and disruptive disputes.  In addition, these provisions could requireus to record additional non-cash expenses.

**Our credit facility imposes significant expensesand restrictive covenants upon us.**

In June 2004 we obtaineda $15 million revolving credit facility, which was reduced in 2005 to $10million, (the “Revolving Facility”) from Bridge Healthcare Finance, LLC.  In August 2004 we obtained a $10 million termloan credit facility from Bridge Opportunity Finance, LLC (the “Term Facility”and together with the Revolving Facility, the “Credit Facility”).  Bridge Opportunity Finance, LLC is anaffiliate of Bridge Healthcare Finance, LLC.

The Credit Facilityinvolves significant interest expenses and other fees.  In addition, except in certain limitedcircumstances, the Revolving Facility cannot be pre-paid in full withoutincurring a significant pre-payment penalty.

The Credit Facilityimposes various restrictions on our activities without the consent of thelenders, including a prohibition on fundamental changes to us or our direct orindirect subsidiaries (including certain consolidations, mergers and sales andtransfer of assets, and limitations on our ability or any of our direct orindirect subsidiaries to grant liens upon our property or assets).  In addition, under the Credit Facility wemust meet certain net worth, earnings and debt service coveragerequirements.  The Credit Facilityincludes events of default (with grace periods, as applicable) and providesthat, upon the occurrence of certain events of default, payment of all amountspayable under the Credit Facility, including the principal amount of, andaccrued interest on, the Credit Facility may be accelerated.  In addition, upon the occurrence of certaininsolvency or bankruptcy related events of default, all amounts payable underthe Credit Facility, including the principal amount of, and accrued intereston, the Credit Facility shall automatically become immediately due andpayable.  We are currently in default ofcertain covenants and requirements contained in the Credit Facility.  As a result, the lender could declare us indefault and accelerate all indebtedness under the Credit Facility at any time.

The expenses andrestrictions associated with the Credit Facility have the effect of limitingour operations.  In addition, our failureto pay required interest expenses and other fees or to meet restrictions underthe Credit Facility would have a material adverse affect on us.

**The agreements governing the convertibledebentures contain covenants and restrictions that may limit our ability tooperate our business.**

The terms of our 2006convertible debentures limit our ability to, among other things: declare or paydividends or distributions on any equity securities, create or incur additionalindebtedness, create additional liens on our assets and repurchase commonstock.  These restrictions couldadversely affect our ability to borrow additional funds or raise additionalequity to fund our future operations.  Inaddition, if we fail to comply with any of the covenants contained in theagreements or otherwise default on the convertible debentures, the holders mayaccelerate the indebtedness, and we may not have sufficient funds available tomake the required payments.  We arecurrently in default of certain covenants contained in the convertibledebentures.  As a result, the holders ofthe debentures could declare us in default and accelerate all indebtedness atany time.

**MedCap Partners L.P. controls a majority of ouroutstanding capital stock, and this may delay or prevent a change of control ofthe company or adversely affect our stock price.**

MedCap Partners L.P. andMedCap Master Fund L.P. (the “MedCap Funds”) control approximately 77% of ouroutstanding capital stock.  In addition,C. Fred Toney, a member of our board of directors, is the managing memberof MedCap Management & Research LLC, the general partner of the MedCapFunds, MedCap is able to exercise control over matters requiring stockholderapproval, such as the election of directors and the approval of significantcorporate transactions.  These types oftransactions include transactions involving an actual or potential change ofcontrol of the company or other transactions that the non-controllingstockholders may deem to be in their best interests and in which suchstockholders could receive a premium for their shares.

**The successful implementation of our businessstrategy depends upon the ability of our management to monitor and controlcosts.**

With respect to ourplanned operations, management cannot accurately project or give any assurancewith respect to our ability to control development and operating costs and/orexpenses in the future.  Consequently, aswe expand our

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commercialoperations, management may not be able to control costs and expensesadequately, and such operations may generate losses.

**The ability to attract and retain highly qualifiedpersonnel to operate and manage our operations is extremely important and ourfailure to do so could adversely affect us.**

Presently, we aredependent upon the personal efforts of our management team.  The loss of any of our officers or directorscould have a material adverse effect upon our business and futureprospects.  We do not presently havekey-person life insurance upon the life of any of our officers ordirectors.  Additionally, as we continueour planned expansion of commercial operations, we will require the services ofadditional skilled personnel.  There canbe no assurance that we can attract persons with the requisite skills andtraining to meet our future needs or, even if such persons are available, thatthey can be hired on terms favorable to us.

**Execution of our business strategy and growth ofour business are substantially dependent upon our ability to attract, developand retain qualified and skilled sales personnel.**

Execution of ourbusiness strategy and continued growth of our business are substantiallydependent upon our ability to attract, develop and retain qualified and skilledsales personnel who engage in selling and business development for ourservices.  The available pool ofqualified sales personnel candidates is limited.  We commit substantial resources to therecruitment, training, development and operational support of our salespersonnel.  There can be no assurancethat we will be able to recruit, develop and retain qualified sales personnelin sufficient numbers or that our sales personnel will achieve productivitylevels sufficient to enable growth of our business.  Failure to attract and retain productivesales personnel could adversely affect our business, financial condition andresults of operations.

**If we are unable to attract qualified nurses andhealthcare professionals for our healthcare staffing business, our businesscould be negatively impacted.**

We rely significantly onour ability to attract and retain nurses and healthcare professionals whopossess the skills, experience and licenses necessary to meet the requirementsof our hospital and healthcare facility clients.  We compete for healthcare staffing personnelwith other temporary healthcare staffing companies and with hospitals andhealthcare facilities.  We mustcontinually evaluate and expand our temporary healthcare professional networkto keep pace with our hospital and healthcare facility clients’ needs.  Currently, there is a shortage of qualifiednurses in most areas of the United States, competition for nursing personnel isincreasing, and salaries and benefits have risen.  We may be unable to continue to increase thenumber of temporary healthcare professionals that it recruits, decreasing the potentialfor growth of our business.  Our abilityto attract and retain temporary healthcare professionals depends on severalfactors, including our ability to provide temporary healthcare professionalswith assignments that they view as attractive and to provide them withcompetitive benefits and wages.  Wecannot assure you that it will be successful in any of these areas.  The cost of attracting temporary healthcareprofessionals and providing them with attractive benefit packages may be higherthan we anticipate and, as a result, if we are unable to pass these costs on toour hospital and healthcare facility clients, our losses could increase.  Moreover, if we are unable to attract andretain temporary healthcare professionals, the quality of our services to ourhospital and healthcare facility clients may decline and, as a result, we couldlose clients.

**The temporary staffing industry is highlycompetitive and the success and future growth of our business depend upon ourability to remain competitive in obtaining and retaining temporary staffingclients.**

The temporary staffingindustry is highly competitive and fragmented, with limited barriers toentry.  We compete in national, regionaland local markets with full-service agencies and in regional and local marketswith specialized temporary staffing agencies. Some of our competitors include AMN Healthcare Services, Inc., CrossCountry, Inc., Medical Staffing Network Holdings, Inc. and On Assignment, Inc.  All of these companies have significantlygreater marketing and financial resources than we do.  Our ability to attract and retain clients isbased on the value of the service we deliver, which in turn depends principallyon the speed with which we fill assignments and the appropriateness of thematch based on clients’ requirements and the skills and experience of ourtemporary employees.  Our ability toattract skilled, experienced temporary professionals is based on our ability topay competitive wages, to provide competitive benefits, to provide multiple,continuous assignments and thereby increase the retention rate of theseemployees.  To the extent thatcompetitors seek to gain or retain market share by reducing prices orincreasing marketing expenditures, we could lose revenues and our margins coulddecline, which could seriously harm our operating results and cause the tradingprice of our stock to decline.  As weexpand into new geographic markets, our success will depend in part on ourability to gain market share from competitors. We expect competition for clients to increase in the future, and thesuccess and growth of our business depend on our ability to remain competitive.

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**Our business depends upon our continued ability tosecure and fill new orders from our hospital and healthcare facility clients,because we do not have long-term agreements or exclusive contracts with them.**

We generally do not havelong-term agreements or exclusive guaranteed order contracts with our hospitaland healthcare facility clients.  Thesuccess of our business depends upon our ability to continually secure neworders from hospitals and other healthcare facilities and to fill those orderswith our temporary healthcare professionals. Our hospital and healthcare facility clients are free to place orderswith our competitors and may choose to use temporary healthcare professionalsthat our competitors offer them. Therefore, we must maintain positive relationships with our hospital andhealthcare facility clients.  If we failto maintain positive relationships with our hospital and healthcare facilityclients, we may be unable to generate new temporary healthcare professionalorders and our business may be adversely affected.

**Fluctuations in patient occupancy at our clients’hospitals and healthcare facilities may adversely affect the demand for ourservices and therefore the profitability of our business.**

Demand for our temporaryhealthcare staffing services is significantly affected by the general level ofpatient occupancy at our hospital and healthcare clients’ facilities.  When occupancy increases, hospitals and otherhealthcare facilities often add temporary employees before full-time employeesare hired.  As occupancy decreases,hospitals and other healthcare facilities typically reduce their use oftemporary employees before undertaking layoffs of their regular employees.  In addition, we may experience morecompetitive pricing pressure during periods of occupancy downturn.  Occupancy at our clients’ hospitals andhealthcare facilities also fluctuates due to the seasonality of some electiveprocedures.  We are unable to predict thelevel of patient occupancy at any particular time and our effect on ourrevenues and earnings.

**We could be difficult to acquire due toanti-takeover provisions in our charter documents and Delaware law.**

Provisions of ourcertificate of incorporation and bylaws may have the effect of making it moredifficult for a third party to acquire, or of discouraging a third party fromattempting to acquire, control of us. These provisions may make it more difficult for stockholders to takecorporate actions and may have the effect of delaying or preventing a change incontrol.  We are subject to theanti-takeover provisions of Section 203 of the Delaware General CorporationLaw.  Subject to specified exceptions,including the approval of the transaction by the board of directors or thecorporation’s stockholders, this section provides that a corporation may notengage in any business combination with any interested stockholder during thethree-year period following the time that such stockholder becomes aninterested stockholder.  This provisioncould have the effect of delaying or preventing a change of control of us.  These factors could limit the price thatinvestors or an acquirer may be willing to pay in the future for shares of ourcommon stock.

**We operate in a regulated industry and changes inregulations or violations of regulations may result in increased costs orsanctions that could reduce our revenues and profitability.**

The healthcare industryis subject to extensive and complex federal and state laws and regulationsrelated to professional licensure, conduct of operations, payment for servicesand payment for referrals.  If we fail tocomply with the laws and regulations that are directly applicable to ourbusiness, we could suffer civil and/or criminal penalties or be subject toinjunctions or cease and desist orders.

Our business isgenerally not subject to the extensive and complex laws that apply to ourhospital and healthcare facility clients, including laws related to Medicare,Medicaid and other federal and state healthcare programs.  However, these laws and regulations couldindirectly affect the demand or the prices paid for our services.  For example, our hospital and healthcare facilityclients could suffer civil or criminal penalties or be excluded fromparticipating in Medicare, Medicaid and other healthcare programs if they failto comply with the laws and regulations applicable to their businesses.  In addition, our hospital and healthcarefacility clients could receive reduced reimbursements, or be excluded fromcoverage, because of a change in the rates or conditions set by federal orstate governments.  In turn, violationsof or changes to these laws and regulations that adversely affect our hospitaland healthcare facility clients could also adversely affect the prices thatthese clients are willing or able to pay for our services.

In addition, improperactions by our employees and other service providers may subject it to regulatoryand litigation risk.

**Further government regulations or healthcarereform could negatively impact our business opportunities, revenues andmargins.**

Although our operationsare not currently subject to any significant government regulations, it is possiblethat, in the future, such regulations may be created.  Although we cannot predict the likelihood orextent of such future regulations, the possibility exists that future ofunforeseen changes may have an adverse impact on the company’s ability to continueor expand our operations as presently planned.

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TheUnited States government has undertaken efforts to control increasinghealthcare costs through legislation, regulation and voluntary agreements withmedical care providers and drug companies. In the recent past, the United States Congress has considered severalcomprehensive healthcare reform proposals. The proposals were generally intended to expand healthcare coverage forthe uninsured and reduce the growth of total healthcare expenditures.  While Congress did not adopt anycomprehensive reform proposals, members of Congress may raise similar proposalsin the future.  If any of these proposalsare approved, hospitals and other healthcare facilities may react by spendingless on healthcare staffing, including nurses. If this were to occur, we would have fewer business opportunities, whichcould seriously harm our business.

State governments havealso attempted to control increasing healthcare costs.  For example, the state of Massachusetts hasrecently implemented a regulation that limits the hourly rate payable totemporary nursing agencies for registered nurses, licensed practical nurses andcertified nurses’ aides.  The state ofMinnesota has also implemented a statute that limits the amount that nursingagencies may charge nursing homes.  Otherstates have also proposed legislation that would limit the amounts thattemporary staffing companies may charge. Any such current or proposed laws could seriously harm our business,revenues and margins.

Furthermore, third partypayers, such as health maintenance organizations, increasingly challenge theprices charged for medical care.  Failureby hospitals and other healthcare facilities to obtain full reimbursement fromthose third party payers could reduce the demand or the price paid for ourstaffing services.

**Significant legal actions could subject us tosubstantial uninsured liabilities.**

In recent years,healthcare providers have become subject to an increasing number of legalactions alleging malpractice, product liability or related legal theories.  Many of these actions involve large claimsand significant defense costs.  Inaddition, we may be subject to claims related to torts or crimes committed byour employees or temporary healthcare professionals.  In some instances, we are required toindemnify our clients against some or all of these risks.  A failure of any of our employees orhealthcare professionals to observe our policies and guidelines intended toreduce these risks, relevant client policies and guidelines or applicablefederal, state or local laws, rules and regulations could result in negativepublicity, payment of fines or other damages. Our professional malpractice liability insurance and general liabilityinsurance coverage may not cover all claims against it or continue to beavailable to us at a reasonable cost.  Ifwe are unable to maintain adequate insurance coverage or if our insurers denycoverage we may be exposed to substantial liabilities.

**We may be legally liable for damages resultingfrom our hospital and healthcare facility clients’ mistreatment of ourhealthcare personnel.**

Because we are in thebusiness of placing our temporary healthcare professionals in the workplaces ofother companies, we are subject to possible claims by our temporary healthcareprofessionals alleging discrimination, sexual harassment, negligence and othersimilar activities by our hospital and healthcare facility clients.  The cost of defending such claims, even ifgroundless, could be substantial and the associated negative publicity couldadversely affect our ability to attract and retain qualified healthcareprofessionals in the future.

**We have asubstantial amount of goodwill and other intangible assets on our balancesheet. Our level of goodwill and other intangible assets may have the effect ofdecreasing our earnings or increasing our losses.**

As of September30, 2006, we had $28.5 million of goodwill and other unamortizedintangible assets on our balance sheet, which represents the excess of thetotal purchase price of our acquisitions over the fair value of the net assetsacquired.  At September 30, 2006,goodwill and other intangible assets represented 74% of our total assets.  An impairment charge of goodwill to earningswould have the effect of decreasing our earnings or increasing our losses, asthe case may be.  If we are required towrite down a substantial amount of goodwill, our stock price could be adverselyaffected.

**Demandfor medical staffing services is significantly affected by the general level ofeconomic activity and unemployment in the United States.**

When economicactivity increases, temporary employees are often added before full-timeemployees are hired.  However, aseconomic activity slows, many companies, including our hospital and healthcarefacility clients, reduce their use of temporary employees before laying offfull-time employees.  In addition, we mayexperience more competitive pricing pressure during periods of economic downturn.  Therefore, any significant economic downturncould have a material adverse impact on our financial position and results ofoperations.

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**RisksRelating to the Proposed Merger with iVOW**

**Crdentia and iVOW stockholderswill not know how many shares of Crdentia common stock iVOW stockholders willreceive in the merger until the closing of the merger.**

In the merger, all sharesof iVOW common stock issued and outstanding immediately prior to the effectivetime will be converted automatically into the right to receive, in theaggregate, approximately $3.5 million in shares of Crdentia common stock,subject to reduction based on the iVOW bank and financing debt assumed byCrdentia, the value of any uncollected accounts receivable at the effectivetime and the value of any iVOW warrants assumed by Crdentia.  The exchange ratio will be based on theaverage closing price of Crdentia common stock for each of the 20 consecutivetrading days ending the second day prior to the closing.  There will be no adjustment to the exchangeratio based on the value of Crdentia or iVOW common stock.  There are no rights to terminate the mergeragreement or the merger based solely on fluctuations in the price of Crdentiaor iVOW common stock.

**The market price of Crdentia’scommon stock has been and will continue to be subject to significantfluctuation.**

The market price ofCrdentia common stock upon and after completion of the merger could be lowerthan its current market price or the market price used to calculate theexchange ratio.  If the price of Crdentiacommon stock used to calculate the exchange ratio increases, iVOW stockholderswould receive fewer shares in the merger than if the exchange ratio were to becalculated now; if such price decreases, iVOW stockholders would receive moreshares of Crdentia common stock in the merger and Crdentia stockholders couldexperience significant dilution.  Youshould obtain recent market quotations of Crdentia common stock before youreturn your proxy card or cast your vote on the issuance of Crdentia securitiesin the merger at the Crdentia stockholder meeting or your vote on the merger atthe iVOW stockholder meeting.

**Crdentia’s relatively low tradingvolume may limit the ability of iVOW stockholders to sell their shares ofCrdentia common stock received in the merger.**

The average daily tradingvolume of Crdentia’s common stock was less than 9,000 shares during the quarterended September 30, 2006.  As a result ofthis low trading volume, you may have difficulty selling Crdentia sharesreceived in the merger in the manner or at the price that might be attainableif Crdentia’s common stock were more actively traded.

**Crdentia’s and iVOW’s directorsand officers have interests that may influence them to support or approve themerger.**

Crdentia director andformer iVOW director C. Fred Toney is a Managing Member of MedCap Management& Research LLC, which is the general partner of MedCap Partners L.P. andMedCap Master Fund L.P. (the “MedCap Funds”). The MedCap Funds collectively own 77% of Crdentia and 23% of iVOW.  James D. Durham, Chief Executive Officer andChairman of Crdentia, and former director of iVOW, and William J. Nydam, adirector of both Crdentia and iVOW, are both investors in the MedCap Funds andown options to purchase iVOW common stock. In addition, certain directors and officers of iVOW have employmentagreements or other arrangements with iVOW as well as continuingindemnification against liabilities that provide them with interests in themerger that are different from, or in addition to, yours and may therefore bemore likely to vote to approve the merger agreement and the merger than if theydid not have these interests.

**The combined company will requireimmediate additional capital to finance its operations.**

Crdentia’s independentregistered public accounting firm has issued a going concern opinion on itsfinancial statements, questioning its ability to continue as a goingconcern.  Crdentia will requiresubstantial further financing due to anticipated future operating losses andcosts, and the combined company will face immediate and substantial cashneeds.  There can be no assurance thatadditional financing will be available or, if available, that the terms of suchfinancing will not be unfavorable to the combined company and its stockholders.

**If the merger is not completed, Crdentia’s andiVOW’s stock prices and future business and operations could be harmed.**

 

If the merger is notcompleted, Crdentia and iVOW may be subject to the following material risks,among others:

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·                  the prices ofCrdentia and iVOW common stock may change to the extent that the current marketprices of Crdentia and iVOW common stock reflect an assumption that the mergerwill be completed;

·                  Crdentia’s andiVOW’s costs related to the merger, such as legal, accounting and some of thefees of their financial advisors, must be paid even if the merger is notcompleted;

·                  under somecircumstances iVOW may be required to pay Crdentia a termination fee of$175,000 if the merger agreement is terminated by iVOW; and

·                  pursuant to theInterim Management Agreement, the working capital of iVOW may have been usedfor the business needs of both companies, and either or both of Crdentia oriVOW may not be able to continue as a going concern.

With respect to iVOW, ifthe merger is terminated and iVOW’s board of directors determines to seekanother merger or business combination, it is not certain that iVOW will beable to find a merger partner or that the new merger partner would be willingto pay an equivalent, higher or more attractive price than that which would bepaid by Crdentia in the merger.  Whilethe merger agreement is in effect, subject to specified exceptions, iVOW isprohibited from soliciting, initiating, encouraging or entering into certaintransactions such as a merger, disposition, sale of assets or other businesscombination other than with Crdentia.  Inaddition, certain major stockholders of iVOW have executed voting agreementsrequiring them to vote in favor of the transaction with Crdentia and prohibitingthem from voting in favor of or soliciting another transaction, subject tocertain exceptions.  These restrictionscould limit iVOW’s ability to enter into an alternative transaction at afavorable price.

Further, the InterimManagement Agreement entered into by Crdentia and iVOW gives Crdentia the rightto manage iVOW’s business and utilize iVOW’s cash to fund the working capitalneeds of both iVOW and Crdentia until the merger is approved or the mergeragreement terminated.  Under the InterimManagement Agreement, Crdentia has no obligation to return any funds usedshould the merger not occur.  As aresult, if the merger is not completed, iVOW may have significantly less cashavailable to it than it would have had the parties not entered into the mergeragreement and Interim Management Agreement.

**Failure to satisfy or waivecertain conditions could prevent the merger from occurring.**

The closing of the mergeris contingent upon certain conditions being satisfied or waived.  If all conditions are not satisfied orwaived, the merger will not occur, and Crdentia and iVOW will lose the intendedbenefits of the merger.  The followingconditions, among others, must be satisfied or waived before Crdentia and/oriVOW are obligated to complete the merger:

·                  the issuance ofCrdentia common stock shall have been authorized or approved in all stateswhere such approval is required;

·                  the mergeragreement must be adopted by the holders of a majority of the outstandingshares of iVOW common stock as of the record date;

·                  the absence ofeffective demands for approasial under the DGCL with respect to no more thanfour percent (4%) of iVOW common stock;

·                  this proxystatement/prospectus must be declared effective by the SEC and no stop ordersuspending such effectiveness shall be in effect; and

·                  the receipt ofall required approvals and/or qualifications from state securities regulatorsfor the issuance of Crdentia common stock in the merger.

Completion of the mergermay result in dilution of future operating results for the stockholders ofCrdentia.

**The completion of the merger maynot result in improved operating results for Crdentia or a financial conditionsuperior to that which would have been achieved by either Crdentia or iVOW on astand-alone basis.**

The merger could fail toproduce the benefits that the companies anticipate, or could have other adverseeffects that the companies currently do not foresee.  In addition, some of the assumptions that thecompanies have made may not be realized. The merger could result in a reduction of operating results per share ofCrdentia as compared to the operative results per share that would have beenachieved by Crdentia or iVOW if the merger had not occurred.

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**Sales of substantial amounts ofCrdentia common stock in the open market by iVOW stockholders could depressCrdentia’s stock price.**

Other than shares held byaffiliates of iVOW or Crdentia, shares of Crdentia common stock that are issuedto stockholders of iVOW will be freely tradable by the stockholders of iVOWwithout restrictions or further registration under the Securities Act.  If the merger with iVOW closes and if iVOW’sstockholders sell substantial amounts of Crdentia common stock in the publicmarket following the transaction, the market price of Crdentia common stock maydecrease substantially.  These salesmight also make it more difficult for Crdentia to sell equity or equity-relatedsecurities at a time and price that it otherwise would deem appropriate.

**Crdentia and iVOW expect to incursignificant costs associated with the merger.**

Crdentia and iVOWestimate that they will incur, on a combined basis, direct transaction costs ofapproximately $200,000 associated with the merger.  Crdentia and iVOW believe the combined entitymay incur charges to operations, which are not reasonably capable of estimationat this time, in the quarter in which the merger is completed or the followingquarters, to reflect costs associated with integrating the two companies. Thereis no assurance that the combined company will not incur additional materialcharges in subsequent quarters to reflect additional costs associated with themerger.

**The merger may not result in theexpected benefits to the combined company.**

The success of the mergerwill depend in part on the success of management of the combined company inintegrating the operations, technologies and personnel of the two companiesfollowing the effective time of the merger. The failure of the combined company to meet the challenges involved insuccessfully integrating the operations of the two companies or otherwise torealize any of the anticipated benefits of the merger could seriously harm thecombined company’s results of operations. Risks from unsuccessful integration of the two companies include thepotential disruption of the combined company’s ongoing business, thedistraction of management and greater than anticipated costs and expendituresfor retaining personnel, eliminating unnecessary resources and integrating thebusinesses.

**Item 3.    Controls andProcedures**

Wemaintain disclosure controls and procedures that are designed to ensure thatinformation required to be disclosed in our Exchange Act reports is recorded,processed, summarized and reported within the time periods specified in the SEC’srules and forms and that such information is accumulated and communicated toour management including our Chief Executive Officer and Chief FinancialOfficer, as appropriate, to allow for timely decisions regarding requireddisclosure.  In designing and evaluatingthe disclosure controls and procedures, management recognizes that any controlsand procedures, no matter how well designed and operated can provide onlyreasonable assurance of achieving the desired control objectives and managementis required to apply its judgment in evaluating the cost-benefit relationshipof possible controls and procedures.

Asrequired by Rule 13a-15(b) under the Exchange Act, we conducted an evaluationunder the supervision and with the participation of our management, includingour Chief Executive Officer and our Chief Financial Officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures as of the end of the period covered by this report.  Based upon the foregoing evaluation, ourprincipal executive officer and our principal financial officer concluded thatour disclosure controls and procedures were effective at the reasonableassurance level as of the end of the fiscal period covered by this report.

Therewas no change in our internal control over financial reporting during thequarter ended September 30, 2006 that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

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**PART II – OTHER INFORMATION**

**Item 1.    Legal Proceedings**

On January 27,2006, we filed suit against the sellers of TravMed USA, Inc. asserting claimsfor breach of non-competition/solicitation agreements, breach of fiduciaryduty, tortious interference with existing and prospective contracts andbusiness relations, and declaratory relief arising out of the acquisition agreement.We are seeking damages related to the above claims.  On May 5, 2006, the sellers of TravMed USA,Inc. filed a counterclaim and application for temporary restraining order andinjunctive relief claiming breach of contract. We believe this counterclaim is without merit and we intend tovigorously defend the counterclaim.

On January 31,2006, we filed suit against the sellers of Arizona Home Health/Private Duty,Inc. asserting claims for fraud, indemnity, and declaratory relief arising outof the acquisition agreement.  OnFebruary 23, 2006, the sellers filed a counterclaim.  We believe this counterclaim is without meritand we intend to vigorously defend the counterclaim.

From time to time,we may become involved in various lawsuits and legal proceedings which arise inthe ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverseresult in these or other matters may arise from time to time that may harm ourbusiness.  Other than as described above,we are not currently aware of any such legal proceedings or claims that webelieve will have, individually or in the aggregate, a material adverse affecton our business, financial condition or operating results.

**Item 2.    Unregistered Sales of Equity Securities andUse of Proceeds**

None

**Item 3.    Defaults Upon Senior Securities**

The disclosure setforth in Notes 5, 6, 7 and 8 to our Unaudited Condensed Consolidated FinancialStatements dated September 30, 2006 included in Item 1 of Part I of thisQuarterly Report, to the extent applicable, is incorporated herein byreference.

**Item 4.    Submission of Matters to a Vote of SecurityHolders**

None

**Item 5.    Other Information**

None

**Item 6.    Exhibits**

(a)          Exhibits
| Exhibit  No. | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|--------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 2.9(6)       |       | Agreement and Plan of Merger and Reorganization,  dated September 20, 2006, by and among Crdentia Corp., iVOW Acquisition Corp.  and iVOW, Inc. Certain schedules and exhibits referenced in the Agreement and  Plan of Merger and Reorganization have been omitted in accordance with Item  601(b)(2) of Regulation S-B. A copy of the omitted schedule and/or exhibit  will be furnished supplementally to the Securities and Exchange Commission  upon request. |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 3.1(2)       |       | Restated Certificate of Incorporation.                                                                                                                                                                                                                                                                                                                                                                                                                             |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 3.2(2)       |       | Restated Bylaws.                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 3.3(1)       |       | Certificate of Amendment to Restated Certificate of  Incorporation.                                                                                                                                                                                                                                                                                                                                                                                                |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 3.4(3)       |       | Certificate of Amendment to Restated Certificate of  Incorporation.                                                                                                                                                                                                                                                                                                                                                                                                |

 

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| 3.5(3)    |   | Certificate of Correction of Certificate of  Amendment to Restated Certificate of Incorporation.                                            |
|-----------|--------|---------------------------------------------------------------------------------------------------------------------------------------------|
|      |   |                                                                                                                                        |
| 3.6(3)    |   | Certificate of Correction of Certificate of  Amendment to Restated Certificate of Incorporation.                                            |
|      |   |                                                                                                                                        |
| 3.7(4)    |   | Certificate of Amendment to Restated Certificate of  Incorporation.                                                                         |
|      |   |                                                                                                                                        |
| 10.64(5)# |   | Amendment to Executive Employment Agreement dated  July 18, 2006 among Crdentia Corp. and James J. TerBeest.                                |
|      |   |                                                                                                                                        |
| 10.65(6)  |   | Interim Management Agreement, dated September 20,  2006, by and among Crdentia Corp., iVOW Acquisition Corp. and iVOW, Inc.                 |
|      |   |                                                                                                                                        |
| 10.66(6)  |   | Crdentia Merger Voting Agreement, dated September  20, 2006, by and among Crdentia Corp., MedCap Partners L.P. and MedCap Master  Fund L.P. |
|      |   |                                                                                                                                        |
| 10.67(6)  |   | iVOW Merger Voting Agreement, dated September 20,  2006, by and among iVOW, Inc., MedCap Partners L.P. and MedCap Master Fund  L.P.         |
|      |   |                                                                                                                                        |
| 31.1      |   | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                   |
|      |   |                                                                                                                                        |
| 31.2      |   | Certification of Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                   |
|      |   |                                                                                                                                        |
| 32.1      |   | Certification of Chief Executive Officer pursuant to  Section 906 of the Sarbanes-Oxley act of 2002.                                   |
|      |   |                                                                                                                                        |
| 32.2      |   | Certification of Chief Financial Officer pursuant to  Section 906 of the Sarbanes-Oxley act of 2002.                                   |

 

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# Indicatesmanagement contract or compensatory plan.

(1)    Previouslyfiled on Form 10-QSB with the Securities and Exchange Commission on August 12,2003 and incorporated herein by reference.

(2)    Previouslyfiled on Form 8-K with the Securities and Exchange Commission on August 22,2002 and incorporated herein by reference.

(3)    Previouslyfiled on Form 8-K/A with the Securities and Exchange Commission on June 28,2004 and incorporated herein by reference.

(4)    Previouslyfiled on Form 8-K with the Securities and Exchange Commission on January 7,2005 and incorporated herein by reference.

(5)    Previouslyfiled with a Current Report on Form 8-K dated July 18, 2006 and incorporatedherein by reference.

(6)    Previouslyfiled with a Current Report on Form 8-K dated September 20, 2006 andincorporated herein by reference.

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SIGNATURES

Pursuantto the requirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the Registrant has duly caused this Report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 

 
|                          |   CRDENTIA  CORP. |
|--------------------------|------------------------|
|                     |                   |
| Dated: November 14, 2006 | By:                    | /s/ James D. Durham |   |
|                     |                   | James D. Durham |
|                     |                   | Chief Executive Officer and |
|                     |                   | Chairman of the Board |
|                     |                   | (Principal Executive Officer) |
|                     |                   |   |
|                     |                   |   |
| Dated: November 14, 2006 | By:                    | /s/ James J. TerBeest |   |
|                     |                   | James J. TerBeest |
|                     |                   | Chief Financial Officer |
|                     |                   | (Principal Financial Officer) |
|                          |                        |  |  |  |  |

 

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