**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-QSB/A**

 

(MarkOne)
|       |       |                                                                                                                                                                                                                                                                       |   |
|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| **ý** | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                     |   |
|       |       |                                                                                                                                                                                                                                                                       |   |
|       |       | **For the quarterly period ended  September 30, 2005.**                                                                                                                                                                                                               |   |
|       |       |                                                                                                                                                                                                                                                                       |   |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                    |   |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                 |   |
| ** ** | ** ** | **For the transition period from                  to**                       |   |

 

**Commission File Number 0-31152**

 

**CRDENTIA CORP.**

(Exact name of small business issuer asspecified in its charter)

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

**14114 Dallas Parkway, Suite 600,Dallas, Texas 75254**

(Address of principal executive offices)

 

**(972) 850-0780**

(Issuer’s telephone number)

 

Checkwhether the issuer (1) filed all reports to be filed by Section 13 or15(d) of the Exchange Act during the past 12 months ( or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  Yes ý  No o

 

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

 

30,544,634 shares of Common Stock, $.0001 par value,outstanding on October 28, 2005.

 

Transitional Small Business Disclosure Format(check one):    Yes o  No ý

 

 

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**CRDENTIACORP.**

 

Form 10-QSB/A QuarterlyReport

For Quarterly Period Ended September 30,2005

 

**EXPLANATORYNOTE**

 

This AmendmentNo.1 to the Quarterly Report on Form 10-QSB/A (“Amendment No. 1”) forCrdentia Corp.  (the “Company”) for thequarterly period ended September 30, 2005, is being filed to amend andrestate Item 1 and 2 of Part I, Item 6 of Part II and the principal executiveofficer and principal financial officer certifications pursuant to Sections 302and 906 of the Sarbanes-Oxley Act of 2002 contained in the original filing madewith the Securities and Exchange Commission (“SEC”) on November 14, 2005(the “Prior Report”).  In the restatedfinancial statements, the Company gives effect to revisions for revenue andpayroll misstatements arising from the use of reports generated by a newlyinstalled software operating system in error. On the unaudited condensed consolidated balance sheet for September 30,2005, we reduced unbilled receivables by $84,544, increased accrued employeecompensation and benefits by $426,295 and increased the accumulated deficit by$510,839.  On the unaudited condensedconsolidated statements of operations for the three months and nine monthsended September 30, 2005, we reduced revenue by $84,544, increased the payrollcosts included in direct operating expenses by $380,804 and increased thepayroll costs included in selling, general and administrative expenses by$45,491.  Refer to Item 1 of Part Ifor further details with respect to the restatement.  As previously disclosed on Forms 8-K filed onDecember 30, 2005 and January 30, 2006, we entered into Securities PurchaseAgreements with Med Cap Partners LP to issue shares of our common stock for$2,750,000.  Also, as previouslydisclosed on Form 8-K filed on January 10, 2006, we entered into aSecurities Purchase Agreement with institutional investors for a privateplacement of convertible debentures in the principal amount of $2,000,000.  Certain of the representations and warrantiescontained in such Securities Purchase Agreements were inaccurate to the extentset forth in the restatement.

 

This AmendmentNo. 1 does not reflect events occurring after the filing of the Prior Report,or modify or update the disclosure presented in the Prior Report.  The Prior Report has not been updated exceptas required to reflect the effects of the restatement and the amendment andrestatement of the items indicated above. Accordingly, this Amendment No. 1 should be read in conjunction with anyfilings made with the SEC subsequent to the filing of the Prior Report.

 

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**CRDENTIACORP.**

 

Form 10-QSB/A QuarterlyReport

For Quarterly Period Ended September 30,2005

 

**Table ofContents**

 
| ** **                              | ** **                                                                                                                             | **Page** |
|-----------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------|----------|
|                                    |                                                                                                                                   |     |
| **PART I - FINANCIAL INFORMATION** | 3                                                                                                                                      |
|                                    |                                                                                                                                   |     |
| Item 1.                                 | Unaudited Condensed Consolidated Financial  Statements                                                                                 | 3        |
|                                    |                                                                                                                                   |     |
|                                    | Unaudited Condensed Consolidated Balance Sheets at  September 30, 2005 and December 31, 2004                                 | 3        |
|                                    |                                                                                                                                   |     |
|                                    | Unaudited Condensed Consolidated Statements of Operations for the  Three Months and Nine Months Ended September 30, 2005 and 2004 | 4        |
|                                    |                                                                                                                                   |     |
|                                    | Unaudited Condensed Consolidated Statements of Cash Flows  for the Nine Months Ended September 30, 2005 and 2004                  | 5        |
|                                    |                                                                                                                                   |     |
|                                    | Notes to Unaudited Condensed Consolidated Financial Statements                                                                         | 6        |
|                                    |                                                                                                                                   |     |
| Item  2.                                | Management’s  Discussion and Analysis or Plan of Operation                                                                        | 22       |
|                                    |                                                                                                                                   |     |
| 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  6.                                | Exhibits                                                                                                                               | 38       |
|                                    |                                                                                                                                   |     |
| **SIGNATURES**                          | 40                                                                                                                                     |
|                                         |                                                                                                                                        |          |  |

----

 

 

**CRDENTIACORP.**

**Unaudited Condensed Consolidated Balance Sheets**

 
| ** **                                                                                                                                                                                                                                                     | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                                     | ** ** | **(As Restated)**            | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                                                                                                                                                |       |                         |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                                                                                      |       | $                            | 302,578    |                        | $          | 362,472 |   |
| Accounts receivable, net of allowance for  doubtful accounts  of $99,838 in 2005 and $114,957 in 2004                                                                                                                                                          |       | 4,804,828                    |       | 2,908,403                   |       |
| Unbilled receivables                                                                                                                                                                                                                                           |       | 559,713                      |       | 303,626                     |       |
| Other current assets                                                                                                                                                                                                                                           |       | 805,934                      |       | 495,579                     |       |
| Total current assets                                                                                                                                                                                                                                           |       | 6,473,053                    |       | 4,070,080                   |       |
|                                                                                                                                                                                                                                                           |       |                         |       |                        |       |
| Property and equipment, net                                                                                                                                                                                                                                    |       | 421,753                      |       | 293,600                     |       |
| Goodwill                                                                                                                                                                                                                                                       |       | 22,734,825                   |       | 12,974,973                  |       |
| Intangible assets, net                                                                                                                                                                                                                                         |       | 2,308,479                    |       | 1,660,717                   |       |
| Other assets                                                                                                                                                                                                                                                   |       | 648,245                      |       | 837,061                     |       |
| Total assets                                                                                                                                                                                                                                                   |       | $                            | 32,586,355 |                        | $          | 19,836,431 |   |
|                                                                                                                                                                                                                                                           |       |                         |       |                        |       |
| Current liabilities:                                                                                                                                                                                                                                           |       |                         |       |                        |       |
| Accounts payable and accrued expenses                                                                                                                                                                                                                          |       | $                            | 1,347,664  |                        | $          | 2,523,069 |   |
| Accrued dividends on convertible preferred  stock                                                                                                                                                                                                              |       | —                       |       | 1,027,254                   |       |
| Accrued employee compensation and benefits                                                                                                                                                                                                                     |       | 882,433                      |       | 554,945                     |       |
| Revolving lines of credit                                                                                                                                                                                                                                      |       | 5,057,451                    |       | 2,521,598                   |       |
| Current portion of note payable to lender,  net of discount                                                                                                                                                                                                    |       | —                       |       | 2,049,816                   |       |
| Note payable to stockholder                                                                                                                                                                                                                                    |       | —                       |       | 400,000                     |       |
| Current portion of notes payable to sellers                                                                                                                                                                                                                    |       | 1,107,578                    |       | 184,948                     |       |
| Other current liabilities                                                                                                                                                                                                                                      |       | 242,739                      |       | 100,017                     |       |
| Subordinated convertible note, net of  discount                                                                                                                                                                                                                |       | 25,000                       |       | 50,000                      |       |
| Total current liabilities                                                                                                                                                                                                                                      |       | 8,662,865                    |       | 9,411,647                   |       |
|                                                                                                                                                                                                                                                           |       |                         |       |                        |       |
| Note payable to lender, less current  portion, net of discount                                                                                                                                                                                                 |       | 2,237,416                    |       | —                      |       |
| Long term bonus payable                                                                                                                                                                                                                                        |       | 953,590                      |       | 884,962                     |       |
| Notes payable to sellers, less current  portion                                                                                                                                                                                                                |       | 2,107,912                    |       | —                      |       |
| Other long-term liabilities                                                                                                                                                                                                                                    |       | 5,273                        |       | 33,045                      |       |
| Total liabilities                                                                                                                                                                                                                                              |       | 13,967,056                   |       | 10,329,654                  |       |
|                                                                                                                                                                                                                                                           |       |                         |       |                        |       |
| Commitments and contingencies                                                                                                                                                                                                                                  |       |                         |       |                        |       |
|                                                                                                                                                                                                                                                           |       |                         |       |                        |       |
| Convertible preferred stock, 10,000,000  shares authorized:                                                                                                                                                                                                    |       |                         |       |                        |       |
| Series B convertible preferred stock   $0.0001 par value, no shares outstanding at 2005 and 3,750,000 shares   outstanding at 2004 (liquidation preference of $750,000 in 2004)                                                                           |       | —                       |       | 750,000                     |       |
| Series B-1 convertible preferred stock    $0.0001 par value, no shares outstanding at 2005 and   93,043 shares outstanding at 2004   (liquidation preference of $5,582,580 in 2004)                                                                       |       | —                       |       | 30,123,400                  |       |
| Series C convertible preferred stock   $0.0001 par value, 183,028 shares outstanding at 2005 and  52,501 shares outstanding at 2004 (liquidation preference  of $54,908,400 in 2005 and $15,750,300 in 2004)                                              |       | 10,020,048                   |       | 1,070,510                   |       |
| Series C preferred stock warrants                                                                                                                                                                                                                         |       | 839,555                      |       | 2,079,910                   |       |
|                                                                                                                                                                                                                                                           |       |                         |       |                        |       |
| Stockholders’ equity (deficit):                                                                                                                                                                                                                           |       |                         |       |                        |       |
| Common stock, par value $0.0001,  150,000,000 shares authorized in 2005  and 50,000,000 shares authorized in 2004, 31,621,040 shares issued  and 30,544,634 shares outstanding in 2005 and 14,202,883 shares issued  and 13,126,477 shares outstanding in 2004 |       | 3,162                        |       | 1,420                       |       |
| Additional paid in capital                                                                                                                                                                                                                                     |       | 112,081,975                  |       | 68,447,288                  |       |
| Treasury stock, 1,076,406 shares at cost                                                                                                                                                                                                                       |       | —                       |       | —                      |       |
| Deferred non-cash stock compensation                                                                                                                                                                                                                           |       | (6,267,258                   | )          | (648,746                    | )          |
| Accumulated deficit                                                                                                                                                                                                                                            |       | (98,058,183                  | )          | (92,317,005                 | )          |
| Total stockholders’ equity (deficit)                                                                                                                                                                                                                      |       | 7,759,696                    |       | (24,517,043                 | )          |
| Total liabilities and stockholders’ equity  (deficit)                                                                                                                                                                                                     |       | $                            | 32,586,355 |                        | $          | 19,836,431 |   |

 

The accompanying notes are anintegral part of these unaudited condensed consolidated financial statements.

 

3

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**CRDENTIACORP.**

**Unaudited Condensed Consolidated Statementsof Operations**

 

 
| ** **                                                                                                | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                | ** ** | **2005**                                  | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                | ** ** | **(As Restated)**                         | ** ** | ** **                                | ** ** | **(As Restated)** | ** ** | ** ** | ** ** |
| Revenue from services                                                                                     |       | $                                         | 9,553,016  |                                      | $          | 5,526,945 |   | $ | 23,882,837 |   | $ | 17,234,443 |   |
| Direct operating expenses                                                                                 |       | 7,584,125                                 |       | 4,266,717                                 |       | 18,743,062 |   | 13,522,086 |   |
| Gross profit                                                                                              |       | 1,968,891                                 |       | 1,260,228                                 |       | 5,139,775 |   | 3,712,357 |   |
|                                                                                                      |       |                                      |       |                                      |       |   |   |   |   |
| Operating expenses:                                                                                       |       |                                      |       |                                      |       |   |   |   |   |
| Selling, general, and administrative  expenses                                                            |       | 2,470,966                                 |       | 2,561,217                                 |       | 6,362,117 |   | 6,766,896 |   |
| Loss on impairment of customer related  intangibles                                                       |       | —                                    |       | 121,440                                   |       | — |   | 121,440 |   |
| Non-cash stock based compensation                                                                         |       | 401,154                                   |       | 140,425                                   |       | 671,488 |   | 299,880 |   |
| Total operating expenses                                                                                  |       | 2,872,120                                 |       | 2,823,082                                 |       | 7,033,605 |   | 7,188,216 |   |
|                                                                                                      |       |                                      |       |                                      |       |   |   |   |   |
| Loss from operations                                                                                      |       | (903,229                                  | )          | (1,562,854                                | )          | (1,893,830 | ) | (3,475,859 | ) |
|                                                                                                      |       |                                      |       |                                      |       |   |   |   |   |
| Non-cash expense for conversion of debt                                                                   |       | —                                    |       | (7,497,250                                | )          | — |   | (7,497,250 | ) |
| Interest expense, net                                                                                     |       | (485,451                                  | )          | (713,266                                  | )          | (1,484,369 | ) | (1,712,376 | ) |
|                                                                                                      |       |                                      |       |                                      |       |   |   |   |   |
| Loss before income taxes                                                                                  |       | (1,388,680                                | )          | (9,773,370                                | )          | (3,378,199 | ) | (12,685,485 | ) |
|                                                                                                      |       |                                      |       |                                      |       |   |   |   |   |
| Income tax expense                                                                                        |       | —                                    |       | —                                    |       | — |   | — |   |
| Net loss                                                                                                  |       | $                                         | (1,388,680 | )                                         | $          | (9,773,370 | ) | $ | (3,378,199 | ) | $ | (12,685,485 | ) |
|                                                                                                      |       |                                      |       |                                      |       |   |   |   |   |
| Deemed dividend related to beneficial  conversion feature on Series A  convertible preferred stock   |       | —                                    |       | —                                    |       | — |   | (1,000,000 | ) |
| Deemed dividend related to beneficial  conversion feature on Series B  convertible preferred stock   |       | —                                    |       | —                                    |       | — |   | (1,250,000 | ) |
| Deemed dividend related to beneficial  conversion feature on Series B-1  convertible preferred stock |       | —                                    |       | (1,233,480                                | )          | — |   | (1,233,480 | ) |
| Deemed dividend related to beneficial  conversion feature on Series B-1  warrants issued             |       | —                                    |       | (360,000                                  | )          | — |   | (360,000 | ) |
| Deemed dividend related to beneficial  conversion feature on Series C  convertible preferred stock   |       | —                                    |       | (677,382                                  | )          | — |   | (677,382 | ) |
| Non-cash preferred stock dividends                                                                        |       | —                                    |       | —                                    |       | (2,362,979 | ) | — |   |
| Net loss attributable to common  stockholders                                                             |       | $                                         | (1,388,680 | )                                         | $          | (12,044,232 | ) | $ | (5,741,178 | ) | $ | (17,206,347 | ) |
| Basic and diluted loss per common share  attributable to common stockholders                              |       | $                                         | (0.05      | )                                         | $          | (1.86 | ) | $ | (0.26 | ) | $ | (2.71 | ) |
| Weighted average number of commonshares  outstanding                                                      |       | 26,841,329                                |       | 6,478,271                                 |       | 22,445,325 |   | 6,349,072 |   |

 

The accompanying notes arean integral part of these unaudited condensed consolidated financialstatements.

 

4

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**CRDENTIACORP.**

**Unaudited Condensed Consolidated Statementsof Cash Flows**

 

 
| ** **                                                                   | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| ** **                                                                   | ** ** | **(As Restated)**                         | ** ** | ** ** | ** ** |
| **Operating activities**                                                     |       |                                      |       |   |   |
| Net loss                                                                     |       | $                                         | (3,378,199 | ) | $ | (12,685,485 | ) |
| Adjustments to reconcile net loss to  net cash used in operating activities: |       |                                      |       |   |   |
| Amortization of subordinated convertible  note discounts                     |       | —                                    |       | 654,167 |   |
| Amortization of lender note discounts                                        |       | 187,600                                   |       | 40,503 |   |
| Amortization of debt issue costs                                             |       | 250,184                                   |       | 283,732 |   |
| Amortization of long-term bonus payable                                      |       | 68,628                                    |       | 62,202 |   |
| Non-cash stock based expense related to  short-term borrowings               |       | 162,500                                   |       | — |   |
| Non-cash expense for conversion of debt                                      |       | —                                    |       | 7,497,250 |   |
| Depreciation and amortization                                                |       | 601,072                                   |       | 740,226 |   |
| Bad debt expense                                                             |       | —                                    |       | 50,050 |   |
| Non-cash stock based compensation                                            |       | 671,488                                   |       | 299,880 |   |
| Loss on impairment of customer intangibles                                   |       | —                                    |       | 121,440 |   |
| Changes in operating assets and  liabilities, net of effects of acquisitions |       |                                      |       |   |   |
| Accounts receivable                                                          |       | (851,578                                  | )          | 91,155 |   |
| Unbilled receivables                                                         |       | (256,087                                  | )          | (50,030 | ) |
| Other assets and liabilities                                                 |       | (180,282                                  | )          | (217,805 | ) |
| Accounts payable and accrued expenses                                        |       | (1,325,405                                | )          | 1,243,162 |   |
| Accrued employee compensation and benefits                                   |       | 358,920                                   |       | (109,817 | ) |
| Net cash used in operating activities                                        |       | (3,691,159                                | )          | (1,979,370 | ) |
|                                                                         |       |                                      |       |   |   |
| **Investing activities**                                                     |       |                                      |       |   |   |
| Purchases of property and equipment                                          |       | (117,415                                  | )          | (166,648 | ) |
| Cash paid for acquisition of subsidiaries,  net of cash received             |       | (4,956,980                                | )          | (4,213,933 | ) |
| Other                                                                        |       | 23,829                                    |       | — |   |
| Net cash used in investing activities                                        |       | (5,050,566                                | )          | (4,380,581 | ) |
|                                                                         |       |                                      |       |   |   |
| **Financing activities**                                                     |       |                                      |       |   |   |
| Issuance of preferred stock                                                  |       | —                                    |       | 5,060,760 |   |
| Exercise of warrants for Series C  preferred stock, net of expenses     |       | 7,709,183                                 |       | — |   |
| Net increase (decrease) in revolving lines  of credit                        |       | 1,594,463                                 |       | (548,126 | ) |
| Repayment of subordinated convertible note                                   |       | (25,000                                   | )          | — |   |
| Proceeds from notes payable to majority  stockholder                         |       | 1,050,000                                 |       | — |   |
| Repayment of notes payable to majority  stockholder                          |       | (1,450,000                                | )          | — |   |
| Proceeds from notes payable to lender                                        |       | —                                    |       | 2,697,802 |   |
| Repayment of note payable to lender                                          |       | —                                    |       | (719,444 | ) |
| Repayment of notes payable to sellers                                        |       | (184,948                                  | )          | (257,494 | ) |
| Debt issuance costs                                                          |       | (11,867                                   | )          | (1,105,703 | ) |
| Net cash provided by financing activities                                    |       | 8,681,831                                 |       | 5,127,795 |   |
|                                                                         |       |                                      |       |   |   |
| Net decrease in cash and cash equivalents                                    |       | (59,894                                   | )          | (1,232,156 | ) |
| Cash and cash equivalents at beginning of  period                            |       | 362,472                                   |       | 1,469,076 |   |
| Cash and cash equivalents at end of period                                   |       | $                                         | 302,578    |   | $ | 236,920 |   |

 

Theaccompanying notes are an integral part of these unaudited condensedconsolidated financial statements.

 

5

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** **

**CRDENTIA CORP.**

**NOTES TO UNAUDITED CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2005**

** **

**Note 1. Organization and Summary of Significant Accounting Policies**

 

Organization

 

Crdentia Corp (the “Company”),a Delaware corporation, is a provider of healthcare staffing services in theUnited States.  Such services includetravel nursing, per diem staffing, contractual clinical services and privateduty home health care. The Company considers these services to be one segment.Each of these services relate solely to providing healthcare staffing tocustomers and the Company utilizes common procedures, processes and similarmethods of identifying and serving these customers.

 

At the beginning of 2003, theCompany was a development stage company with no commercial operations. Duringthat year, the Company pursued its operational plan of acquiring companies inthe healthcare staffing field and completed the acquisition of four operatingcompanies. The companies acquired in 2003 — Baker Anderson Christie, Inc.,New Age Nurses, Inc., Nurses Network, Inc., and PSR Nurses, Ltd.(through the acquisition of PSR Nurses Holdings Corp. and PSR Nurse Recruiting, Inc.,which hold the limited partner and general partner interests in PSR Nurses,Ltd.) — provide the foundation for future growth. During 2004, the Companycompleted the acquisitions of Arizona Home Health Care/Private Duty, Inc.and Care Pros Staffing, Inc. On March 29, 2005, the Company acquired TravMed USA, Inc. and HealthIndustry Professionals, LLC. On May 4, 2005, the Company acquired PrimeStaff, LP and Mint Medical Staffing Odessa.

 

The accompanying financialstatements include the results of the wholly-owned subsidiaries discussed abovefrom their respective dates of acquisition. All intercompany transactions have been eliminated in consolidation.

 

Restatement

 

These restated financial statementsgive effect to revisions for revenue and payroll misstatements arising from theuse of reports generated by a newly installed software operating system inerror. The restated unaudited condensed consolidated balance sheet forSeptember 30, 2005, has been adjusted to reduce unbilled receivables by$84,544, increase accrued employee compensation and benefits by $426,295 andincrease the accumulated deficit by $510,839. The restated unaudited condensedconsolidated statements of operations for the three months and nine monthsended September 30, 2005, have been adjusted to reduce revenue by $84,544,increase payroll costs included in direct operating expenses by $380,804 andincrease payroll costs included in selling, general and administrative expensesby $45,491.

 

Basis ofPresentation

 

The accompanying unauditedfinancial data as of and for the three and nine months ended September 30,2005 and 2004 have been prepared by the Company pursuant to the rules andregulations of the Securities and Exchange Commission. Certain information andfootnote disclosures normally included in financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America have been condensed or omitted pursuant to such rules andregulations. These unaudited condensed consolidated financial statements shouldbe read in conjunction with the audited financial statements and the notesthereto included in the Company’s annual Report on Form 10-KSB for theyear ended December 31, 2004.

 

In the opinion of management,all adjustments (which include only normal recurring adjustments) necessary topresent fairly the financial position, results of operations, and cash flows asof and for the three and nine months ended September 30, 2005 have beenmade. The results of operations for the nine months ended September 30,2005 are not necessarily indicative of the operating results for the full year.

 

6

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Liquidity

 

The Company generated a net loss of $3,378,199 for the nine monthsended September 30, 2005 and used cash in operations of $3,691,159 duringthe first nine months of 2005. Additionally, although the Company ended the first nine months of 2005with a working capital deficit of $2.2 million, the Company was able to secureadditional funding during 2004 and the first nine months of 2005 to finance itsoperations as it continues to execute its business plan to acquire and growcompanies involved in healthcare staffing. As discussed in Note 8, in March 2005 the Company’s majoritystockholder exercised warrants to purchase 108,333 shares of Series CConvertible Preferred Stock providing $6.4 million to the Company.  Also, as discussed in Note 8, in May 2005the Company’s majority stockholder exercised warrants to purchase 22,187 sharesof Series C Convertible Preferred Stock providing $1.3 million to theCompany.  The infusion of $7.7 millioninto the Company enabled it to acquire additional companies and to retirecertain liabilities. Also, following the three acquisitions discussed in Note2, the Company increased its borrowings under its accounts receivable line, butat September 30, 2005, there is no additional borrowing availability underthis line.  In the third quarter of 2005,additional short-term funding of $600,000 in the form of an over-advance on theaccounts receivable line was secured from Bridge Healthcare Finance, LLC.  The Company will need to raise $1.5 millionto $2.0 million before calendar year end 2005 or pursue other strategic optionsto fund operations.

 

There is no assurance that the Company will be able to raise the amountof debt or equity capital required to meet its objectives.  If additional debt or equity capital is notreadily available, the Company will be forced to scale back its acquisition activitiesand its operations until income exceeds expenses.  This would result in an overall slowdown ofthe Company’s development and could result in the failure of the Company’sbusiness.

 

Stock-BasedCompensation

 

As permitted under theprovisions of Statement of Financial Accounting Standard (SFAS) No. 123, *Accounting for Stock-Based Compensation*, the Companycontinues to account for employee stock-based transactions under AccountingPrinciples Board Opinion (APB) No. 25, *Accounting for StockIssued to Employees*. However, SFAS 123 requires the Company todisclose pro forma net loss and loss per share as if the fair value method hadbeen adopted.  Under the fair valuemethod, compensation cost is measured at the grant date based on the fair valueof the award and is recognized over the service period, which is usually thevesting period.  For non-employees, costis also measured at the grant date, using the fair value method, but isactually recognized in the financial statements over the vesting period orimmediately if no further services are required.

 

If the Company had elected thefair value method of accounting for employee stock-based compensation,compensation cost would be recorded at the estimated fair value of the stockaward grants over the service period, regardless of later changes in stockprices and price volatility.  The date ofgrant fair values for options granted have been estimated based on theBlack-Scholes pricing model.

 

7

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The table below shows net lossper share attributable to common stockholders for the three and nine monthsended September 30, 2005 and 2004 as if the Company had elected the fairvalue method of accounting for stock options.

 
| ** **                                                                                                                    | ** ** | **Three  Months  Ended** | ** ** | **Three  Months  Ended** | ** ** | **Nine  Months  Ended** | ** ** | **Nine  Months  Ended** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                                                                                                    | ** ** | **September 30,**   | ** ** | **September 30,**   | ** ** | **September 30,**  | ** ** | **September 30,**  | ** ** |
| ** **                                                                                                                    | ** ** | **2005**                 | ** ** | **2004**                 | ** ** | **2005**                | ** ** | **2004**                | ** ** |
|                                                                                                                          |       |                     |       |                     |       |                    |       |                    |       |
| Net loss attributable to common   stockholders as reported                                                                    |       | $                        | (1,388,680 | )                        | $          | (12,044,232             | )          | $                       | (5,741,178 | ) | $ | (17,206,347 | ) |
| Add: stock-based employee   compensation in reported net   loss, net of related tax effects                                   |       | 401,154                  |       | 140,425                  |       | 671,488                 |       | 299,880                 |       |
| Deduct: stock-based employee   compensation determined under   fair value method for all awards,   net of related tax effects |       | (465,902                 | )          | (2,144,537               | )          | (790,116                | )          | (2,352,628              | )          |
| Proforma net loss attributable to   common stockholders, as adjusted                                                          |       | $                        | (1,452,618 | )                        | $          | (14,048,344             | )          | $                       | (5,859,806 | ) | $ | (19,259,095 | ) |
| Loss per share attributable to   common stockholders:                                                                         |       |                     |       |                     |       |                    |       |                    |       |
| Basic and diluted, as reported                                                                                                |       | $                        | (.05       | )                        | $          | (1.86                   | )          | $                       | (.26       | ) | $ | (2.71 | ) |
| Basic and diluted, as adjusted                                                                                                |       | $                        | (.05       | )                        | $          | (2.17                   | )          | $                       | (.26       | ) | $ | (3.03 | ) |

 

Earnings Per Share

 

Basic per share data has beencomputed on the loss attributable to common stockholders for each perioddivided by the weighted average number of shares of common stock outstandingfor each period (excluding the restricted common stock issued to certainofficers in May 2005 as discussed in Note 9).   Diluted earnings per common share includeboth the weighted average number of common shares and any common shareequivalents such as convertible securities, options or warrants in thecalculation.  As the Company recorded netlosses for the three and nine months ended September 30, 2005 and 2004,common share equivalents outstanding would be anti-dilutive, and as such, havenot been included in diluted weighted average shares outstanding.  Common share equivalents that were excludedin the September 30, 2005 calculations totaled 41,546,158.

 

New Accounting Pronouncements

 

On December 16, 2004, the FinancialAccounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), *Share-Based Payment*, which is a revision of SFAS No. 123,*Accounting for*

 

8

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*Stock-Based Compensation*.Statement 123R supersedes APB Opinion No. 25, *Accountingfor Stock Issued to Employees*. Generally, the approach in Statement 123R is similar to the approachdescribed in Statement 123.  However,Statement 123R requires all share-based payments to employees, including grantsof employee stock options, to be recognized in the income statement based ontheir fair values.  Pro forma disclosureis no longer an alternative.  The Companyexpects to adopt Statement 123R on January 1, 2006.

 

The Company is evaluating the impact ofadopting SFAS 123R and expects that it will record non-cash stock compensationexpense.  The adoption of SFAS 123R isnot expected to have a significant effect on the Company’s financial conditionor cash flows but is expected to have an effect on the company’s results ofoperations.  The future impact of theadoption of SFAS 123R cannot be predicted at this time because it will dependon the levels of share-based payments granted by the Company in the future.  However, had the Company adopted SFAS 123R inprior periods, the impact of the standard would have approximated the impact ofSFAS 123 as described in the pro forma net loss attributable to commonstockholders included in the Stock-Based Compensation policy footnote.

 

**Note 2. Acquisitions**

 

TravMed USA, Inc.

 

On March 29, 2005, the Company acquired TravMed USA, Inc. (“TravMed”)in exchange for $3,215,490 in cash, $3,215,490 in notes payable, and $125,650of net acquisition costs. The primary purpose of the acquisition was to enablethe Company to expand its market share in the nurse staffing industry. Thefollowing table summarizes the assets acquired and liabilities assumed as ofthe closing date:

 
| Tangible assets acquired           |   | $         | 1,189,471 |   |
|------------------------------------|--------|-----------|-----------|--------|
| Customer related intangible assets |   | 492,000   |      |
| Goodwill                           |   | 5,916,549 |      |
| Total assets acquired              |   | 7,598,020 |      |
| Liabilities assumed                |   | 1,041,390 |      |
| Net assets acquired                |   | $         | 6,556,630 |   |

 

The acquisition was accounted for using the purchase method ofaccounting. Customer related intangible assets will be amortized over their estimateduseful life of five years.  The purchaseprice allocated to customer relationships was determined by management’sestimate based on a consistent model for all acquisitions developed by aprofessional valuation group.  Goodwillrepresents the excess of merger consideration over the fair value of assetsacquired. The Company will be required to issue shares of its Common Stock tothe former stockholders of TravMed should its results of operations exceedperformance standards established in the merger agreement.  The goodwill acquired may not be amortizedfor federal income tax purposes.

 

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HealthIndustry Professionals, LLC

 

On March 29, 2005, theCompany acquired Health Industry Professionals, LLC (HIP) in exchange for$1,350,900 in cash, 1,283,684 shares of the Company’s Common Stock valued at$2,601,600, (determined by the average of $2.03 per share which approximatesthe trading value as quoted on the OTC Bulletin Board 3 days before and 3 daysafter the acquisition date),  and $30,653of net acquisition costs. The primary purpose of the acquisition was to enablethe Company to expand its market share in the nurse staffing market.  The following table summarizes the assetsacquired and liabilities assumed as of the closing date:

 
| Tangible assets acquired            |   | $         | 44,000    |   |
|-------------------------------------|--------|-----------|-----------|--------|
| Customer  related intangible assets |   | 342,000   |      |
| Goodwill                            |   | 3,647,153 |      |
| Total assets acquired               |   | 4,033,153 |      |
| Liabilities  assumed                |   | 50,000    |      |
| Net assets acquired                 |   | $         | 3,983,153 |   |

 

The acquisition was accountedfor using the purchase method of accounting. Customer related intangible assets will be amortized over theirestimated useful life of five years.  Thepurchase price allocated to customer relationships was determined by management’sestimate based on a consistent model for all acquisitions developed by aprofessional valuation group.  Goodwillrepresents the excess of merger consideration over the fair value of assetsacquired. The Company will be required to issue shares of its Common Stock tothe former stockholders of HIP should its results of operations exceedperformance standards established in the merger agreement.****Thegoodwill acquired may not be amortized for federal income tax purposes.

 

Prime Staff,LP and Mint Medical Staffing Odessa

 

On May 4, 2005, theCompany acquired Prime Staff, LP and Mint Medical Staffing Odessa in exchangefor $150,000 in cash, 165,042 shares of the Company’s Common Stock valued at$287,264 (determined by the average of $1.74 per share which approximates thetrading value as quoted on the OTC Bulletin Board 3 days before and 3 daysafter the acquisition date),  and $78,638of net acquisition costs. The primary purpose of the acquisition was to enablethe Company to expand its market share in the nurse staffing market.  The following table summarizes the assetsacquired and liabilities assumed as of the closing date:

 
| Tangible assets acquired           |   | $       | 33,400  |   |
|------------------------------------|--------|---------|---------|--------|
| Customer related intangible assets |   | 292,000 |    |
| Goodwill                           |   | 190,502 |    |
| Total assets acquired              |   | 515,902 |    |
| Liabilities assumed                |   | —  |    |
| Net assets acquired                |   | $       | 515,902 |   |

 

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The acquisition was accountedfor using the purchase method of accounting. Customer related intangible assets will be amortized over their estimateduseful life of five years.  The purchaseprice allocated to customer relationships was determined by management’sestimate based on a consistent model for all acquisitions developed by aprofessional valuation group.  Goodwillrepresents the excess of merger consideration over the fair value of assetsacquired.  The goodwill acquired may notbe amortized for federal income tax purposes.

 

Unaudited ProForma Summary Information

 

The following unaudited proforma summary approximates the consolidated results of operations as if allacquisitions (including 2004 acquisitions) had occurred as of the beginning ofeach period presented, after giving effect to certain adjustments, includingamortization of specifically 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 periods presented orof future results of operations.

 
| ** **                                                                         | ** ** | **Three Months  Ended  September 30,** | ** ** | **Nine Months  Ended  September 30,** | ** ** | **Nine Months  Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                         | ** ** | **2004**                                    | ** ** | **2005**                                   | ** ** | **2004**                                   | ** ** |
| ** **                                                                         | ** ** | ** **                                  | ** ** | ** **                                 | ** ** | ** **                                 | ** ** |
| Revenue from services                                                              |       | $                                           | 13,165,567 |                                       | $          | 30,167,958                                 |       | $ | 41,814,519 |   |
|                                                                               |       |                                        |       |                                       |       |                                       |       |
| Net loss                                                                           |       | (9,382,434                                  | )          | (3,112,036                                 | )          | (11,529,551                                | )          |
|                                                                               |       |                                        |       |                                       |       |                                       |       |
| Net loss attributable to  common stockholders                                      |       | (11,653,296                                 | )          | (5,475,015                                 | )          | (16,050,413                                | )          |
| Basic and diluted net loss  per common share  attributable to common  stockholders |       | (1.43                                       | )          | (.24                                       | )          | (2.01                                      | )          |
| Weighted-average shares  of common stock outstanding (basic and diluted)           |       | 8,126,997                                   |       | 22,929,376                                 |       | 7,997,798                                  |       |
|                                                                                    |            |                                             |            |                                            |            |                                            |            |  |  |  |

 

11

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**Note 3. Accounts Payable and Accrued Expenses**

 

Accounts payable and accrued expenses consistof the following:

 
| ** **       | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------|------------|------------------------|------------|-----------------------|------------|
| ** **       | ** ** | **2005**               | ** ** | **2004**              | ** ** |
|             |       |                   |       |                  |       |
| Accounts payable |       | $                      | 752,632    |                  | $          | 1,815,778 |   |
| Accrued expenses |       | 595,032                |       | 707,291               |       |
|             |       |                   |       |                  |       |
|             |       | $                      | 1,347,664  |                  | $          | 2,523,069 |   |

 

 

**Note 4. Revolving Line of Credit**

 

On June 16, 2004, the Company enteredinto a Loan and Security Agreement with Bridge Healthcare Finance, LLC,pursuant to which the Company obtained a revolving credit facility up to$15,000,000 (the “Loan”).  During thefirst quarter of 2005, the revolving line of credit facility was reduced to$10,000,000 permitting the Company to lower its effective interest rate throughlower unused line fees.  The Loan had anoriginal term of three years and bears interest at a rate equal to the greaterof three percent (3.0%) per annum over the prime rate or nine and one-halfpercent (9.5%) per annum (9.75% at September 30, 2005).  Interest is 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 credit facility after deducting charges for interest expense,unused line and account management fees. Except in certain limited circumstances, the Loan cannot be prepaid infull without the Company 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 covenantswere restructured; however, at September 30, 2005, the Company was not incompliance with the restructured covenants. Bridge Healthcare Finance, LLC waived compliance with the covenants forthe three months ended September 30, 2005. The Loan includes events of default (with grace periods as applicable)and provides that, upon the occurrence of certain events of default, payment ofall amounts payable under the Loan, including the principal amount of, andaccrued interest on, the Loan may be accelerated.  There are also cross default provisionsbetween the Loan and the Term Loan discussed in Note 5.  The outstanding balance on the Loan is$4,457,451 at September 30, 2005 (excluding the over-advance of $600,000described below), which represents the total availability under the linerelative to the amount of receivables outstanding at that date.

 

During the third quarter of 2005, Bridge Healthcare Finance, LLC made a$600,000 credit line available to the Company in the form of an over-advance onthe Company’s Loan.  The line of 

 

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credit will be used as necessary to pay certain remaining amounts dueon acquisitions completed in March, 2005 and for working capital purposes.  The line accrues interest at the revolvingline of credit rate discussed above.  The$600,000 has been completely drawn down at September 30, 2005, and must berepaid by December 31, 2005.  Asadditional consideration for the line, the Company is required to pay a monthlyfee of $15,000 through December 31, 2005. The maturity date of the related revolving credit Loan discussed aboveis being 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 the Company.

 

**Note 5. Notes Payable to Lender**

 

Pursuant to a loan agreement dated August 31, 2004, the Companyobtained a term loan credit facility (“Term Loan”) in the amount up to$10,000,000 from Bridge Opportunity Finance, LLC, an affiliate of BridgeHealthcare Finance, LLC. The Company may obtain loans under the agreement tofund permitted acquisitions.  Any loansobtained under the Term Loan are due and payable in full on August 31,2007 and bear interest at the rate of fifteen and one-quarter percent (15.25%)per annum.  Interest is payablemonthly.  The Term Loan is secured by allassets of the Company.  On August 31,2004, the Company received proceeds from the Term Loan of $2,697,802 for theacquisitions of Arizona Home Health Care/Private Duty, Inc. and Care ProsStaffing, Inc.  To date, this is theonly advance received under the Term Loan and no principal payments have beenmade by the Company to reduce this amount.

 

The Term Loan provides that the Company shall issue warrants topurchase shares of Common Stock to the lender up to 12% of the Company’soverall capitalization on the date of borrowing. On August 31, 2004, theCompany issued warrants to purchase 905,758 shares of Common Stock at a priceof $3.15 per share in connection with the first borrowing under the creditfacility.  As a result, the Term Loan hasbeen recorded net of a discount of $810,000 which represents the estimated fairmarket value related to the warrants at the date of issuance.  The discount is being amortized to interestexpense over the life of the Term Loan.

 

Except in certain limited circumstances, the Term Loan cannot beprepaid in full without the Company incurring a significant prepaymentpenalty.  The Term Loan also containscertain financial covenants, including the maintenance of minimum tangible networth, minimum debt service coverage ratios, minimum EBITDA, maximum capitalexpenditure limits and maximum operating lease obligations. At March 31,2005, the Company was out of compliance with certain financial covenants of theTerm Loan, for which a waiver was received from the lender. In May 2005,the covenants were restructured; however, at September 30, 2005, theCompany was not in compliance with the restructured covenants. BridgeHealthcare Finance, LLC waived compliance with the covenants for the threemonths ended September 30, 2005. The Term Loan includes events of default (with grace periods asapplicable) and provides that, upon the occurrence of certain events ofdefault, payment of all amounts payable under the Term Loan, 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.

 

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**Note 6. Notes Payable to Stockholders**

 

On November 29, 2004, MedCap PartnersL.P., the Company’s majority stockholder, loaned the Company $400,000 forworking capital purposes.  During thefirst quarter of 2005, the Company borrowed an additional $1,050,000 from themajority stockholder for working capital purposes.  The notes required interest at 5% and werepayable on demand.  These notes plusaccrued interest were repaid on March 29, 2005.  As an incentive to the majority stockholderto provide the working capital until acquisitions were consummated in the firstquarter of 2005, the Company issued 77,751 shares of common stock to themajority stockholder at an average market value of $2.09 per share.  The related expense of $162,500 was recorded asinterest expense in the accompanying statement of operations during the firstquarter of 2005.

 

**Note 7. Notes Payable to Sellers**

 

As partial consideration for the acquisition of TravMed USA, Inc.on March 29, 2005, the Company issued unsecured subordinated notes to theformer TravMed stockholders in the total amount of $3,215,490. The notes arethree-year convertible notes bearing interest at 7.75%.  Monthly interest payments are required forthe first six months followed by principal and interest payments the nextthirty months to fully repay the debt. See additional discussion in Note 11.

 

**Note 8.  Convertible Preferred Stock**

 

Convertible Preferred Stock Issued andOutstanding

 

The Company is authorized toissue 10,000,000 shares of preferred stock at a par value of $0.0001. At September 30,2005 and December 31, 2004 there are shares issued and outstandingconsisting of the following:

 
| ** **                                  | ** ** | **September 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|---------------------------------------------|------------|-----------------------------|------------|----------------------------|------------|
| ** **                                  | ** ** | **Shares**                  | ** ** | **Shares**                 | ** ** | **Shares** | ** ** | **Shares** | ** ** |
| ** **                                  | ** ** | **Issued**                  | ** ** | **Outstanding**            | ** ** | **Issued** | ** ** | **Outstanding** | ** ** |
|                                        |       |                        |       |                       |       |   |   |   |   |
| Series B Convertible Preferred Stock   |       | —                      |       | —                     |       | 6,250,000 |   | 3,750,000 |   |
| Series B-1 Convertible Preferred Stock |       | —                      |       | —                     |       | 97,582 |   | 93,043 |   |
| Series C Convertible Preferred Stock   |       | 183,028                     |       | 183,028                    |       | 52,501 |   | 52,501 |   |

 

The conversion price of allConvertible Preferred Stock is subject to appropriate adjustment in the eventof stock splits, stock dividends, reverse stock splits, capitalreorganizations, recapitalizations, reclassifications, and similar occurrences,as well as the issuance of Common Stock in consideration of an amount less thanthe then effective conversion price.

 

14

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All Convertible Preferred Shares issued andoutstanding are convertible currently at the option of the holder. The Companyhas evaluated the potential effect of any beneficial conversion terms relatedto convertible instruments. As a result, the convertible instruments may have acarrying amount that differs significantly from its redemption amount. In suchcases, the difference between the carrying amount and the redemption amount(limited to the actual proceeds received) is recorded as a beneficialconversion feature and deducted as a deemed dividend in determining net lossattributable to common stockholders. The table below summarizes the redemptionrequirements and beneficial conversion of the Convertible Preferred Sharesoutstanding as of September 30, 2005:

 
| **Series of  Convertible** | ** ** | **Shares**      | ** ** | **Carrying** | ** ** | **Common Shares  Issuable  Upon** | ** ** | **Beneficial  Conversion  Recorded at** | ** ** |
|---------------------------------|------------|-----------------|------------|--------------|------------|-----------------------------------|------------|-----------------------------------------|------------|
| **Preferred Stock**             | ** ** | **Outstanding** | ** ** | **Amount**   | ** ** | **Conversion**                    | ** ** | **Issuance**                            | ** ** |
|                            |       |            |       |         |       |                              |       |                                    |       |
| C                               |       | 183,028         |       | $            | 10,020,048 |                              | 18,302,800 |                                    | $          | 1,070,510 |   |
|                                 |            |                 |            |              |            |                                   |            |                                         |            |  |  |

 

Series B Convertible Preferred Stock (Series B)

 

The holder of the Series B is entitled to receive a quarterlydividend in an amount equal to .00833 shares of Common Stock for each share ofoutstanding Series B held by them. In the event of any liquidation orwinding up of the Company, the holder of the Series B shares will beentitled to receive in preference to the holders of Common Stock, and any otherseries of Preferred Stock, an amount equal to the amount of their purchaseprice. The Series B is convertible at the option of the holder into commonshares at an initial conversion ratio of one share of Common Stock for threeshares of Series B.  The conversionratio upon voluntary conversion is subject to adjustment under certaincircumstances.  Unless previouslyvoluntarily converted prior to such time the Series B shares will beautomatically converted into Common Stock at a conversion ratio of one share ofCommon Stock for three shares of Series B upon the earlier of the closingof an underwritten public offering of Common Stock pursuant to a registrationstatement under the Securities Act of 1933, as amended, with aggregate netproceeds of at least $25 million, or the date specified by written consent oragreement of the holders of a majority of the then outstanding shares of Series B.

 

On June 16, 2004, the Company issued 6,250,000 shares of Series Bat a per share price of $0.20 to MedCap Partners L.P.  The Company recorded a deemed dividend due tothe beneficial conversion price of $1,250,000 which represents the lesser ofthe proceeds or the beneficial conversion feature of $3.2 million.

 

On September 30, 2004 the Board of Directors declared a dividendand distribution to the Series B holder. The dividend and distributionconsisted of quarterly dividends that were payable on September 30, 2004for shares not converted and quarterly dividends that were payable on  September 30, 2004, December 31,2004, March 31, 2005 and June 30, 2005 for 2,500,000 Series Bshares converted into Common Stock. As a result, 114,583 shares of Common Stockwere issued on September 30, 2004 related to the dividend anddistribution.  On March 22, 2005, 

 

15

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the Board of Directors declared a dividend to the Series Bholder.  The dividend consisted ofquarterly dividends that were payable on December 31, 2004 which had anestimated fair value of $81,218 and quarterly dividends that were payable on March 31,2005 which had an estimated fair value of $59,375.  The dividends were paid through the issuanceof 62,488 shares of common stock during March 2005.

 

On September 30, 2004, the holder voluntarily converted 2,500,000shares of Series B into 833,333 shares of Common Stock.   On March 29, 2005, the holdervoluntarily converted 3,750,000 shares of Series B into 1,250,000 sharesof Common Stock.

 

Series B-1 Convertible Preferred Stock (Series B-1)

 

The holders of the Series B-1 are entitled to receive a quarterlydividend in an amount equal to 2.5 shares of Common Stock for each share ofoutstanding Series B-1 held by them. If any dividend is declared on theCommon Stock, the holders of the Series B-1 will be entitled to receivedividends out of the legally available funds as if each share of Series B-1had been converted to Common Stock. The holders of the Series B-1 have theright, at the option of the holder at any time, to convert shares of the Series B-1into shares of the Company’s Common Stock at an initial conversion ratio of onehundred shares of Common Stock for each one share of Series B-1. The Series B-1is convertible at the option of the holder into common shares at an initialconversion ratio of one hundred shares of Common Stock for each share of Series B-1.  The conversion ratio upon voluntaryconversion is subject to adjustment under certain circumstances.  Unless previously voluntarily converted priorto such time the Series B-1 shares will be automatically converted intoCommon Stock at an initial conversion ratio of one hundred shares of CommonStock for each share of Series B-1 upon the earlier of the closing of anunderwritten public offering of Common Stock pursuant to a registrationstatement under the Securities Act of 1933, as amended, with aggregate netproceeds of at least $25 million, or the date specified by written consent oragreement of the holders of a majority of the then outstanding shares of Series B-1.

 

On August 9, 2004, the Company issued 3,750 shares of Series B-1Convertible Preferred Stock at a per share price of $60 to an investor for cashproceeds of $225,000.  The Companyrecorded a deemed dividend due to the beneficial conversion price of $225,000which represents the lesser of the proceeds or the beneficial conversionfeature of $937,500.

 

Also on August 9, 2004, the Company issued 4,166 shares of Series B-1Convertible Preferred Stock at a per share price of $60 to the Company’sChairman and Chief Executive Officer for cash proceeds of $249,960. The Companyrecorded a deemed dividend due to the beneficial conversion price of $249,960which represents the lesser of the proceeds or the beneficial conversionfeature of $1.0 million.

 

On August 9, 2004, the Company issued 29,990 shares of Series B-1Convertible Preferred Stock, issued 40,822 shares of Common Stock and paidapproximately $225,000 in cash in exchange for the cancellation of all theoutstanding principal and accrued and unpaid interest 

 

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under certain promissory notes (Seller Notes) that were issued in 2003in connection with the purchase of certain subsidiaries.

 

On September 30, 2004, the Company issued 12,642 shares of Series B-1Convertible Preferred Stock in exchange for the conversion of $758,640 inoutstanding principal plus accrued and unpaid interest under certainConvertible Subordinated Promissory Notes (Notes) issued in 2003. The holdersof such Notes included the Company’s Chairman and Chief Executive Officer, amember of the Company’s Board of Directors and an entity whose managing memberis also on the Company’s Board of Directors. The Company recorded a deemeddividend due to the beneficial conversion price of $758,640 which represents thelesser of the cancelled principal and accrued interest or the beneficialconversion feature of $3.7 million.

 

On August 31, 2004, the Company issued MedCap Partners L.P. awarrant to purchase 6,000 shares of Series B-1 Convertible Preferred Stockfor $60 per share for five years.  Thesewarrants have not been exercised at September 30, 2005.

 

On September 30, 2004, the Board of Directors declared a dividendand distribution to the Series B-1 holders. The dividend and distributionconsisted of quarterly dividends that were payable on September 30, 2004for shares not converted and a distribution equal to the dividends that wouldhave been payable on September 30, 2004, December 31, 2004, March 31,2005 and June 30, 2005 to those shareholders electing early conversion oftheir 4,112 shares of Series B-1 into Common Stock.  As a result, 157,203 shares of Common Stockwere issued on September 30, 2004 related to the dividend anddistribution.  On March 22, 2005,the Board of Directors declared a dividend to the Series B-1 holders.  The dividend consisted of quarterly dividendsthat were payable on December 31, 2004 which had an estimated fair valueof $604,780, and quarterly dividends that were payable on March 31, 2005which had an estimated fair value of $441,940. The dividends were paid through the issuance of 465,208 shares of commonstock during March 2005.

 

On September 30, 2004, certain holders of 4,112 shares of Series B-1converted their shares into 411,200 shares of Common Stock.  On October 19, 2004, a holder of 427shares of Series B-1 converted his shares into 42,700 shares of commonstock.

 

On November 10, 2004, the Company entered into an agreement toconvert approximately $2.7 million of Seller Notes and accrued interest to Series B-1Convertible Preferred Stock.

 

On December 16***,*** 2004, theCompany issued 1,582 shares of Series B-1 Convertible Preferred Stock at aper share price of $60 to investors for cash proceeds of $94,920.  The Company recorded a deemed dividend due tothe beneficial conversion price of $94,920 which represents the lesser of theproceeds or the beneficial conversion feature of $447,962.

 

On March 29, 2005, holders of all of the Convertible Preferred Series B-1voluntarily converted their 93,043 shares of preferred Series B-1 into9,304,300 shares of Common Stock.

 

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Series C Convertible Preferred Stock (Series C)

 

The holders of Series Care entitled to receive, when declared by the Board of Directors, a dividend oneach quarter end beginning September 30, 2004 and ending December 31,2005 in an amount equal to 2.5 shares of Common Stock for each share ofoutstanding Series C held by them. In the event of any liquidation orwinding up of the Company, the holders of the Series C will be entitled toreceive in preference to the holders of Common Stock an amount equal to fivetimes their initial purchase price plus any declared but unpaid dividends andany remaining liquidation proceeds will thereafter be distributed on a pro ratabasis to the holders of the Company’s Common Stock and any other series ofPreferred Stock expressly entitled to participate in such distribution.  Assuming exercise of all of the warrants topurchase shares of Series C Preferred Stock, upon a liquidation or windingup of the Company, the holders of Series C Preferred Stock would beentitled to receive approximately $92,000,000 prior to the payment of anyamounts to the holders of other equity securities.  The Series C is convertible at theoption of the holder into common shares at an initial conversion ratio of onehundred shares of Common Stock for each share of Series C.  The conversion ratio upon voluntaryconversion is subject to adjustment under certain circumstances.  Unless previously voluntarily converted priorto such time, the Series C will be automatically converted into CommonStock at an initial conversion ratio of one hundred shares of Common Stock foreach share of Series C upon the earlier of (i) the closing of anunderwritten public offering of our Common Stock pursuant to a registrationstatement under the Securities Act of 1933, as amended, with aggregate netproceeds of at least $25 million, or (ii) the date specified by writtenconsent or agreement of the holders of a majority of the then outstandingshares of Series C. The description of the foregoing rights, preferencesand privileges of the Series C is qualified in its entirety by theCertificate of Designations, Preferences and Rights of Series C filed withthe Secretary of State of the State of Delaware on August 31, 2004.

 

Warrants to Purchase Convertible PreferredStock

 

As of September 30, 2005, warrants to purchase ConvertiblePreferred Stock are outstanding as follows:

 

 
| **Series of Convertible  Preferred Stock** | ** ** | **Warrants** | ** ** | **Exercise Price  Per share** | ** ** |
|-------------------------------------------------|------------|--------------|------------|-------------------------------|------------|
|                                            |       |         |       |                          |       |
| B-1                                             |       | 6,000        |       | $                             | 60         |   |
| C                                               |       | 124,077      |       | $                             | 60         |   |

 

 

On March 29, 2005, 108,333 of the Series Cwarrants were exercised providing proceeds, net of issue costs, of$6,435,687.  On May 2, 2005, 22,187of the Series C warrants were exercised providing net proceeds of$1,273,496.  Dividends accrue on warrantsbut are payable only upon exercise. Accordingly, dividends declared for the quarters September 30,2004, December 31, 2004 and March 31, 2005 became payable on thewarrants exercised at March 31, 2005, with an estimated fair value of $1,411,464.  These dividends were paid in March 2005through the issuance of 705,732 shares of common stock.  Dividends relative to the 22,187 warrants 

 

18

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exercised in May 2005 amounted to$200,792 and were paid in the second quarter of 2005 through the issuance of110,935 shares of common stock.

 

**Note 9. Common Stock**

 

The Company is authorized to issue150,000,000 shares of common stock at a par value of $0.0001.  The authorized shares were increased in January 2005from 50,000,000 shares.

 

In connection with an agreement, 250,000shares of Common Stock were delivered by parties to the agreement, to an escrowagent.  These shares will be releasedfrom escrow as follows:  (i) beginningon July 1, 2004 and continuing on the first day of each month through andincluding June 1, 2005, the Company, or its assignee, shall pay $31,250 tothe escrow agent, and the escrow agent shall cause 10,417 shares to betransferred to the Company or its assignee; and (ii) beginning on July 1,2005 and continuing on the first day of each month through and including June 1,2006, the Company, or its assignee, shall pay $46,875 to the escrow agent, andthe escrow agent shall cause 10,417 shares to be released to the Company or itsassignee.  The escrow agent shalldistribute funds received from the Company, or its assignee, to thestockholders who are parties to the Stock Purchase Agreement. For July, 2004,through December, 2004, the Company assigned its right to purchase under theStock Purchase Agreement to an existing shareholder.  Neither the Company nor its assigneepurchased shares subsequent to December, 2004, and, in accordance with the agreement,the transfer agent was authorized to return all remaining shares to the partieswho initially tendered their shares to the escrow agent.

 

On May 31, 2005, the Company granted3,700,000 shares of restricted stock to four of its officers.  The restricted stock has been valued at$6,290,000, which represents the trading value of the stock as quoted on theOTC Bulletin Board on May 31, 2005. All shares of restricted stock vest in five years or earlier in theevent the average daily trading volume for the Company’s common stock reachesspecified levels or in certain other circumstances.  The $6,290,000 value has been reflected ascommon stock issued and outstanding with an offsetting amount included in theequity section as deferred non-cash stock compensation.  The deferred non-cash stock compensationamount is being amortized monthly over the five year expected vesting period ofthe restricted stock grant.  ThePresident’s restricted stock grant of 900,000 shares is subject to forfeitureof 300,000 shares per quarter for the second, third and fourth quarters of 2005if certain revenue and EBITDA targets are not achieved.  The second quarter and third quarter targetswere not achieved, but forfeiture has not yet been reflected since theachievement of targets is ultimately measured on a cumulative basis through December 31,2005.  The remaining grants are notsubject to forfeiture except in the event grantee’s continuous service isterminated for any reason, other than death or disability prior to the fifthanniversary of the grant date.  Non-cashstock based compensation in the accompanying statement of operations for thethird quarter and nine months ended September 30, 2005 includes $314,500and $419,333, respectively, related to these grants.

 

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In May 2005, the Board of Directorsapproved the grant of options to key employees to purchase 831,050 shares ofthe Company’s common stock under the 2004 option plan at $1.70 per share (fairmarket value on the date of grant).  Theoptions vest 25% after one year and monthly thereafter on a straight-line basisover three years.  The options expire inten years.

 

In August 2005, the Board of Directorsapproved the grant of options to key employees to purchase 95,850 shares of theCompany’s common stock under the 2004 option plan at $1.60 per share (fairmarket value on the date of grant).  Theoptions vest 25% after one year and monthly thereafter on a straight-line basisover three years.  The options expire inten years.

 

**Note 10. Supplemental Disclosure to the Cash Flow Statement**

 
| ** **                                                                           | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
|--------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                           | ** ** | **2005**               | ** ** | **2004**               | ** ** |
|                                                                                 |       |                   |       |                   |       |
| Supplemental cash flow disclosures:                                                  |       |                   |       |                   |       |
| Cash paid for interest                                                               |       | $                      | 754,830    |                   | $          | 713,689 |   |
| Cash paid for income taxes                                                           |       | —                 |       | —                 |       |
|                                                                                 |       |                   |       |                   |       |
| Non-cash investing and financing  activities:                                        |       |                   |       |                   |       |
| Conversion of debt into common stock                                                 |       | —                 |       | 126,548                |       |
| Conversion of debt into preferred stock                                              |       | —                 |       | 9,296,590              |       |
| Conversion of preferred stock into common  stock                                     |       | 30,873,400             |       | 3,496,720              |       |
| Issuance of the following in connection  with acquisitions:                          |       |                   |       |                   |       |
| Common stock issued                                                                  |       | 2,888,864              |       | 690,000                |       |
| Revolving credit line assumed                                                        |       | 941,390                |       | —                 |       |
| Notes payable issued                                                                 |       | 3,215,490              |       | 275,000                |       |
| Common stock issued as payment of preferred  stock dividends                         |       | 3,390,233              |       | —                 |       |
| Common stock issued associated with working  capital loans from majority stockholder |       | 162,500                |       | —                 |       |
| Preferred stock warrants                                                             |       | —                 |       | 1,658,162              |       |
| Common stock warrants                                                                |       | —                 |       | 1,458,124              |       |
|                                                                                      |            |                        |            |                        |            |  |  |

 

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**Note11.  Subsequent Events**

 

The Companydid not make the October 31, 2005 debt service payments of $118,246 required byterms of the $3.2 million of notes payable to sellers.  Accordingly, the Company received a notice ofdefault in early November 2005.  The duedate of the notes may be accelerated such that the entire balance of the notespayable to sellers is due, but such acceleration option cannot be exerciseduntil November 21, 2005.  If sellersexercise their option, the Company has six months to cure the default.  If cured, payment due dates revert back tothe original non-accelerated terms.  Thedefault under the notes payable to sellers triggers defaults under therevolving loan and term loan discussed in Notes 4 and 5.  The Company expects to cure the defaults onthe notes payable to sellers, revolving loan and term loan by November 30,2005; accordingly, the notes payable to sellers due beyond one year and theterm loan continue to be classified as non-current.  Also, as a result of this default, BridgeHealthcare Finance, LLC has an option to discontinue making revolving creditloans to the Company on receivables of TravMed USA, Inc., the acquisition whichgave rise to the notes payable to sellers. On November 9, 2005, Bridge Healthcare Finance, LLC waived their rightto exercise this option through November 30, 2005.

 

In November2005, the Board of Directors declared second quarter and third quarter 2005dividends on the Series C Preferred Stock, which will require the issuance of915,140 shares of common stock.  Also, inNovember 2005, the Board of Directors approved the grant of options to keyemployees and directors to purchase 177,417 shares of the Company’s commonstock under the 2004 option plan @ $2.00 per share (fair market value on thedate of grant).  The options vest 25%after one year and monthly thereafter on a straight-line basis over threeyears.  The options expire in ten years.

 

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**ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLANOF OPERATION**

 

*This report contains forward-lookingstatements.  These statements relate tofuture events or our future financial performance.  In some cases, you can identifyforward-looking statements by terminology such as “may,” “will,” “should,” “expect,”“plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,”the negative of such terms or other comparable terminology.  These statements are only predictions.  Actual events or results may differmaterially.*

 

*Although we believe that theexpectations reflected in the forward-looking statements are reasonable, wecannot guarantee future results, levels of activity, performance orachievements.  Moreover, neither we, norany other person, assume responsibility for the accuracy and completeness ofthe forward-looking statements.  We areunder no obligation to update any of the forward-looking statements after thefiling of this Quarterly Report to conform such statements to actual results orto changes in our expectations.*

 

*The following discussion of ourfinancial condition and results of operations should be read in conjunctionwith our consolidated financial statements and the related notes and otherfinancial information appearing elsewhere in this Quarterly Report. Readers arealso urged to carefully review and consider the various disclosures made by uswhich attempt to advise interested parties of the factors which affect ourbusiness, including without limitation the disclosures made under the caption “Management’sDiscussion and Analysis or Plan of Operation,” under the caption “Risk Factors,”and the audited consolidated financial statements and related notes included inour Annual Report on Form 10-KSB for the year ended December 31, 2004,previously filed with the Securities and Exchange Commission.*

 

**OVERVIEW**

 

Weare a provider of healthcare staffing services, focusing on the areas of travelnursing, per diem staffing, contractual clinical services, and private dutyhome care.  Our travel nurses arerecruited domestically as well as internationally, and placed on temporaryassignments 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 healthcare facilitiesand our private duty home care group provides nursing case management andstaffing for skilled and non-skilled care in the home. We consider thedifferent services described above to be one segment as each of these servicesrelate solely to providing healthcare staffing to customers that are healthcareproviders and utilize similar distribution methods, common procedures,processes and similar methods of identifying and serving these customers.

 

During2003, we pursued our operational plan of acquiring companies in the healthcarestaffing field and completed acquisitions of four companies. In 2004, wepurchased two additional companies, and in the first nine months of 2005purchased three additional companies.  Wehave contracted with more than 1500 healthcare facilities across 49 U.S. statesand the District of Columbia.

 

Thecompanies we acquired in 2003 — Baker Anderson Christie, Inc., New Age Nurses,Inc., Nurses Network, Inc., and PSR Nurses, Ltd. (through our acquisition ofPSR Nurses Holdings Corp. and PSR Nurse Recruiting, Inc., which hold thelimited partner and general partner interests in PSR Nurses, Ltd.) — providethe foundation for our continued growth. During 2003 we began operating the acquired companies, combining thevarious back offices and support staff and began streamlining theoperations.  We continued our acquisitionprogram in 2004 and acquired Care Pros Staffing, Inc. and Arizona Home HealthCare/Private Duty, Inc.  On March 29,2005, we acquired TravMed USA, Inc. and Health Industry Professionals,LLC.  On May 4, 2005, we acquiredPrimeStaff, LP and Mint Medical Staffing Odessa.  We have achieved our goal to acquire at leastthree companies in 2005.

 

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Althoughwe have raised $8 million to date in 2005, we will need to raise $1.5 millionto $2 million before calendar year end 2005 and additional capital during thenext twelve months to satisfy debt service requirements and other workingcapital needs.  If additional capital isnot readily available, our business could fail if we cannot successfully scaleback our operations until our income exceeds our expenses or pursue otherstrategic alternatives.

 

Somekey factors we are focusing on to improve performance are as follows:

 

•        We are identifying innovative ways to attractand retain nurses such as a nurse stock program and competitive compensationpackages.

 

•        We are installing new operating software toassist us in more effectively managing gross profits by nurse and by healthcarefacility.

 

•        We are vigorously managing professionalliability insurance costs, workers compensation insurance costs, and healthcare costs to enhance gross margins.

 

•        We are expanding our home health business inan effort to improve gross margins through a better mix of the servicesprovided.

 

•        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 currently working to raise $8 millionto $10 million of debt and equity for working capital needs, for debtretirement and for acquisitions..

 

•        We are working to resolve the significant (inexcess of $92 million) Series C Preferred Stock liquidation preference(assuming exercise of all Series C warrants).

 

•        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**

 

Althoughwe have raised $8 milion to date in 2005, we will need to raise additionalcapital during the next twelve months to satisfy debt service requirements andworking capital needs.  We are currentlyworking to raise $8 million to $10 million in a combination of debt and equityin a private placement transaction with qualified investors.  If we are successful in raising more than the$2 million to $3 million needed to satisfy debt service requirements andworking capital needs, we will employ additional funds for internal growth,retirement of higher cost debt, and targeted acquisitions which satisfy our duediligence review.

 

InJune 2004, we obtained a $15 million revolving line of credit facility fromBridge Healthcare Finance, LLC (reduced to $10 million in March 2005).  In August 2004, we obtained a $10 millionterm loan credit facility from Bridge Opportunity Finance, LLC.  Bridge Opportunity Finance, LLC is anaffiliate of Bridge Healthcare Finance, LLC. During the third quarter of 2005, Bridge Healthcare finance, LLC made a$600,000 credit line available to us in the form of an over-advance on ourrevolving line of credit.  We had$2,521,598 and $5,057,451 outstanding at December 31, 2004 and September 30,2005, respectively, under our revolving line of credit facility (including anyover-advances) and $2,697,802 of principal (after adding back the discount) of term loan outstanding at December31, 2004 and September 30, 2005. Agreements for 

 

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both the revolving line ofcredit facility and the term loan facility contain financial covenants for themaintenance of minimum net worth, minimum EBITDA, maximum capital expenditurelimits and maximum operating lease obligations. At March 31, 2005, we were out of compliance with financial covenants inboth agreements, for which waivers were received from the lenders.  In May 2005 we renegotiated covenants relatedto both the revolving line of credit facility and the term loan; however, atSeptember 30, 2005, we were not in compliance with the revised covenants.  Bridge Healthcare Finance, LLC waivedcompliance with the covenants for the three months ended September 30, 2005.  Accordingly, the term loan (which matures onApril 30, 2007) has been classified as a long-term liability at September 30,2005.  Failure to satisfy these covenantsor to be granted waivers to such violations would severely restrict oreliminate our ability to obtain additional funding under these agreements.

 

We generated a net loss of$3,378,199 for the nine months ended September 30, 2005 and used cash inoperations of $3,691,159 during the first nine months of 2005.  Additionally, although we ended the firstnine months of 2005 with a working capital deficit of $2.2 million, we wereable to secure additional funding during 2004 and the first nine months of 2005to finance our operations as we continue to execute our business plan toacquire and grow companies involved in healthcare staffing.  In March 2005 our majority stockholderexercised warrants to purchase 108,333 shares of Series C Convertible PreferredStock providing $6.4 million to us. Also, in May 2005 our majority stockholder exercised warrants topurchase 22,187 shares of Series C Convertible Preferred Stock providing $1.3million to us.  The infusion of $7.7million enabled us to acquire additional companies and to retire certainliabilities. Also, following the three acquisitions during the first ninemonths of 2005, we increased our borrowings under our accounts receivable line,but at September 30, 2005, there is no additional borrowing availability underthis line.  In the third quarter of 2005,additional short-term funding of $600,000 in the form of an over-advance on theaccounts receivable line was secured from Bridge Healthcare Finance, LLC.  Although we have raised $8 million to date in2005, we will need to raise an additional $2 million to $3 million during thenext twelve months to satisfy debt service requirements and working capital needs.  There is no assurance that we will be able toraise the amount of debt or equity capital required to meet ourobjectives.  Our challenging financialcircumstances may make the terms, conditions and cost of any available capitalrelatively unfavorable.  If additionaldebt or equity capital is not readily available, we will be forced to scaleback our acquisition activities and our operations until our income exceeds ourexpenses.  This would result in anoverall slowdown of our development.  Ourshort-term need for capital may force us to consider and potentially pursueother strategic options sooner than we might otherwise have desired.

 

Wedid not make the October 31, 2005 debt service payments of $118,246 required byterms of the $3.2 million of notes payable to sellers.  Accordingly, we received a notice of defaultin early November 2005.  The due date ofthe notes may be accelerated such that the entire balance of the notes payableto sellers is due, but such acceleration option cannot be exercised untilNovember 21, 2005.  The default under thenotes payable to sellers triggers defaults under the revolving loan and termloan discussed in Notes 4 and 5.  Weexpect to cure the defaults on the notes payable to sellers, revolving loan andterm loan by November 30, 2005; accordingly, the notes payable to sellers duebeyond one year and the term loan continue to be classified asnon-current.  Also, as a result of thisdefault, Bridge Healthcare Finance, LLC has an option to discontinue makingrevolving credit loans to the Company on receivables of TravMed USA, Inc., theacquisition which gave rise to the notes payable to sellers.   On November 9, 2005, Bridge HealthcareFinance, LLC waived their right to exercise this option through November 30,2005.

 

Our capital commitments for the next twelvemonths are minimal as our business does not require the purchase of plants,factories, extensive capital equipment or inventory.

 

**CRITICALACCOUNTING POLICIES AND MANAGEMENT JUDGEMENT**

 

Thepreparation of the financial statements in accordance with accountingprinciples generally accepted in the United States of America requires us tomake judgments, estimates, and assumptions 

 

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regarding uncertainties thataffect the reported amounts of assets and liabilities, disclosure of contingentassets and liabilities, and the reported amounts of revenues and expenses.Areas that require significant judgments, estimates, and assumptions includethe assignment 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. We use historical experience, qualifiedindependent consultants and all available information to make these judgmentsand estimates, and actual results will inevitably differ from those estimatesand assumptions that are used to prepare the company’s financial statements atany given time.

 

**Accounts Receivable**

 

Accountsreceivable are reduced by an allowance for doubtful accounts that provides areserve with respect to those accounts for which revenue was recognized butwhich management subsequently determines that payment is not expected to bereceived.  We analyze the balances ofaccounts receivable to ensure that the recorded amounts properly reflect theamounts expected to be collected.  Thisanalysis involves the application of varying percentages to each accountsreceivable category based on the age of the uncollectible accountsreceivable.  The amount ultimatelyrecorded as the reserve is determined after management also analyzes thecollectibility of specific large or problematic accounts on an individualbasis, as well as the overall business climate and other factors.  Our estimate of the percentage ofuncollectible accounts may change from time to time and any such change couldhave a material impact on our financial condition and results of operations.

 

**Purchase Accounting, Goodwill and Intangible Assets**

 

Allbusiness acquisitions have been accounted for using the purchase method ofaccounting and, accordingly, the statements of operations include the resultsof 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  purchase price to the fair value of the  assets acquired  and  liabilities assumed  when we obtaininformation sufficient to complete the allocation,  but in any case,within one year after acquisition.

 

Goodwillarising from the acquisitions of businesses is recorded as the excess of thepurchase price over the estimated fair value of the net assets of the businessesacquired.  Statement of FinancialAccounting Standards No. 142 (“Goodwill and Other Intangible Assets”) providesthat goodwill is to be tested for impairment annually or more frequently ifcircumstances indicate potential impairment. Consistent with this standard, we will review goodwill, as well as otherintangible assets and long-term assets, for impairment annually or morefrequently as warranted, and if circumstances indicate that the recorded valueof any such other asset is impaired, such asset is written down to its new,lower fair value.  If any item ofgoodwill or such other asset is determined to be impaired, an impairment losswould be recognized equal to the amount by which the recorded value exceeds theestimated fair market value.

 

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**RESULTS OFOPERATIONS**

 

Thefollowing condensed financial information includes Crdentia Corp. plus theresults of operations of all companies acquired from their respective dates ofacquisition (in thousands).

 
| ** **                                          | ** ** | **For the three months  ended September 30,** | ** ** | **For the nine months  ended September 30,** | ** ** |
|-----------------------------------------------------|------------|-----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                          | ** ** | **2005**                                      | ** ** | **2004**                                     | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                |       |                                          |       |                                         |       |   |   |   |   |
| Revenue from services                               |       | $                                             | 9,553      |                                         | $          | 5,527 |   | $ | 23,883 |   | $ | 17,234 |   |
| Direct operating expenses                           |       | 7,584                                         |       | 4,267                                        |       | 18,743 |   | 13,522 |   |
| Gross profit                                        |       | 1,969                                         |       | 1,260                                        |       | 5,140 |   | 3,712 |   |
|                                                |       |                                          |       |                                         |       |   |   |   |   |
| Operating expenses:                                 |       |                                          |       |                                         |       |   |   |   |   |
| Selling, general and administrative  expenses       |       | 2,471                                         |       | 2,562                                        |       | 6,362 |   | 6,767 |   |
| Loss on impairment of customer related  intangibles |       | —                                        |       | 121                                          |       | — |   | 121 |   |
| Non-cash stock based compensation                   |       | 401                                           |       | 140                                          |       | 672 |   | 300 |   |
| Total operating expenses                            |       | 2,872                                         |       | 2,823                                        |       | 7,034 |   | 7,188 |   |
|                                                |       |                                          |       |                                         |       |   |   |   |   |
| Loss from operations                                |       | (903                                          | )          | (1563                                        | )          | (1,894 | ) | (3,476 | ) |
|                                                |       |                                          |       |                                         |       |   |   |   |   |
| Non-cash expense for conversion of debt             |       | —                                        |       | (7,497                                       | )          | — |   | (7,497 | ) |
| Interest expense, net                               |       | (486                                          | )          | (713                                         | )          | (1,484 | ) | (1,712 | ) |
|                                                |       |                                          |       |                                         |       |   |   |   |   |
| Loss before income taxes                            |       | (1,389                                        | )          | (9,773                                       | )          | (3,378 | ) | (12,685 | ) |
|                                                |       |                                          |       |                                         |       |   |   |   |   |
| Income tax expense                                  |       | —                                        |       | —                                       |       | — |   | — |   |
|                                                |       |                                          |       |                                         |       |   |   |   |   |
| Net loss                                            |       | (1,389                                        | )          | (9,773                                       | )          | (3,378 | ) | (12,685 | ) |
|                                                |       |                                          |       |                                         |       |   |   |   |   |
| Deemed dividends                                    |       | —                                        |       | (2,271                                       | )          | — |   | (4,521 | ) |
| Non-cash preferred stock dividends                  |       | —                                        |       | —                                       |       | (2,363 | ) | — |   |
| Net loss attributable to common  stockholders       |       | $                                             | (1,389     | )                                            | $          | (12,044 | ) | $ | (5,741 | ) | $ | (17,206 | ) |

 

***Three months ended September 30, 2005 compared to the three monthsended September 30, 2004***

 

Revenuesin the third quarter of 2005 were $9,553,000 compared to revenues of $5,527,000in the third quarter of 2004.  Revenueshave increased in the third quarter of 2005 compared to the third quarter of2004 due to acquisitions in August 2004 and March and May of 2005.  However, the loss of certain larger customersin 2004 and 2005 and the soft demand experienced in the industry offset asignificant portion of the increase in revenue due to acquisitions.  In the third quarter of 2005 approximately39% (57% in the third quarter of 2004) of our revenue was derived from theplacement of travel nurses on assignment, typically 13 weeks in length.  Such assignments generally involve temporaryrelocation to the geographic 

 

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area of the assignment.  In the third quarter of 2005, we alsoprovided per diem nurses to satisfy the very short-term needs of healthcarefacilities.  Per diem services provided53% of our revenue in the third quarter of 2005 (29% in the third quarter of2004).  Per diem revenue became a largerportion of our revenue in the third quarter of 2005 compared to the thirdquarter of 2004 because of our acquisition of per diem businesses late in thethird quarter of 2004.  The remainingamount of our revenue in the third quarter of 2005 and 2004 came from providingclinical management and staffing to healthcare facilities and private dutyhomecare.  During the third quarter of2005 and 2004, most of our customers were acute care hospitals locatedthroughout the continental United States.

 

             Our overall gross profit in thethird quarter of 2005 was $1,969,000 or 20.6% of revenues compared to$1,260,000 or 22.8% of revenues in the third quarter of 2004. Our gross profitis the difference between the revenue we realize when we bill our customers forthe services of our healthcare professionals and our direct operating costs,which include the cost of the healthcare professionals and the related housingand travel costs, certain employment related taxes and workers compensationinsurance coverage.  The gross profitdeclined in the third quarter of 2005 compared to the third quarter of 2004 dueto somewhat lower margins on our acquisitions in 2005..

 

Ourselling, general and administrative costs were $2,471,000******or25.9% of revenues in the third quarter of 2005 compared to $2,562,000  or 46.3%******ofrevenues in the third quarter of 2004. Selling, general and administrative expenses are comprised primarily ofpersonnel costs, legal and audit fees related to being a public company andvarious other office and administrative expenses.   Selling, general and administrative costs asa percentage of revenue are down in the third quarter of 2005 following theelimination of redundant costs in our travel business in October 2004.  Also, the dollar amount of selling, generaland administrative costs has remained constant even though revenue hasincreased indicating that we have been able to effectively achieve economies ofscale with a larger revenue base.

 

Non-cashstock based compensation expense increased from $140,000 in the third quarterof 2004 to $401,000 in the third quarter of 2005 reflecting incrementalamortization related to granting 3,700,000 shares of restricted stock toofficers of the Company in May 2005.

 

The$7,497,000 non-cash charge for conversion of debt in 2004 represents a chargerelated to inducement to convert seller debt to preferred stock.  The amount was calculated by considering thefair market value of the preferred stock issued upon conversion of the sellerdebt.

 

Interestcosts decreased from $713,000 in the third quarter of 2004 to $486,000 in thethird quarter of 2005 which decrease reflects lower overall rates on the newdebt facilities we obtained in 2004 (which were restructured in the firstquarter of 2005).

 

Deemeddividends were $2,271,000 in the third quarter of 2004.  The deemed dividends relate to beneficialconversion features of our Series B-1 and Series C convertible preferred stockand beneficial conversion features of Series B-1 warrants issued.

 

***Nine months ended September 30, 2005 compared to the nine  months ended September 30, 2004***

 

Revenuesfor the first nine months of 2005 were $23,883,000 compared to revenues of$17,234,000 for the first nine months of 2004. Revenues have increased in the first nine months of 2005 compared to thefirst nine months of 2004 due to acquisitions in August 2004 and March and Mayof 2005.  However, the loss of certainlarger customers in 2004 and 2005 and the soft demand experienced in theindustry offset a significant portion of the increase in revenue due toacquisitions.  In the first nine monthsof 2005 approximately 38% (77% in the first nine months of 2004) 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 of2005, we also provided per 

 

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diem nurses to satisfy thevery short-term needs of healthcare facilities. Per diem services provided 51% of our revenue for the first nine monthsof 2005 (19% in the first nine months of 2004). Per diem revenue became a larger portion of our revenue in the firstnine months of 2005 compared to the first nine months of 2004 because of ouracquisition of per diem businesses in the third quarter of 2004.  The remaining amount of our revenue in thefirst nine months of 2005 and 2004 came from providing clinical management andstaffing to healthcare facilities and private duty homecare.  During the first nine months of 2005 and2004, most of our customers were acute care hospitals located throughout thecontinental United States.

 

Our overall gross profit in the first nine months of 2005 was$5,140,000 or 21.5% of revenues compared to $3,712,000 or 21.5% of revenues inthe first nine months of 2004. Our gross profit is the difference between therevenue we realize when we bill our customers for the services of ourhealthcare professionals and our direct operating costs, which include the costof the healthcare professionals and the related housing and travel costs,certain employment related taxes and workers compensation insurance coverage.

 

Ourselling, general and administrative costs were $6,362,000******or26.6% of revenues in the first nine months of 2005 compared to $6,767,000 or39.3%******of revenues in the first ninemonths of 2004.  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 are down in thefirst nine months of 2005 following the elimination of redundant costs in ourtravel business in October 2004.  Also,the dollar amount of selling, general and administrative costs has decreasedeven though revenue has increased indicating that we have been able to effectivelyachieve economies of scale with a larger revenue base.

 

Non-cashstock based compensation expense increased from $300,000 in the first ninemonths of 2004 to $671,000 in the first nine months of 2005 reflectingincremental amortization related to granting 3,700,000 shares of restrictedstock to officers of the Company in May 2005.

 

The$7,497,000 non-cash charge for conversion of debt in 2004 represents a chargerelated to inducement to convert seller debt to preferred stock.  The amount was calculated by considering thefair market value of the preferred stock issued upon conversion of the sellerdebt.

 

Interestcosts decreased from $1,712,000 in the first nine months of 2004 compared to$1,484,000 in the first nine months of 2005 which decrease reflects loweroverall rates on the new debt facilities we obtained in 2004 (which wererestructured in the first quarter of 2005).

 

Deemeddividends were 4,521,000 in the first nine months of 2004.  The deemed dividends relate to beneficialconversion features of our Series A, Series B, Series B-1 and Series Cconvertible preferred stock and beneficial conversion features of Series B-1warrants issued.

 

Thenon-cash preferred stock dividends in the first nine months of 2005 relate tocommon stock dividends declared by the Board of Directors on our Series B,Series B-1 and Series C convertible preferred stock as well as cumulativecommon stock dividends declared for September 30, 2004, December 31, 2004 andMarch 31, 2005 related to the warrants exercised on March 29, 2005 for 108,333shares of Series C convertible preferred stock and cumulative common stockdividends declared for December 31, 2004 and March 31, 2005 related to thewarrants exercised on May 2, 2005 for 22,187 shares of Series C convertible preferredstock.   The common stock dividends onthe warrants are payable once the warrants are exercised.

 

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**RiskFactors**

 

Wewere formed in November 1997, and commenced operations on August 7, 2003following our acquisition of Baker Anderson Christie, Inc.  Any investment in our Common Stock involves ahigh degree of risk.  You should considercarefully the following information about these risks, together with the otherinformation contained in this report, before you decide to buy our CommonStock.  The risks and uncertaintiesdescribed below 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 this reportincluding those contained in the section captioned “Management’s Discussion andAnalysis or Plan of Operation” under Item 2. In such case, the trading price of our Common Stock could decline, andyou may lose all or part of the money you paid to buy our Common Stock.

 

**If wefail to raise additional capital in the near future, our business will fail.**

 

We have limited cash resources and will need to raise additionalcapital through public or private financings or other arrangements in order tomeet current commitments and continue development of our business.  We cannot assure you that additional capitalwill be available to us when needed, if at all, or, if available, will beobtained on terms attractive to us.  Ourfailure to raise additional capital when needed could cause us to cease ouroperations.

 

We have financed our operations since inception primarily through theprivate placement of equity and debt securities and loan facilities.  Although our management recognizes the needto raise funds in the near future, there can be no assurance that we will besuccessful in consummating any fundraising transaction, or if we do consummatesuch a transaction, that its terms and conditions will not require us to giveinvestors warrants or other valuable rights to purchase additional interest inour company, or be otherwise unfavorable to us. Among other things, the agreements under which we issued some of ourexisting securities include, and any securities that we may issue in the futuremay also include, terms that could impede our ability to raise additionalfunding.  The issuance of additionalsecurities could impose additional restrictions on how we operate and financeour business.  In addition, our currentdebt financing arrangements involve significant interest expense and restrictivecovenants that limit our operations.

 

**We may face difficultiesintegrating our acquisitions into our operations and our 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 some of these companies. In addition, beginning in August 2003 and throughMay 2005 we acquired eight businesses.

 

These acquisitions involve numerousrisks, including:

 

•             potential loss of revenuesfollowing the acquisition;

 

•             difficulties integrating acquired personneland distinct cultures into our business;

 

•             difficulties integrating acquired companiesinto our operating, financial planning and financialreporting systems;

 

•             diversion of management attention fromexisting operations; and

 

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•             assumption of liabilities and exposure tounforeseen liabilities of acquired companies, including liabilities for theirfailure to comply with healthcare regulations.

 

These acquisitions may also involvesignificant cash expenditures, debt incurrence and integration expenses thatcould seriously harm our financial condition and results of operations. We mayfail to achieve expected efficiencies and synergies. Any acquisition mayultimately have a negative impact on our business and financial condition.

 

**OurSeries C Convertible Preferred Stock has a significant liquidation preference.**

 

As of November 1, 2005, we had (i) 183,028 shares of Series C PreferredStock outstanding and (ii) warrants (the “Warrants”) to purchase 124,077 sharesof Series C Preferred Stock outstanding. We anticipate selling additional shares of Series C Preferred Stock andissuing additional warrants to purchase shares of Series C PreferredStock.  Each share of Series C Preferredstock is convertible into one hundred (100) shares of our common Stock.  In the event of any liquidation or winding upof our company, the holders of the Series C Preferred Stock will be entitled toreceive, in preference to the holders of our other equity securities, an amountequal to five times the original purchase price per share, or $300 per share,plus any dividends declared on the Series C Convertible Preferred Stock but notpaid.  Assuming the exercise of alloutstanding Warrants, upon a liquidation or winding up of our company theholders of our Series C Preferred Stock would be entitled to receive approximately$92,000,000 prior to the payment of any amounts to the holders of our otherequity securities.  As a result, upon aliquidation or winding up of the Company, there may not be sufficient proceeds,following the payment of the Series C liquidation preference described above,to make any distribution to the holders of our other equity securities.

 

**Thereis a lack of an active public market for our Common Stock, and the tradingprice of our common stock is subject to volatility.**

 

The quotation of shares of our Common Stock on the OTC Bulletin Boardbegan on June 3, 2003.  There can be noassurance, however, that a market will develop or continue for our CommonStock.  Our Common Stock may be thinlytraded, if traded at all, even if we achieve full operation and generatesignificant revenue and is likely to experience significant pricefluctuations.  In addition, our stock isdefined as a “penny stock” under Rule 3a51-1 adopted by the Securities andExchange Commission under the Securities Exchange Act of 1934, as amended. Ingeneral, a “penny stock” includes securities of companies which are not listedon the principal stock exchanges or the National Association of SecuritiesDealers Automated Quotation System (“Nasdaq”) or National Market System (“NasdaqNMS”) and have a bid price in the market of less than $5.00; and companies withnet tangible assets of less than $2,000,000 ($5,000,000 if the issuer has beenin continuous operation for less than three years), or which have recordedrevenues of less than $6,000,000 in the last three years.  “Penny stocks” are subject to rule 15g-9,which imposes additional sales practice requirements on broker-dealers thatsell such securities to persons other than established customers and “accreditedinvestors” (generally, individuals with net worth in excess of $1,000,000 orannual incomes exceeding $200,000, or $300,000 together with their spouses, orindividuals who are officers or directors of the issuer of the securities). Fortransactions covered 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 adverselyaffect the ability of broker-dealers to sell our Common Stock, and therefore,may adversely affect the ability of our stockholders to sell Common Stock inthe public market.

 

The trading price of our common stock is likely to be subject to widefluctuations.  Factors affecting thetrading price of our common stock may include:

 

•                  Variations in our financial results;

 

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•                  Announcements of innovations, new solutions,strategic alliances or significant agreements by us or by our competitors;

 

•                  Recruitment or departure of key personnel;

 

•                  Changes in estimates of our financial resultsor changes in the recommendations of any securities analysts that elect tofollow our common stock;

 

•                  Market conditions in our industry, theindustries of our customers and the economy as a whole; and

 

•                  Sales of substantial amounts of our commonstock, or the perception that substantial amounts of our common stock will besold, by our existing stockholders in the public market.

 

**Ourneed to raise additional capital in the future could have a dilutive effect onyour investment.**

 

We will need to raise additional capital.  One possibility for raising additionalcapital is the public or private sale of our Common Stock or securitiesconvertible into or exercisable for our Common Stock.  Such sales could be consummated at a significantdiscount to the trading price of our stock.

 

If we sell additional shares of our Common Stock, such sales willfurther dilute the percentage of our equity that our existing stockholdersown.  In addition, our recent privateplacement financings have involved the issuance of securities at a price pershare that represented a discount to the trading prices listed for our CommonStock on the OTC Bulletin Board and it is possible that we will close futureprivate placements involving the issuance of securities at a discount toprevailing trading prices.  Dependingupon the price per share of securities that we sell in the future, astockholder’s interest in us will be further diluted by any adjustments to thenumber of shares and the applicable exercise price required pursuant to theterms of the agreements under which we previously issued securities.  No assurance can be given that previous orfuture investors, finders or placement agents will not claim that they areentitled to additional anti-dilution adjustments or dispute our calculation ofany such adjustments.  Any such claim ordispute could require us to incur material costs and expenses regardless of theresolution and, if resolved unfavorably to us, to effect dilutive securitiesissuances or adjustments to previously issued securities.  In addition, future financings may includeprovisions requiring us to make additional payments to the investors if we failto obtain or maintain the effectiveness of SEC registration statements byspecified dates or take other specified action. Our ability to meet these requirements may depend on actions byregulators and other third parties, over which we will have no control.  These provisions may require us to makepayments or issue additional dilutive securities, or could lead to costly anddisruptive disputes.  In addition, theseprovisions could require us to record additional non-cash expenses.

 

**Ourcredit facility imposes significant expenses and restrictive covenants upon us.**

 

InJune 2004 we obtained a $15 million revolving credit facility, which wasreduced in 2005 to $10 million, (the “Revolving Facility”) from BridgeHealthcare Finance, LLC.  In August 2004we obtained a $10 million term loan credit facility from Bridge OpportunityFinance, LLC (the “Term Facility” and together with the Revolving Facility, the“Credit Facility”).  Bridge OpportunityFinance, LLC is an affiliate of Bridge Healthcare Finance, LLC.

 

TheCredit Facility involves significant interest expenses and other fees.  In addition, except in certain limitedcircumstances, the Revolving Facility cannot be pre-paid in full without usincurring a significant pre-payment penalty.

 

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TheCredit Facility imposes various restrictions on our activities without theconsent of the lenders, including a prohibition on fundamental changes to us orour direct or indirect subsidiaries (including certain consolidations, mergersand sales and transfer of assets, and limitations on our ability or any of ourdirect or indirect subsidiaries to grant liens upon our property orassets).  In addition, under the CreditFacility we must 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 and payable.

 

Theexpenses and restrictions associated with the Credit Facility have the effectof limiting our operations.  In addition,our failure to pay required interest expenses and other fees or to meetrestrictions under the Credit Facility would have a material adverse affect onus.

 

**MedCapPartners L.P. controls a majority of our outstanding capital stock, and thismay delay or prevent change of control of our company or adversely affect ourstock price.**

 

MedCap Partners L.P. controls approximately 52% of our outstandingcapital stock, on a fully diluted as-converted basis.  As a result, MedCap is able to exercisecontrol over matters requiring stockholder approval, such as the election ofdirectors and the approval of significant corporate transactions.  These types of transactions includetransactions involving an actual or potential change of control of our companyor other transactions that the non-controlling stockholders may deem to be intheir best interests and in which such stockholders could receive a premium fortheir shares.  C. Fred Toney, a member orour Board of Directors, is the managing member of MedCap Management &Research LLC, the general partner of MedCap Partners L.P.

 

**Theability to attract and retain highly qualified personnel to operate and manageour operations is extremely important and our failure to do so could adverselyaffect us.**

 

Presently, we are dependent upon the personal efforts of our managementteam.  The loss of any of our officers ordirectors could 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 or directors.Additionally, as we continue our planned expansion of commercial operations, wewill require the services of additional skilled personnel.  There can be no assurance that we can attractpersons with the requisite skills and training to meet our future needs or,even if such persons are available, that they can be hired on terms favorableto us.

 

**We havehad a short operating history.**

 

We were formed in November 1997 andcommenced operations on August 7, 2003 with our acquisition of BakerAnderson Christie, Inc.  We are a “start-up”operation and subject to all the risks inherent in a new business venture, manyof which are beyond our control, including the ability to implement successfuloperations, lack of capital to finance acquisitions and failure to achievemarket acceptance.  In addition, as a start-upventure we will face significant competition from many companies virtually allof which are larger, better financed and have significantly greater marketrecognition than us.

 

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**Thesuccessful implementation of our business strategy depends upon the ability ofour management to monitor and control costs.**

 

With respect to our plannedoperations, management cannot accurately project or give any assurance withrespect to our ability to control development and operating costs and/orexpenses in the future.  Consequently, aswe expand our commercial operations, management may not be able to controlcosts and expenses adequately, and such operations may generate losses.

 

**We maybecome subject to governmental regulations and oversight, which could adverselyaffect our ability to continue or expand our business strategy.**

 

Although our operations arecurrently not subject to any significant government regulations, it is possiblethat, in the future, such regulations may be legislated. Although we cannotpredict the extent of any such future regulations, a possibility exists thatfuture or unforeseen changes may have an adverse impact upon our ability tocontinue or expand our operations as presently planned.

 

**If we areunable to attract qualified nurses and healthcare professionals for ourhealthcare staffing business, our business could be negatively impacted.**

 

We rely significantly on ourability to attract and retain nurses and healthcare professionals who possessthe skills, experience and licenses necessary to meet the requirements of ourhospital and healthcare facility clients. We compete for healthcare staffingpersonnel with other temporary healthcare staffing companies and with hospitalsand healthcare facilities. We must continually evaluate and expand ourtemporary healthcare professional network to keep pace with our hospital andhealthcare 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 continueto increase the number of temporary healthcare professionals that we recruit,decreasing the potential for growth of our business. Our ability to attract andretain temporary healthcare professionals depends on several factors, includingour ability to provide temporary healthcare professionals with assignments thatthey view as attractive and to provide them with competitive benefits andwages. We cannot assure you that we will be successful in any of these areas.The cost of attracting temporary healthcare professionals and providing themwith attractive benefit packages may be higher than we anticipate and, as aresult, if we are unable to pass these costs on to our hospital and healthcarefacility clients, our losses could increase. Moreover, if we are unable toattract and retain temporary healthcare professionals, the quality of ourservices to our hospital and healthcare facility clients may decline and, as aresult, we could lose clients.

 

**Thetemporary staffing industry is highly competitive and the success and futuregrowth of our business depend upon our ability to remain competitive inobtaining and retaining temporary staffing clients.**

 

The temporary staffing industry ishighly competitive and fragmented, with limited barriers to entry. We competein national, regional and local markets with full-service agencies and inregional and local markets with specialized temporary staffing agencies. Someof our competitors include AMN Healthcare Services, Inc., CrossCountry, Inc., Medical Staffing Network Holdings, Inc. and OnAssignment, Inc. All of these companies have significantly greatermarketing and financial resources than we do. Our ability to attract and retainclients is based on the value of the service we deliver, which in turn dependsprincipally on the speed with which we fill assignments and the appropriatenessof the match based on clients’ requirements and the skills and experience ofour temporary employees. Our ability to attract skilled, experienced temporaryprofessionals is based on our ability to pay competitive wages, to providecompetitive benefits, to provide multiple, continuous assignments and therebyincrease the retention rate of these employees. To the extent that competitorsseek to gain or retain market share by reducing prices or 

 

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increasing marketing expenditures, we could loserevenues and our margins could decline, which could seriously harm ouroperating results and cause the trading price 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 forclients to increase in the future, and the success and growth of our businessdepend on our ability to remain competitive.

** **

**Our business depends upon ourcontinued ability to secure and fill new orders from our hospital andhealthcare facility clients, because we do not have long-term agreements orexclusive contracts with them.**

 

We generally do not have long-termagreements or exclusive guaranteed order contracts with our hospital andhealthcare facility clients. The success of our business depends upon ourability to continually secure new orders from hospitals and other healthcarefacilities and to fill those orders with our temporary healthcareprofessionals. Our hospital and healthcare facility clients are free to placeorders with our competitors and may choose to use temporary healthcareprofessionals that our competitors offer them. Therefore, we must maintainpositive relationships with our hospital and healthcare facility clients. If wefail to maintain positive relationships with our hospital and healthcarefacility clients, we may be unable to generate new temporary healthcareprofessional orders and our business may be adversely affected.

 

**Fluctuations in patient occupancyat our clients’ hospitals and healthcare facilities may adversely affect thedemand for our services and therefore the profitability of our business.**

 

Demand for our temporary healthcarestaffing services is significantly affected by the general level of patientoccupancy at our hospital and healthcare clients’ facilities. When occupancyincreases, hospitals and other healthcare facilities often add temporaryemployees before full-time employees are hired. As occupancy decreases,hospitals and other healthcare facilities typically reduce their use oftemporary employees before undertaking layoffs of their regular employees. Inaddition, we may experience more competitive pricing pressure during periods ofoccupancy downturn. Occupancy at our clients’ hospitals and healthcarefacilities also fluctuates due to the seasonality of some elective procedures.We are unable to predict the level of patient occupancy at any particular timeand its effect on our revenues and earnings.

 

**Healthcare reform could negativelyimpact our business opportunities, revenues and margins.**

 

The U.S. government has undertakenefforts to control increasing healthcare costs through legislation, regulationand voluntary agreements with medical care providers and drug companies. In therecent past, the U.S. Congress has considered several comprehensive healthcarereform proposals. The proposals were generally intended to expand healthcarecoverage for the uninsured and reduce the growth of total healthcareexpenditures. While the U.S. Congress did not adopt any comprehensive reformproposals, members of Congress may raise similar proposals in the future. Ifany of these proposals are approved, hospitals and other healthcare facilitiesmay react by spending less on healthcare staffing, including nurses. If thiswere to occur, we would have fewer business opportunities, which couldseriously harm our business.

 

State governments have alsoattempted to control increasing healthcare costs. For example, the state ofMassachusetts has recently implemented a regulation that limits the hourly ratepayable to temporary nursing agencies for registered nurses, licensed practicalnurses and certified nurses’ aides. The state of Minnesota has also implementeda statute that limits the amount that nursing agencies may charge nursinghomes. Other states have also proposed legislation that would limit the amountsthat temporary staffing companies may charge. Any such current or proposed lawscould seriously harm our business, revenues and margins.

 

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Furthermore, third party payers,such as health maintenance organizations, increasingly challenge the pricescharged for medical care. Failure by hospitals and other healthcare facilitiesto obtain full reimbursement from those third party payers could reduce thedemand or the price paid for our staffing services.

 

**We operate in a regulated industry and changes in regulationsor violations of regulations may result in increased costs or sanctions thatcould reduce our revenues and profitability.**

 

The healthcare industry is subjectto extensive and complex federal and state laws and regulations related toprofessional licensure, conduct of operations, payment for services and paymentfor referrals. If we fail to comply with the laws and regulations that aredirectly applicable to our business, we could suffer civil and/or criminalpenalties or be subject to injunctions or cease and desist orders.

 

Our business is generally notsubject to the extensive and complex laws that apply to our hospital andhealthcare facility clients, including laws related to Medicare, Medicaid andother federal and state healthcare programs. However, these laws andregulations could indirectly affect the demand or the prices paid for ourservices. For example, our hospital and healthcare facility clients couldsuffer civil or criminal penalties or be excluded from participating inMedicare, Medicaid and other healthcare programs if they fail to comply withthe laws and regulations applicable to their businesses. In addition, ourhospital and healthcare facility clients could receive reduced reimbursements,or be excluded from coverage, because of a change in the rates or conditionsset by federal or state governments. In turn, violations of or changes to theselaws and regulations that adversely affect our hospital and healthcare facilityclients could also adversely affect the prices that these clients are willingor able to pay for our services.

 

In addition, improper actions byour employees and other service providers may subject us to regulatory andlitigation risk.

 

**Competitionfor acquisition opportunities may restrict our future growth by limiting ourability to make acquisitions at reasonable valuations.**

 

Our business strategy includesincreasing our market share and presence in the temporary healthcare staffingindustry through strategic acquisitions of companies that complement or enhanceour business. We have historically faced competition for acquisitions. In thefuture, such competition could limit our ability to grow by acquisitions orcould raise the prices of acquisitions and make them less attractive to us.

** **

**Significantlegal actions could subject us to substantial uninsured liabilities.**

 

In recent years, healthcareproviders have become subject to an increasing number of legal actions allegingmalpractice, product liability or related legal theories. Many of these actionsinvolve large claims and significant defense costs. In addition, we may besubject to claims related to torts or crimes committed by our employees ortemporary healthcare professionals. In some instances, we are required toindemnify our clients against some or all of these risks. A failure of any ofour employees or healthcare professionals to observe our policies andguidelines intended to reduce these risks, relevant client policies andguidelines or applicable federal, state or local laws, rules and regulationscould result in negative publicity, payment of fines or other damages. Ourprofessional malpractice liability insurance and general liability insurancecoverage may not cover all claims against us or continue to be available to usat a reasonable cost. If we are unable to maintain adequate insurance coverageor if our insurers deny coverage we may be exposed to substantial liabilities.

 

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**We may belegally liable for damages resulting from our hospital and healthcare facilityclients’ mistreatment of our healthcare personnel.**

 

Because we are in the business ofplacing our temporary healthcare professionals in the workplaces of othercompanies, 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 ofdefending such claims, even if groundless, could be substantial and theassociated negative publicity could adversely affect our ability to attract andretain qualified healthcare professionals in the future.

** **

**Executionof our business strategy and growth of our business are substantially dependentupon our ability to attract, develop and retain qualified and skilled salespersonnel.**

 

Execution of our business strategyand continued growth of our business are substantially dependent upon ourability to attract, develop and retain qualified and skilled sales personnelwho engage in selling and business development for our services. The availablepool of qualified sales personnel candidates is limited. We commit substantialresources to the recruitment, training, development and operational support ofour sales personnel. There can be no assurance that we will be able to recruit,develop and retain qualified sales personnel in sufficient numbers or that oursales personnel will achieve productivity levels sufficient to enable growth ofour business. Failure to attract and retain productive sales personnel couldadversely affect our business, financial condition and results of operations.

** **

**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 September 30, 2005, we had$25.0 million of goodwill and other unamortized intangible assets on ourbalance sheet, which represents the excess of the total purchase price of ouracquisitions over the fair value of the net assets acquired.   At September 30, 2005, goodwill and otherintangible assets represented 77% of our total assets.

 

In July 2001, the FinancialAccounting Standards Board issued SFAS No. 141, *Business Combinations*, and SFAS No. 142, *Goodwill and Other Intangible Assets*. SFASNo. 141 requires that the purchase method of accounting be used for allbusiness combinations initiated after June 30, 2001, as well as allpurchase method business combinations completed after June 30, 2001. SFASNo. 142 requires that, subsequent to January 1, 2002, goodwill not beamortized but rather that it be reviewed annually for impairment. In the eventimpairment is identified, a charge to earnings would be recorded. We haveadopted the provisions of SFAS No. 141 and SFAS No. 142. Although itdoes not affect our cash flow, an impairment charge of goodwill to earnings hasthe effect of decreasing our earnings or increasing our losses, as the case maybe. If we are required to write down a substantial amount of goodwill, ourstock price could be adversely affected.

** **

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

 

When economic activityincreases, temporary employees are often added before full-time employees arehired. However, as economic activity slows, many companies, including ourhospital and healthcare facility clients, reduce their use of temporaryemployees before laying off full-time employees. In addition, we may experiencemore competitive pricing pressure during periods of economic downturn.Therefore, any significant economic downturn could have a material adverseimpact on our financial position and results of operations.

 

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**ITEM 3.  CONTROLS AND PROCEDURES**

 

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 our 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.

 

Therehas been no change in our internal controls over financial reporting during ourmost recent fiscal quarter that has materially affected, or is reasonablylikely to materially affect, our internal controls over financial reporting.

 

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## ***PART II.  OTHER INFORMATION***

 
| **Item 1.** | ** ** | **Legal  Proceedings**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|        |       | The Company is subject to  legal proceedings and claims which have arisen in the ordinary course of its  business and have not been adjudicated. Although there can be no assurance as  to the ultimate disposition of these matters, it is the opinion of the  Company’s management, based upon the information available at this time, that  the expected outcome of these matters, individually or in the aggregate, will  not have a material adverse effect on the results of operations and financial  condition of the Company. |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| **Item 2.** | ** ** | **Unregistered  Sales of Equity Securities and Use of Proceeds**                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|        |       | None.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |

 
| **Item 6.** | ** ** | **Exhibits** |
|-------------|------------|--------------|
|        |       |         |   |   |
|        |       | (a)          |   | Exhibits |

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                    |
|-----------------|------------|------------------------------------------------------------------------------------------------------------------------------------|
| 3.1(2)          |       | Restated Certificate of  Incorporation.                                                                                            |
| 3.2(3)          |       | Certificate of Amendment  to Restated Certificate of Incorporation.                                                                |
| 3.3(4)          |       | Certificate of Amendment  to Restated Certificate of Incorporation.                                                                |
| 3.4(4)          |       | Certificate of Correction  of Certificate of Amendment to Restated Certificate of Incorporation.                                   |
| 3.5(4)          |       | Certificate of Correction  of Certificate of Amendment to Restated Certificate of Incorporation.                                   |
| 3.6(2)          |       | Restated Bylaws.                                                                                                                   |
| 3.7(5)          |       | Certificate of  Designations, Preferences and Rights of Series A Preferred Stock of Crdentia  Corp.                                |
| 3.8(6)          |       | Certificate of Amendment  of Certificate of Designations, Preferences and Rights of Series A Preferred  Stock of Crdentia Corp.    |
| 3.9(7)          |       | Certificate of Designations,  Preferences and Rights of Series B Preferred Stock of Crdentia Corp.                                 |
| 3.10(8)         |       | Certificate of Correction  of Certificate of Designations, Preferences and Rights of Series B Preferred  Stock of Crdentia Corp.   |
| 3.77(9)         |       | Certificate of  Designations, Preferences and Rights of Series B-1 Preferred Stock of  Crdentia Corp.                              |
| 3.12(10)        |       | Certificate of Correction  of Certificate of Designations, Preferences and Rights of Series B-1  Preferred Stock of Crdentia Corp. |
| 3.13(11)        |       | Certificate of  Designations, Preferences and Rights of Series C Preferred Stock                                                   |

 

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|     |   | of Crdentia Corp.                                                                                                                |
|----------|--------|----------------------------------------------------------------------------------------------------------------------------------|
|     |   |                                                                                                                             |
| 3.14(10) |   | Certificate of Correction  of Certificate of Designations, Preferences and Rights of Series C Preferred  Stock of Crdentia Corp. |
| 3.15(12) |   | Certificate of Amendment  to Amended and Restated Certificate of Incorporation of Crdentia Corp.                                 |
| 3.16(13) |   | Certificate of Amendment  of Certificate of Designations, Preferences and Rights of Series C Preferred  Stock of Crdentia Corp.  |
| 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.                            |

 

 

(2)                                  Filed with a Current Report on Form 8-K datedAugust 22, 2002.

(3)                                  Filed with a Quarterly Report on Form 10-QSBdated August 12, 2003.

(4)                                  Filed with an amended Current Report on Form8-K/A dated June 28, 2004.

(5)                                  Filed with a Current Report on Form 8-K datedDecember 30, 2003.

(6)                                  Filed with a Current Report on Form 8-K datedFebruary 20, 2004.

(7)                                  Filed with a Current Report on Form 8-K datedJune 22, 2004.

(8)                                  Filed with an amended Current Report on Form8-K/A dated October 10, 2004.

(9)                                  Filed with a Current Report on Form 8-K datedAugust 24, 2004.

(10)                            Filed with an amended Current Report on Form8-K/A dated October 10, 2004.

(11)                            Filed with a Current Report on Form 8-K datedSeptember 7, 2004.

(12)                            Filed with a Current Report on Form 8-K datedJanuary 1, 2005.

(13)                            Filed with a Current Report on Form 8-K datedMarch 21, 2005.

 

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## ***SIGNATURES***

 

In accordance with the requirements ofSection 13 of 15(d) of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed in its behalf by the undersigned, thereuntoduly authorized.

 
| Date: February  2, 2006 | By     | /S/ James D.  Durham                       |   |
|-------------------------|--------|--------------------------------------------|--------|
|                    |   |  James D. Durham                      |
|                    |   |  Chairman and Chief Executive Officer |

 

 

 
| Date: February  2, 2006 | By     | /S/ James J.  TerBeest   |   |
|-------------------------|--------|--------------------------|--------|
|                    |   | James J.  TerBeest       |
|                    |   | Chief  Financial Officer |
|                         |        |                          |        |  |

 

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